Too-Big-To-Fail


Shortly after I started this blog I wrote a couple of posts on the AIG debacle. One called –The demise of AIG and the other titled – More on AIG’s fall.

The first post referenced this in-depth NY Times article on why AIG was rescued.

I should have picked up on some aspects of this, more at the time, but I was probably more sharply focussed on some other aspects. However, a couple of recent articles and some comment elsewhere caused me to go back and re-read some earlier material. In part this revisit was prompted by Goldman, Sach’s recent profit announcement.

The NY Times noted :-

Although it was not widely known, Goldman, a Wall Street stalwart that had seemed immune to its rivals’ woes, was A.I.G.’s largest trading partner, according to six people close to the insurer who requested anonymity because of confidentiality agreements. A collapse of the insurer threatened to leave a hole of as much as $20 billion in Goldman’s side, several of these people said.

Days later, federal officials, who had let Lehman die and initially balked at tossing a lifeline to A.I.G., ended up bailing out the insurer for $85 billion.

Their message was simple: Lehman was expendable. But if A.I.G. unspooled, so could some of the mightiest enterprises in the world.

A Goldman spokesman said in an interview that the firm was never imperiled by A.I.G.’s troubles and that Mr. Blankfein participated in the Fed discussions to safeguard the entire financial system, not his firm’s own interests.

Yet an exploration of A.I.G.’s demise and its relationships with firms like Goldman offers important insights into the mystifying, virally connected — and astonishingly fragile — financial world that began to implode in recent weeks.

The NYT article looks at the role of AIG’s London Financial Products unit and some of the links it had with Goldman Sachs. considerable governance implications come to mind from the NYT article.

Yesterday I came across this article by Michael Lewis at Vanity Fair. It explores the role of AIG’s Financial Products Unit and that of Joe Cassano who headed the unit. The article  goes into quite a lot of detail which amplfies some of that in the NYT article of last September.

It deals as well with some of the nonsense generated when AIG paid bonuses earlier this year.

Interestingly, it notes how banks and investment houses, such as Goldman and Merill Lynch, benefited hugely from the US government bailing out AIG.

This article again raises in my mind issues of governance within such large organizations, especially where there are very dominant senior exceutives.

Then this morning I came across this post at Anti-Dismal which sort of triggered it all off in my mind.

Anti-Dismal identifies the moral hazard issue which emerges when you accept the Too Big To Fail argument. He refers to some useful sources.

Then Willem Buiter in his often provocative Maverecon Blog at the FT recently addressed possible remedies for Too Big To Fail. Some of this ground having previously been covered by Lord Lawson, former British Chancellor under Thatcher. Buiter’s piece is worth reading anyway,if for no other reason than some of his vivid and acerbic desciptions of people and situations.

It is perhaps worth noting that Buiter in an earlier post made this comment as to why we had the huge market convulsions in late 2008:-

Even then, I don’t accept the interpretation that it was Lehman’s filing for bankruptcy protection that triggered the cardiac arrest in global financial markets in the second half of September 2008.  Instead the financial sector convulsions of the last quarter of 2008 were caused by the realisation that (1) most of the US and European border-crossing banks were insolvent without government financial support, that (2) the rot extended to the shadow banking sector (AIG), and that (3) the US authorities (Treasury, Fed, SEC) were not on top of the issue and that Congress was bound to act irresponsibly.

Buiter casts a wider net than Lewis in his article.

So what does it all mean. A cynic might take the view that globally we have seen personal wealth and jobs suffer, because of the actions of a few engendered by the demand from theconsumers of investment products which in many cases were us,or our surrogates, for ever increasing returns. The same cynic might then look at what is happening now and suspect that the cycle is beginning all over again.

As this comment from Streetwise Professor might tend to indicate:-

Somebody should be stepping in–but nobody is. Why not? Partly, no doubt, it is Goldman’s political heft. It is likely too that important policy makers don’t want to crack down on a major source of risk capital to the markets in the fear that this would impede a recovery. Even though in reality, that risk capital is your money and mine, with the exception that we have no chance of capturing the upside, and are left with a good chunk of the downside. This is a piece with the hair-of-the-dog strategy being pursued by Treasury and the Fed.

So Goldman repays TARP monies and announces huge profits. So does J P Morgan announce good profits as well and repays TARP funds. The survivors of the crisis are even bigger behemoths than before. Thus the survivors have become even more Too-Big-To-Fail.

The wheel turns.

On a final cynical note I draw your attention to this amusing, but biting spoof memo on employee bonuses at Goldman published at The New Yorker. The extract below is the final paragraph:-

I’d like to thank everyone who made this possible—for a second time. Respect to President Obama for keeping us in the green. Thanks to the big guy upstairs (me). And let’s not forget all the ordinary Americans, who, for some unfathomable reason, have refused to put us behind bars. We are literally taking money out of their wallets. Seriously, with these returns we are making Madoff look like a little kid with his hand caught in the cookie jar. Amateur!

Enjoy

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