Bailout Nation Will Thrive as Long as AIG Lives: Jonathan Weil
Commentary by Jonathan Weil
June 17 (Bloomberg) -- To believe Christopher Dodd, the Connecticut Democrat who is chairman of the Senate Banking Committee, the end of government bailouts is near. In truth, the financial-overhaul legislation now before Congress would do little to arrest the bailouts already in progress.
When the U.S. government rescued American International Group Inc. in 2008, it reasoned that a disorderly failure of the financial-services giant would lead to an economic catastrophe. What the Treasury and Federal Reserve said they needed was a way to wind down systemically important institutions without sending them into bankruptcy courts, to keep the companies from triggering defaults on their obligations that would cascade throughout the broader financial system.
Congressional leaders say their final bill will deliver the resolution authority regulators have been seeking. “It will end bailouts, ensuring that failing firms can be shut down without relying on taxpayer bailouts or threatening the stability of our economy,” Dodd said June 10 at the House-Senate conference committee where the differences between the two chambers’ bills are being negotiated.
It wouldn’t end AIG’s rescue, though. The reason AIG hasn’t failed is that the Fed and the Treasury continue to stand behind it. There’s no sign this will change anytime soon. Nor would the legislation force the government to do otherwise.
Liquidation Plans
Under the text being considered by the conference committee, the Federal Deposit Insurance Corp. would gain new “orderly liquidation authority” over large bank-holding companies and non-bank financial firms. The Treasury secretary, with Fed and FDIC approval, could initiate the resolution process upon concluding that the country faced a potential crisis because a large financial institution was in danger of defaulting or had done so already.
If the absence of such authority was what prevented the government from letting AIG fail in 2008, you might think regulators would be itching to test-drive these new procedures. Yet there seems to be no eagerness at the Treasury or the Fed to try this new tool on AIG once it becomes available. If the government wants the markets to believe it would ever liquidate a failing company of AIG’s size in the future, a good place to start would be with AIG itself after this proposal is enacted.
As of May 27, AIG owed the Treasury and the Federal Reserve Bank of New York $132.4 billion, according to a June 10 report by the Congressional Oversight Panel, led by Harvard Law School professor Elizabeth Warren. The government, which controls almost 80 percent of AIG’s equity, hasn’t announced a timeline for its exit strategy. The Treasury and Fed say they remain hopeful AIG can make good on its promise to repay the money.
‘Poisonous’ AIG Rescue
That’s a highly uncertain prospect, especially after the recent collapse of AIG’s $35.5 billion deal to sell its main Asian insurance operation to U.K.-based Prudential Plc. Warren’s oversight panel said the Treasury “will likely remain a significant shareholder in AIG through 2012,” and that taxpayers “remain at risk for severe losses.” Meanwhile, as the panel said, “the government’s actions in rescuing AIG continue to have a poisonous effect on the marketplace.”
AIG still has an investment-grade credit rating, solely because of its U.S. backstop. And by paying AIG’s creditors in full, the government has encouraged massive misallocations of capital toward pretty much any company perceived to have a too- big-to-fail guarantee.
Cutting Losses
It is conceivable that AIG might pay back taxpayers in full if given a long enough timetable to sell off its parts. Yet the longer the government refrains from putting the company through the wood-chipper, the more it lets moral hazard metastasize. It shouldn’t hesitate to cut its losses if AIG’s prospects dim.
The end-of-bailouts rhetoric looks even more ridiculous when you consider that both the House and Senate bills explicitly exclude Fannie Mae and Freddie Mac from the Treasury’s new powers. They’ve drawn $145 billion already from their unlimited credit line from the government. And it’s not just Fannie and Freddie that are being continuously rescued when the government absorbs their losses. It’s the whole U.S. banking system.
Between them, the two government-chartered companies guarantee more than $5 trillion of mortgages. Without those guarantees, many of the underlying loans would bounce right back onto the books of the companies that issued them, which would cause those lenders’ balance sheets to balloon, leaving a lot of them undercapitalized. The only way Fannie and Freddie can keep making good on its commitments, at a time when delinquencies are soaring, is to keep tapping the Treasury for more money.
The government has no choice, though. It can’t stop paying, because that would tank the banking system and the housing market. Unlike AIG, Fannie and Freddie bonds were sovereign debt long before the government took its 80 percent stake in the companies in 2008. The U.S. for decades had implicitly pledged that it would stand behind their obligations, even though it still keeps them off the federal balance sheet.
The real facts are sobering enough. The last thing we need is for someone of Dodd’s stature to be misleading anyone into thinking this proposal would accomplish something it’s expressly designed not to do. An end to bailouts? We can only dream.
No comments:
Post a Comment