The Fiscal Times vs Elizabeth Warren

By Felix Salmon
August 16, 2010

What does The Fiscal Times, the online newspaper founded by Pete Peterson, have against Elizabeth Warren?

On Friday, it ran a peculiar piece by Eric Pianin:

Warren’s critics say that her aggressive advocacy and stinging rhetoric make her the wrong choice to head a new agency that will have to mediate between conflicting industry and consumer advocacy interests as it writes and enforces a raft of new regulations.

This just isn’t true: the CFPB does not have to mediate between industry and consumer interests. The whole point of the CFPB is that it exists only to serve consumers. The Food and Drug Administration doesn’t look to balance the needs of consumers with those of pharmaceutical companies; similarly, the CFPB will simply set standards which big banks will have to meet. There are lots of financial regulators charged with ensuring the health of the banking sector; the CFPB the only one charged with looking after consumers. So anybody like Pianin who thinks that the CFPB ought to be at least in part captured by the banks is fundamentally missing its raison d’etre.

Then, today, the Fiscal Times followed up with another piece, by John Berry, saying that she doesn’t have “the balanced judgment needed to direct the new Consumer Financial Protection Agency within the Federal Reserve”. (It’s Bureau, not Agency, but never mind.) Again, it’s not the CFPB’s job to be balanced: it’s the CFPB’s job to protect consumers. But that’s not the real weakness of the column, which zeroes in on one of the reports that Warren released as head of the Congressional Oversight Panel. Warren was critical of Treasury’s actions in the AIG bailout, and Berry says that just isn’t fair:

Warren and the panel simply ignored reality in asserting that the government “failed to exhaust all options” before risking taxpayer money in the rescue…

What might have been the cost to the financial system and the economy if the government had held off hoping for the best as rating agencies speedily lowered AIG’s credit rating — triggering new demands for payments under the credit default swap contracts — and some creditor had forced AIG into bankruptcy? A partial answer can be found on the New York Federal Reserve Bank’s website. The report speculates in detail whether the many AIG insurance subsidiaries might have been able to survive a bankruptcy by their parent. The conclusion was that nobody could be sure — and if worse came to worse perhaps the government could help pay policyholders claims!

“In the ordinary course of business, the costs of an AIG failure would have been borne by its shareholders and its creditors,” Warren said. “But the government instead shifted those costs in full to taxpayers. This meant we rescued highly sophisticated investors who voluntarily accepted grave risks.”

That sort of language is misleading and only reinforces the views that the government wasted taxpayer money to save the fat cats. It’s misleading, first, because AIG shareholders were virtually wiped out. Second, much of the government’s assistance has been repaid and there is a good chance that within two or three years it all will be. Third, the true cost of an AIG failure — with its disastrous impact on the financial system — would have been borne by the additional millions of Americans who would have lost jobs and income during the even deeper recession that would have occurred.

This is wrongheaded on many levels. For one thing, it’s simply true that the government failed to exhaust other options before bailing out AIG, which got rescued by the government pretty much immediately after the government found out it was in trouble.

Berry also fails to link to the Fed report in question, linking instead just to the New York Fed’s homepage. Not helpful. But the fact is that, yes, if AIG’s shareholders and creditors were wiped out, then policyholders might, ultimately, have to get rescued by the government. That’s as it should be: insurance policyholders, like small bank depositors, should be protected from corporate failure. What’s clear is that bailing out small AIG policyholders makes a lot more sense, both politically and in terms of moral hazard, than bailing out enormous AIG creditors like Goldman Sachs, who ought to be able to look after themselves. I don’t know what exactly Berry is trying to convey with his exclamation mark, but taking the risk of bailing out AIG policyholders is clearly preferable to taking the certainty of bailing out AIG creditors.

Berry then finds an entirely unobjectionable quote from Warren, which he proceeds to label “misleading”, even when it is no such thing. Certainly it’s a lot easier to understand than Berry’s objections. Warren wants shareholders and creditors to share the pain; Berry says that hey, shareholders were “virtually” wiped out (which means they weren’t wiped out), without mentioning that creditors were paid off in full. The fact that the government may or may not end up being repaid is entirely a function of the degree to which it’s willing to accept a below-market interest rate on its loan, and in any case doesn’t change the fact that AIG’s creditors didn’t realize any of the downside risk that they were voluntarily taking on — and being paid to take on, with higher yields.

As for the idea that “additional millions of Americans would have lost jobs and income” had the government not intervened in AIG as it did, well, maybe. And maybe not. But it’s not the COP’s job to start disappearing down that particular rabbit hole: instead, its job is simply to look at whether TARP money was well spent. And two things seem pretty obvious to me: firstly, if the TARP money were leveraged through the addition of some funds from AIG creditors, the government would have got more bank for its buck. And secondly, the government never seriously considered doing that. It’s right and proper for Warren to point that out. And it’s certainly no disqualification when it comes to the CFPB job, no matter what weird jihad the editors of the Fiscal Times seem to be on.

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