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Thursday, December 13 , 2018, 1:13 am | Fair 45º


The Daily Capitalist: AIG Must Fail

The troubled insurer's creditors have already protected themselves

AIG has come back for its fourth bailout and got a pledge of another $30 billion, which brings the total to $173.3 billion. Fed chairman Ben Bernanke told Congress, “If there’s a single episode in this entire 18 months that has made me more angry, I can’t think of one.” Wow, is this guy angry.

Bernanke said the Fed “really had no choice” but to stabilize the company in September because the failure of a major financial firm in a crisis “can be disastrous for the economy.” With millions of policyholders and thousands of derivatives and credit-insurance counterparties, Bernanke said AIG’s downfall would have been “devastating to the stability of the world financial system.”

We shouldn’t be too upset; after all we have a valid investment. We taxpayers own 78 percent of AIG and I’m sure we’ll get that back. Wait, you say AIG’s market cap is $1.2 billion? Well, at least we know what they’re doing with the money. Wait, you say they won’t divulge who the counterparties are that will “suffer” if AIG goes bankrupt? But, I thought we were bailing out AIG not Goldman Sachs, Merrill Lynch, UBS and Deutsche Bank and other foreign counterparties.

Is Bernanke correct? Do we have a choice? Will the entire economy go down if AIG fails?

The insurer’s portfolio of credit default swaps was still notionally worth $ 302.2 billion at the end of 2008. NYU economics professor Nouriel Roubini says without bailing them out, Goldman and just about every banker in the United States and Europe that is an AIG creditor would suffer huge losses and go down. He says they and the banks should be taken over by the feds and liquidated in an orderly fashion. Which seems to me to be a good argument for bankruptcy without the need for taxpayer funds.

Here’s the dirty little secret, Nouriel: All the companies that did business with AIG have already written down the value of their counterparty benefits. Goldman has said its exposure to AIG isn’t material and “is offset by collateral and hedges.” I am sure their other creditors have done the same thing.

Jim Rogers, famous investor and former partner of George Soros, and who has been quite right about the economy lately, says:

“Suppose AIG goes bankrupt. It is better that AIG goes bankrupt and we have a horrible two or three years than that the whole U.S. goes bankrupt. ... AIG has trillions of dollars of obligations; let them fail, let the courts sort it out and start over. Otherwise we’ll never start over. ... I think it’s astonishing, they’re ruining the U.S. economy, they’re ruining the U.S. government, they’re ruining the U.S. central bank and they’re ruining the U.S. dollar. ... (Y)ou have too much debt, too much borrowing and too much consumption, and you’re going to solve that problem with more debt, more consumption and more borrowing? These people are nuts.”

He’s right. He’s worried about us catching the Japanese disease.

It seems that AIG’s competitors, the ones who didn’t write all those bad credit default swaps, are waiting for them to fail so they can pick up the pieces. Business will get done without AIG. According to The Wall Street Journal:

“Competitors who have been overshadowed for years by AIG’s dominance in key commercial insurance markets now see AIG’s problems as an opportunity. But there is growing frustration that the government keeps stepping in to thwart what could be business prospects for them,” said Andrew Barile, an insurance consultant in Rancho Santa Fe.

Moreover, it’s daunting having the government as a big investor in a competitor.

“The challenge is that we have a regulator who also is an investor,” said Mike Foley, chief executive officer of Zurich Financial Services Group’s (ZFSVY) North American commercial segment. “From a competitive dynamic, it creates some confusion if your competitor is also your regulator.”

This is how it is supposed to work with capitalism. Bad companies go broke and good companies come along and fill in the gaps, quickly. It prevents something economists call “moral hazard”: rewarding bad economic behavior.

What Rogers is saying is that the government is thwarting a valid and necessary economic recovery process. It is important to let AIG fail in order to achieve recovery. The impact to the world economy will not be pretty, but it will be far less than “Shock Jock” Bernanke thinks. It will result in a quicker turnaround of the economy. Ben simply hasn’t thought through the issue sufficiently and is afraid of the political fallout if he does “nothing.”

Ben is angry because nothing he or his partners at the Treasury have done has worked so far and he doesn’t have a clue why.

— Jeff Harding is a principal of Montecito Realty Investors LLC. A student of economics, he has a strong affinity for free-market economics. This commentary originally appeared on his blog, The Daily Capitalist.

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