LOOTING THE GOVERNMENT

The problem with government bailout policy is that it encourages companies to take unreasonable risks, knowing full well that Congress will not permit them to fail. It is equivalent to having a two-headed flipping-coin, you choose heads, and always "win"! The results are a run on government coffers.

A good deal of this came to the fore today, (March 18, 2009) as the nation agonizes over the news of American International Group (AIG) and its plan to give annual bonuses to its executives and it CEO faces a congressional hearing. Recall that this is the company, now about 80 per cent owned by U.S. taxpayers, which has over the last few months received roughly $170 billion from the government. It is also the one which recently announced the largest quarterly loss in corporate history—a $62 billion dollar shortfall. According to a recent AP accounts, AIG is an international insurance-agency giant which is critical to the well-being and stability of the U.S. and world financial systems. The nearly two hundred billion dollars (of bailout funds) they recently swallowed, was spent to cover their losses to banks (such as Swiss UBS AG, Morgan Stanley, Citigroup), to retirement funds and others who suffered loss related to complex mortgage investments. They also supply capital as collateral needed for common loans and day-to-day business transactions which help to keep money flowing to businesses and homeowners. It is generally accepted that the collapse of AIG could cause widespread damage to banks and consumers around the globe.

One expects that a function of an agency such as AIG, would be to analyze risks of companies they are about to insure, and if these are wanting, to withhold their insurance contracts. Today such "common sense-Franklinesque" ideas sound a "bit quaint" --as if, bankers and insurers should actually be attempting to assess risk. But perhaps that is exactly what they should have been doing. But why have they not?

These AIG executives, who recently awarded themselves some $165 million dollars in bonuses simply signed off on these contracts with little thought of the consequences! Thinking--"oh well--someone else will have to review these decisions--some day, but I'll be long gone." Some of these employees walked away with more than $6 million dollars in their pockets!

It was three months ago that this same AIG, after happily accepting the first bailout money, blithely sent its executives on an all-expenses paid, half-a-million dollar jaunt to the St Regis Resort Hotel at Monarch Beach, in California (in the heart of that state’s Republican territory). That revelation caused a well-earned, but short-lived flurry of press attention. But then other disasters--the stock market crash, unemployment, mortgage defaults, etc. etc. took over the front pages and we forgot about it.

( Note here that the first award,made by Bernanke and Bush, was completed with the authority of under a little known, 1930s law which permitted the Fed to award these funds at their (the Fed’s) own discretion and with no strings attached).

But now in mid-March, after a few months of severe economic woe, when more than 12 million Americans lost their jobs (and their health-insurance coverage), and when national suffering has expanded across the map like a dark, spreading stain. It is at this time, that we are informed as taxpayers, with the latest bill in our collective pockets for nearly 85% of the worth of their failed company, that some of those who actually helped grease the skids under the nation’s economy by looking the other way at the flagrant, high-risk behavio of the companies they insured, will be awarded millions in bonus money.

Further fuel was added to the fire when Andrew Cuomo, New York State’s Attorney General, revealed today that AIG paid out bonuses of $1 million or more, to 73 employees. Eleven of these employees no longer even work there! This revelation only served to underscore the hyperbole and misstatements emanating from the company executives who suggested the bonuses were paid to "retain" these people.

What does this all mean?

The obvious is that the system is a mess! The nation has been on a twenty-year binge of excess which touches all and every aspect of its functions. Excess, greed and incompetence are rampant. The Bush-years reactionary philosophy of "anything goes which makes a profit" has finally been discredited. It's under-lying concept that"the markets will police themselves" and other similar shibboleths have been repudiated. But unfortunately these poisonous concepts are buried at depth, in our collective consciousness. The nation needs a deep colonic irrigation to remove these embedded toxins.

Part of that process of 'clean out' will require a radical change in our system of banking and financial oversight. Soon a comment on that.

But what about these bonuses? If we really need AIG, we may actually require the services of these people, as incompetent and unrepentant as they may appear. Can we start abrogating contracts for revenge purposes? This is certainly not a good precedent to set, though it might feel good to those who are suffering on Main Street as they are forced to foot the bill for a week at the St Regis.

What can we do from where we are now? How do we change the broken system? Somehow. we must avoid the situation that will only compound our troubles…that is, government "bailouts" to companies and executives which permit the conspirators and guilty to continue at their jobs, remain affluent even after they have effectively robbed us. Without change they will only do it again and again. That is not a good precedent to set either.

Perhaps the Obama Administration has been too tentative in regard to its promise of change. Rather than simply giving away money, time and time again, would it not have been wiser to take over AIG, once its apparent losses exceeded it assets. It is, in fact, a government agency at present. Only the need to support the fiction of its independence is supported to assuage the feelings of some elements in the nation who see "nationalization" as a red flag and some terrible evil. That reservation is preventing us from facing up to reality, and doing the right thing.

It’s time for the government to begin planning for a better, less vulnerable economic system, with more controls and less incentives for some to take inordinate risks and expect a "I win, you loose," result.

In that regard, I present here a remarkable recent article entitled: "Looting the American Coffers," NY Times (March 9, 2009) http://www.nytimes.com/2009/03/11/business/economy/11leonhardt.html?em. In it David Leonhardt reviews a prescient paper entitled "Looting", written in 1993 by Professors Akerlof and Romer (Akerlof later received the Nobel Prize in economics).

Written sixteen years ago, "Looting" documents the case of certain real estate investors in Texas in who "took advantage of the government" by borrowing huge amounts of money on risky investments they made huge profits with no regard to the predictable losses which, when their enterprise failed left the government to pay the tab. Does this sound familiar?

"They displayed a ‘total disregard for even the most basic principles of lending, failing to verify standard information about their borrowers or, in some cases, even to ask for that information.’ The investors ‘acted as if future losses were somebody else’s problem," the economists wrote. They were right." (See Leonhardt, 3-09-2009).

To a large extent the economic disaster we are experiencing today is the result of "investor looting". These "investors' have already walked away with their ill-gotten gains. Leaving us to hold the bag.

"But the future also requires the kind of overhaul that Mr. Bernanke has begun to sketch out. Firms will have to be monitored much more seriously than they were during the Greenspan era. They can’t be allowed to shop around for the regulatory agency that least understands what they’re doing. The biggest Wall Street paydays should be held in escrow until it’s clear they weren’t based on fictional profits.

Above all, as Mr. Romer says, the federal government needs the power and the will to take over a firm as soon as its potential losses exceed its assets. Anything short of that is an invitation to loot. " (See Leonhardt, 3-09-2009).

And why not?