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Charlie Rose continues to do, far and away, the most thoughtful and lucid work on the ongoing financial crisis. The following conversation from last night's show is another good example. It includes my friend Nouriel Roubini, who came straight over from Charlie's show to a Money:Tech dinner I was hosting in New York.
Take your second deep breath of the week. We are at a cusp tonight, with a Treasury deal allegedly on the table to provide a $80b bridge loan to doombound insurance company AIG. The deal would apparently include warrants to the government, and heavy incentives to disgorge AIG's many assets quickly in a kind of low-grade firesale.
It seems clear that were that not to happen tonight then AIG would file for bankruptcy tomorrow, and that would have immense and unknowable consequences. While that does not make an AIG bailout required, it is also true that chemistry experiments with unknown outcomes should be done on small scale and at home, not in global capital markets during a crisis.
The main risks tonight are political, not economic, however. Congress is frustrated at feeling like it is playing from behind in this debacle, and in an election year with massive financial commitments being made -- Bear Stearns plus Fannie/Freddie plus A.I.G. plus, plus -- and with an angry electorate having had this ill-explained to them, we are at an incredibly risky moment along multiple dimensions.
More here.
I wish people would shut up about "moral hazard". Yes, bridging AIG through its current crisis is not something you want to do; and yes, it would be better if the market solved its own problem. But even a cursory analysts of the serpentine connections between AIG and capital markets tells you that the latter just can't happen, so you have to hold your nose, be an adult, and live with the former.
Moral hazard, while real sometimes and in some places, is vastly overrated as an effect. Granted, it's seductive in the same way that risk homeostasis is -- the notion that, for example, people drive faster and take more risks because they have seatbelts -- but like risk homeostasis, moral hazard is vastly over-diagnosed. People at major financial services outfits don't project five years into the future and say, "Lever up, boys and girls. We'll either make a lot of money now, or be bailed out later." Real people in real markets don't think that way. Matter of fact, if anything, they're short-sighted in that regard to a fault.
Further, imagining that people load up with "end of the world" liabilities in an effort to be anointed with "too big to fail" status is muddled non-thinking from run-amok conspiracy theorists. They would be better off sticking to, you know, perhaps denying the Apollo moon landings. Because the idea that a GM can now credibly post-AIG make the case that capital markets will blow up if we don't assist it too is silly -- and suggesting that auto companies (just to pick an example) will now plaster themselves with leverage bombs to make their own "We're dangerous too!!" case stronger is sillier still.
The Treasury announcement with respect to using the Fed and Section 13(3) of the Federal Reserve Act to bridge insurer AIG is out. Here is the release:
Release Date: September 16, 2008
For release at 9:00 p.m. EDTThe Federal Reserve Board on Tuesday, with the full support of the Treasury Department, authorized the Federal Reserve Bank of New York to lend up to $85 billion to the American International Group (AIG) under Section 13(3) of the Federal Reserve Act. The secured loan has terms and conditions designed to protect the interests of the U.S. government and taxpayers.
The Board determined that, in current circumstances, a disorderly failure of AIG could add to already significant levels of financial market fragility and lead to substantially higher borrowing costs, reduced household wealth and materially weaker economic performance.
The purpose of this liquidity facility is to assist AIG in meeting its obligations as they come due. This loan will facilitate a process under which AIG will sell certain of its businesses in an orderly manner, with the least possible disruption to the overall economy.
The AIG facility has a 24-month term. Interest will accrue on the outstanding balance at a rate of three-month Libor plus 850 basis points. AIG will be permitted to draw up to $85 billion under the facility.
The interests of taxpayers are protected by key terms of the loan. The loan is collateralized by all the assets of AIG, and of its primary non-regulated subsidiaries. These assets include the stock of substantially all of the regulated subsidiaries. The loan is expected to be repaid from the proceeds of the sale of the firm’s assets. The U.S. government will receive a 79.9 percent equity interest in AIG and has the right to veto the payment of dividends to common and preferred shareholder.
While not unexpected, this is still staggering stuff. And there is lots to be worried about here, including what "collateralized" really means in such a fluid context, and why the U.S. has not been joined by the central banks of any other countries, but I'll save that for a subsequent post.
For now, I am more adamant than ever that the President and Congress need to get out in front of growing voter anger and confusion before it's too late. This, plus Lehman, Fannie/Freddie, and Bear Stearns needs to explained to people right now.
Some quick links (not all of them AIG related) that others may find interesting:
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