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Friday, March 20, 2009

Crocodile Tears over AIG

If politicians spill any more crocodile tears over AIG , the EPA might have to declare Washington, D.C. a protected wetland.

Sweep aside the phony expressions of “outrage” over AIG’s government-financed $165 million in bonuses (the information was in black and white) and ask yourself this:

Who supplied the money?

When politicians hand out other people’s money to businesses, they have no right to complain about the results. The politicians are primarily at fault. The bonuses couldn’t have been paid without them.

Adam Smith wrote in The Wealth of Nations, “People of the same trade seldom meet together, even for merriment and diversion, but the conversation ends in a conspiracy against the publick. . . . It is impossible indeed to prevent such meetings, by any law which either could be executed, or would be consistent with liberty and justice. But though the law cannot hinder people of the same trade from sometimes assembling together, it ought to do nothing to facilitate such assemblies; much less to render them necessary.”

You’ll find no sympathy for the mostly nationalized AIG here, but let’s have no more sanctimonious pronouncements from the facilitators on Capitol Hill. What should happen now? Unless the money goes right back to those it was borrowed from, it hardly matters. We and our children will have to repay the debt one way or another. Nevertheless, ex-post-facto tax increases, bills of attainders, and executive-branch abrogation of contracts would indeed be worrisome.

The facilitators say they had to bail out AIG or another Dark Age would have descended on the world. But of course they would say that. Other firms would have salvaged the profitable parts of the company. The rest would have been renegotiated. As for AIG’s counterparties in mortgage-related securities, perhaps they could better weather the storm of an AIG bankruptcy if they weren’t hogtied by inflexible, arbitrary capital requirements imposed by unaccountable government authorities who can’t possibly know the nuanced particulars of time and place.

On the other hand, have the bailout proponents tried calculating the consequences of the AIG rescue in terms of moral hazard? Will future counterparties exercise more or less diligence in light of this episode?

Leading Inquisitors

Predictably, the leading inquisitors into the causes of the financial turmoil are themselves among the most culpable: Rep. Barney Frank, Sen. Chris Dodd, and New York Attorney General Andrew Cuomo. AIG got into trouble because it in effect wrote insurance policies (credit default swaps) against the failure of securities based on mortgages, too many of which were waiting to blow up when the housing bubble burst. Who created the housing bubble? Who created the incentive environment in which writing bad loans paid off handsomely?

It may be hard to tell from the news coverage, but politicians and bureaucrats deserve the lion’s share of the blame, particularly for their government-sponsored enterprises Fannie Mae and Freddie Mac, which bought up and securitized a slew of bad mortgage loans, thereby encouraging lenders to write more of them. This was only the tip of the policy iceberg.

Enter Frank, Dodd, and Cuomo. There were no bigger boosters of Fannie and Freddie in Congress than Frank and Dodd. (The GSEs were vigorous lobbyists and campaign donors.) Every time someone questioned the GSEs’ fiscal integrity, these guys assured us everything was fine.

And then there’s Cuomo, Bill Clinton’s last secretary of housing and urban development and close friend of the Mortgage Bankers Association, which likes any policy that makes writing mortgages safer—for its members. According to the Village Voice, Cuomo pushed the GSEs to buy more and more dubious mortgages, while requiring them to report less and less. “In other words,” Wayne Barrett writes, “HUD wanted Fannie and Freddie to buy risky loans, but the department didn’t want to hear just how risky they were.” Cuomo also “took to reshape the Federal Housing Administration, which guarantees millions of mortgages. These actions, too, sought to maximize homeownership—this time by opening the FHA’s door to borrowers unable to qualify in the past, a lofty goal that has also helped spur an FHA delinquency rate that exceeds its subprime competitors. . . . Cuomo even supported down-payment and closing-cost assistance programs that allowed FHA borrowers to buy a home without spending a cent of their own money up front.”  (If you want to appreciate what a sewer Washington is, read the Barrett’s article.)

Are these guys pursuing AIG out of guilty consciences? Most likely. Will they ever have their day in the hot seat? Not likely.

More Regulation?

The received wisdom is that we need more regulation now, perhaps a Food Drug Administration for the financial industry. This would be foolish and pernicious. We already have regulators falling over themselves. Moreover, the FDA kills thousands of people a year by delaying the marketing of new drugs. Some would like a financial regulatory regime that would prohibit anyone from executing a transaction before a bureaucratic overseer understands its consequences. Such a regime may not actually kill people, as the FDA does, but it would make us poorer. In the miasma of crisis it’s easy to overlook the benefits of financial innovation. By shifting risk to willing parties and increasing liquidity, innovative investment instruments make products and services available we would otherwise not see. For this to work properly, however, government must never blunt the market’s discipline with guarantees and even implicit promises of bailouts. Regulation doesn’t protect us. It merely encourages innovators to take less transparent and perhaps more risky paths. The innovators will always be a step ahead of the regulators. The only true protection we can have is market discipline–the threat of bankruptcy. Government regulation is a shoddy, ineffective substitute that only creates a false sense of security. (Ask Bernie Madoff’s victims.)

Many companies, bedazzled by computer risk models that presume to measure the immeasurable or rewarded for abolishing lending standards, engaged in reckless and even reprehensible conduct leading up to the current crisis. But never forget that only one institution could have created the housing bubble, which made that conduct widespread, lucrative, and substantially free of market discipline: the State. We should hardly look to it for salvation.

  • Sheldon Richman is the former editor of The Freeman and a contributor to The Concise Encyclopedia of Economics. He is the author of Separating School and State: How to Liberate America's Families and thousands of articles.