A.I.G.'s House of Cards and global capital markets
http://www.nytimes.com/2009/02/28/business/28nocera.html?_r=1&8dpc
Here's another great review of what's actually going on, in case folks still feel a little lost. Other than spewing of bile and grinding of teeth, my first reaction is this: our current grand MBS mess could have happened with any hot investment--not just houses. any commodity or asset or tulip could have gotten hot, and folks would have securitized them and other folks would have sold derivatives of them. A big well respected "insurance" company would have "insured" them. So what could have stopped it all?
Well, a regulatory system, with sufficient global oversight, that would force insurance companies to actually hold the capital reserves necessary to pay their insureds, should the worst happen. We didn't have this. Indeed, we didn't even have this in our own country -- nevermind in the london markets or the german markets or the asian markets.
And perhaps a global securities regulatory system that wouldn't allow investment banks to report as "assets" stuff that was insured by insurance companies with inadequate capital reserves.
Banks and insurance companies, like people, will always try to cheat, always try to grab that extra buck. Anyone remember the gigantic settlement State Farm had to pay out for failing to properly represent its insureds in court? We typically control these things through our civil and criminal laws, and through regulation.
But our police powers never caught up with the sheer magnitude of the kinds of money that were moving around. Maybe if we didn't get london money buying CDS's, and a therefore a ginormous multinational in the form of AIG, this financial meltdown wouldn't have been so bad. So we never wrote rules protecting against it. Stated differently, a mini-AIG, that issued CDS's to make money for investors only within the states, would never fail quite so spectacularly: they wouldn't have so many CDS's, and there wouldn't be so many mortgage backed securities--because the banks wouldn't make and buy so many, having only US-sourced money to invest and US investors to please. Theoretically, the laws already on our books would have covered this smaller-scale disaster (or did, until they repealed Glass-Steagall).
I remember the infant days of NAFTA, and the shift in economic thinking. Ross Perot and the "giant sucking sound." But the globalization of capital markets never received the same kinds of popular attention. So while folks would protest mexican labor and environmental standards, they didn't so much think of what might happen if a ton of unregulated or under-regulated foreign money started swimming around everywhere. Little kinks in the system -- loopholes --- that allowed things like CDSs to exist -- allowed through so much more money than anyone could ever wrap their little green-laced brains around. So much, in fact, that the banks doing all the buying hadn't a clue as to the risks they were taking on, apparently.
This crisis is NOT my fault or your fault. When trusted the government to open our borders, we trusted them to do it safely and smartly. We thought we would be informed of the potential hazards and pitfalls.
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"So we never wrote rules protecting against it. "
In fact, the SEC relaxed rules drastically, rules which would have significantly limited the downside. This was done circa 2004 under Donaldson, when some firms were allowed to leverage at up to 40:1 and without significant monitoring! That meant that a 2.5% drop in asset price would wipe out the gamble, er, investment, entirely.
Has nothing been learned since September?? It's capitalism, dummy. (Not that capitalism is all bad, just saying, if you gamble ya gotta take your losses).
The system needs a contained domino effect washout, slowly and painfully or quickly and painfully.
March 1, 2009 1:32 AM | Reply | Permalink