The truth is that Fannie Mae and Freddie Mac were started by the government but became private companies, and so their shenanigans were as deplorable in recent years as the now defunct Wall Street investment banks (the remaining ones are now "bank holding" companies). And they enjoyed an artificially low cost of financing because most investors assumed (correctly as it turned out) that they were "quasi" Government Sponsored Enterprises (GSEs). There was plenty of bad policy and deplorable management to go around.
But About That AIG Bailout.....
However the current economic crisis, as we have discussed here, is NOT primarily about housing. Rather, its roots can be found in the legally off-the-books wildly dangerous "derivatives" trading that really led to all the "toxic" (read: worthless) assets in large financial institutions left holding the bag so to speak. The insane mortgages were fueled by that appetite for derivatives products on Wall Street.
So added to all this, AIG (and others) step in to provide another insane product, namely "insurance" for investors. This means the investors pay a premium on their investment (reducing their profit a little bit) to pay AIG, which then promised investors around the world that if the investment failed, then AIG would pay back the investors the amount of their investments, essentially creating truly "risk free" investments in complicated financial instruments and various bonds.
The US government, through Congress and 2 successive Presidents, made all this virtually untraceable and unmanageable, not subject to any regulation. The result? A whole lot of these "insurance" policies were issued without any money to back up the promises made by the insurance company, often AIG. Who were AIG's investors they were insuring? The insured investors are called AIG's "counterparties."
And those investors were often large financial institutions then providing financing to other smaller financial institutions. Mixed in with all this are various retirement funds, charities, municipalities, sovereign funds, pensions and so forth.
So if AIG is dissolved, you can start to imagine how all these other financial institutions would be wiped out and how that could start a world-wide daisy chain reaction.
That's why AIG keeps getting our money. It's not AIG we're keeping afloat - it's all those other institutions that were relying on the insurance AIG provided to secure their investment risk. AIG is effectively dismantled.
With that in mind now, you can follow this post from Talking Points Memo by publisher and political journalist Josh Marshall that goes into some further and more frightening detail:
I'm sure the knowledgeable people already know this. But it turns out that one of the features of the 2005 Bankruptcy bill was to put derivative counter parties at the front of the line ahead of other creditors in bankruptcy proceedings. Actually, from what I can tell, they don't just go to the head of the line. They got to skip the line entirely. As the Financial Times noted last fall, "the 2005 changes made clear that certain derivatives and financial transactions were exempt from provisions in the bankruptcy code that freeze a failed company's assets until a court decides how to apportion them among creditors." As the article notes, ironically, this provision which Wall Street pushed for and got to protect investment banks actually ended up hastening the collapse of Lehman and Bear Stearns last year.
Down in the article there are also the mentions of the entertainingly named "International Swaps and Derivatives Association", one of the lobbies that helped get the change in place.
Along these lines, TPM Reader GG sent in this last night ...Respectfully, you guys are totally misunderstanding something crucial in the AIG bailout: Derivatives claims are not stayed in bankruptcy. (Yet another brilliant innovation from the 2005 bankruptcy reform legislation.)
If AIG were to go down, derivatives counterparties would be able to seize cash/collateral while other creditors and claimants would have to stand by and wait.
Depending on how aggressive the insurance regulators in the hundreds of jurisdictions AIG operates have been, the subsidiaries might or might not have enough cash to stay afloat. If policyholders at AIG and other insurance companies started to cancel/cash in policies, there would definitely not be enough cash to pay them. Insurers would be forced to liquidate portfolios of equities and bonds into a collapsing market.
In other words, I don't think the fear was so much about the counterparties as about the smoking heap of rubble they would leave in their wake.
Additionally, naming AIG's counterparties without knowing/naming those counterparties' counterparties and clients would be at best useless, and very likely dangerous. Let's say Geithner acknowledges that Big French Bank is a significant AIG counterparty. (Likely, but I have no direct knowledge.) BFB then issues a statement confirming this, but stating it was structuring deals for its clients, who bear all the risk on the deals, and who it can't name due to confidentiality clauses.
Since everyone knows BFB specialized in setting up derivatives transactions for state-affiliated banks in Central and Eastern Europe, these already wobbly institutions start to face runs. In some cases this leads to actual riots in the streets, especially since the governments there don't have the reserves to help out. If you're Tim Geithner, do you risk it? Or do you grit your teeth and let a bunch of senators call you a scumbag for a few more hours?
I'd be curious to hear what other knowledgeable readers think about this. But separate from the immediate financial implications related to AIG, it does point us toward the larger political economy point: the self-reinforcing cycle in which financialization leads to vast sums of money concentrated in the hands of paper-jobbers, who then mobilize that money in Washington to rewrite the laws to privilege them for even greater profits.
A final question, I'd be curious to hear from people who work in this space what even the notional rationale would be for having derivative counter parties able to skip the line in a bankruptcy proceeding.
