The bailouts of 2007-2009: the case of AIG
Now comes a symposium of five articles, published in the AEA outreach Journal of Economics Perspectives, several of which read clearly as a kind of apologia pro vita sua for the actions of the authors themselves. The idea seems to be that, if only readers could be made to understand the conditions under which the authors were operating, they would forgive (or maybe even retrospectively appreciate?) the actions taken to save GM and Chrysler, Fannie Mae and Freddie Mac, Bear Stearns and AIG (but not Lehman).
For me, the most interesting and revelatory of the pieces is the one on AIG, interesting in itself but especially so given the recent court decision that slapped the government’s wrist for treating AIG too harshly. In the article we learn, which was news to me, that the problem was not just with the CDS written on supersenior tranches of mortgage backed securities (as emphasized by the GAO report). It turns out that AIG’s security lending operation was equally problematic. AIG had been lending out its massive holding of corporate bonds (assets of its insurance business) and using the proceeds to buy illiquid mortgage backed securities.
In effect, AIG was running an on-balance-sheet shadow bank operation, “money market funding of capital market lending” (my words, not the authors’). When the value of AIG’s mortgage portfolio came into question, the borrowers of the original bonds sent the bonds back and asked for cash. Thus, there was a cash crunch at AIG even before the collateral crunch from the CDS position that ultimately brought the firm down. News to me, and important news, since we remember that UBS got into trouble for much the same reason. Liquidity kills you quick.
Also news to me are some facts about Maiden Lane II and Maiden Lane III, the two Fed facilities that arose from the AIG bailout. The first, so we learn, absorbed the illiquid mortgage positions from the securities lending facility, paying a 48% discount from face value (p. 87). The second bought the supersenior tranches referenced by AIG’s CDS positions, at 47% of face value (p. 97). These are big discounts, and the Fed subsequently passed them on to private buyers by liquidating just as soon as private buyers could be found. Subsequently there have been small writedowns of both sets of assets, but nowhere near the discounts required by the Fed.
The actions of the Fed take on special importance when viewed against the background of the actions NOT taken by the TARP. Remember, Paulson’s original idea was to run some auctions in order to buy troubled assets, but that didn’t happen. Instead the Fed did it, in Maiden Lane II and Maiden Lane III. (Maiden Lane I did a similar thing for Bear Stearns.) And the Fed’s actions were all on top of all the TARP loans that recapitalized AIG and kept it out of bankruptcy.
Judge Wheeler’s decision not to award damages amounts to an assessment that shareholders were not harmed by government intervention. Sounds right to me. Government assistance of $182.3 billion is hardly harm!