Bogus Gold

AIG was back in the news this weekend. But to me the interesting part wasn't the titillating story about the company paying some of their executives $165 million dollars in bonuses on the heels of receiving billion in taxpayer funded bailouts. This further cemented AIG's image as the most evil railroad-baron of the current age, but it wasn't all that interesting to me. It's being covered plenty of places if you want to hear about it.

I was far more interested in the current effort to "follow the money." As AIG continues to receive billions in taxpayer funded bailouts, those funds are flowing out to AIG's creditors all over the world. But who exactly are these mysterious creditors, and why can't we start negotiating directly with them instead of shoveling seemingly endless buckets of money into the hole where a previously solvent American financial system used to be? Surely AIG knows whom it needs to pay off.

Apparently people are starting to ask this question a lot, and the lack of clear answers from AIG only deepens the mystery. From a New York Times editorial on the topic yesterday:

A.I.G. has not said who they are, and neither have government officials in charge of the A.I.G. bailouts — mainly Treasury Secretary Timothy Geithner and Federal Reserve Chairman Ben Bernanke — despite repeated inquiries from Congress. (The Wall Street Journal, citing confidential documents, reported recently that about $50 billion in 2008 bailout money from A.I.G. went to at least two dozen firms, including Goldman Sachs, Merrill Lynch, Bank of America and European banks.) Late last week there was talk that more official information was forthcoming, but no one has seen it yet.

The reason this is becoming increasingly important is quite simple: sticker shock. The enormity of the financial hole AIG dug for itself is just now starting to receive the appreciation it has long deserved. It's beginning to dawn on some people that we may not be able to afford to pay off all of AIG's debts. We might have to start choosing between which creditors to pay.

And before you get too huffy about the risk this places upon so many investors, let's recall that the lions share of AIG debts come from their sale of credit default swaps. And, as I covered a short while ago, let's remember that in many cases this amounted to the high-finance world's trendiest form of gambling. From the same NYT editorial:

Still, the trading partners knew, or should have known, how dangerous the swaps were. And that is not necessarily the whole story. In the manic years of this decade, credit default swaps took off as a way to bet on the likelihood of default by a firm or an investment portfolio, without having to own any financial interest in the firm or portfolio. That is definitely not insurance, it is gambling. The reason it is not illegal gambling is that, in 2000, Congress specifically exempted credit default swaps from state gaming laws.

The result? Eric Dinallo, the insurance superintendent for New York State, has said that some 80 percent of the estimated $62 trillion in credit default swaps outstanding in 2008 were speculative.

Just doing some rough math here, but 80 percent of $62 trillion dollars is $49.6 trillon dollars... in what amounts to gambling debts.

I don't think the U.S. taxpayer has the ability to pay off that kind of debt... scratch that... I don't think the U.S. taxpayer would stand for putting the nation and future generations so deeply into the hole just to cover the gambling debts of a bunch of "heads I win, tails you lose" speculators.

It would seem to me that in order to maintain the credibility necessary to get any long-term solution to the ongoing problem in the financial sector, the government is going to have to start drawing some distinctions between serious investments - no matter how risky - and raw speculative bets. There simply isn't enough money to treat all comers equally.

Rather than hounding the Obama administration to do something symbolic about all that AIG bonus money, we should be demanding to get a full accounting of the debts AIG is asking the U. S. taxpayers to bail them out from.