Last weekend, the U.S. government decided that it would let Lehman Brothers Holdings Inc. (NYSE: LEH) fail -- leading to history's biggest bankruptcy -- valued at $639 billion. But that was fine because the government said that people knew Lehman was in trouble. Of course, people also knew since August 2007 that Bear Stearns was in trouble, but that didn't stop the government from forking over $29 billion of taxpayer money to bail it out. And people knew for years that Fannie Mae (NYSE: FNM) and Freddie Mac (NYSE: FRE) were in trouble -- but that did not stop the US from pledging between $200 billion and $800 billion to nationalize them.
But this morning, we discover that the government has crossed over the line in the sand it drew over the weekend -- it will loan $85 billion of taxpayer money -- at a variable interest rate starting at 14.5% -- Libor, which doubled yesterday from roughly 3% to 6%, plus 8.5% according to the Wall Street Journal [subscription required] -- to avoid what would have been the $1 trillion bankruptcy of American International Group (NYSE: AIG). In exchange for this two year loan, according to the New York Times, the Fed gets as collateral all the $1 trillion of AIG's assets plus warrants to purchase 80% of AIG stock.
The incompetence of this government is breathtaking. On Sunday, it could have loaned AIG $40 billion to keep its credit rating from getting downgraded. It refused to do so -- trying to force JPMorgan Chase (NYSE: JPM) and Goldman Sachs Group (NYSE: GS) to help raise private financing -- and credit agencies went ahead and downgraded AIG on Monday. Now, instead of a bridge loan which would have tided AIG over until it could sell some assets to raise capital, the government is making a two-year loan that is twice as big. And we, the taxpayers, are likely to own this pile of assets that may be worth far less than the $1 trillion stated on its books. If there's any good news, the stated collateral is more than 10 times the amount of the loan.
As I posted yesterday, the reason AIG got into such a mess is that it owed $14.5 billion in Credit Default Swap (CDS) premiums. "[CDSs] pay the buyer face value in exchange for the underlying securities or the cash equivalent should a country or company fail to adhere to its debt agreements," according to Bloomberg News.
And thanks to an amendment provided to a government re-authorization bill in 2000, John McCain's chief economic adviser, Phil "Americans are Whiners" Gramm, made it possible for this CDS market to reach $62 trillion. How so? Gramm's bill let the CDS market to operate without any government scrutiny. That's important because if a government agency was responsible for monitoring the CDS market, it would not have grown so big.
Gramm has a point about Americans being whiners -- since he won't personally need to pay the $85 billion in taxpayer money to bailout AIG and the $639 billion bankruptcy of Lehman -- both of which were triggered by a rapid rise in CDS premiums and the cost of CDS unwindings. He doesn't care if it costs American taxpayers. As Vice Chairman of UBS AG (NYSE: UBS), his company has helped wealthy people dodge US taxes. And, as I posted, UBS's contempt for America extended to its toxic Auction Rate Securities (ARS) which it dumped on its poorer clients to get the ARS off UBS's books.
And as chief economic advisor to John McCain, imagine how much more damage Gramm could do -- if only we could get McCain in the White House in November. PaineWebber, the brokerage UBS acquired in 2001, used to have a marketing slogan "Thank You PaineWebber" -- now American taxpayers can change that slogan to "Thank You Phil Gramm".
Peter Cohan is President of Peter S. Cohan & Associates. He also teaches management at Babson College and edits The Cohan Letter. He owns AIG securities and has no financial interest in the other securities mentioned.
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Reader Comments (Page 1 of 1)
9-17-2008 @ 10:06AM
John said...
If US taxpayers are going to have an 80% stake in Freddie, Fannie and AIG, that also means the the taxpayers will be held accountable for 80% of future liabilities too. I don't like that scenario, especially when you consider that the real estate market hasn't come close to bottoming out.
$1 trillion in AIG assets, yeah right. Let me guess, most of the "value" is in real estate. LOL
9-17-2008 @ 4:44PM
Chris K. said...
Yeah, this whole thing is Gramm's fault. I can't believe that Bush let one guy kill our entire economy. What was he thinking?
Are you serious? You would have bitched if they bailed out AIG last week for $40b.
Of course, the incompetence of the ratings agencies had nothing to do with the mess we're in. The world would have looked no different if tranched CDO's had been rated accurately, right? Hardly.
How about the bond buyers? Did they really think you could get an extra spread w/o more risk?
People I know with PhDs in economics and finance can barely form an opinion on whether the AIG bailout is good or bad because we just don't know enough about the consequences of the alternate course of action (doing nothing).
Your propagandist grandstanding is petty.
9-17-2008 @ 11:39PM
Henry Blankett said...
Interesting that Chris K. would throw around the word "propaganda". He is, after all, the same genius who claimed Sarah Palin really did understand what Freddie and Fannie were. (http://www.bloggingstocks.com/2008/09/09/palin-doesnt-know-much-about-fannie-and-freddie/)
Keep the hits coming, Chris. Keep the hits coming.
9-18-2008 @ 9:12AM
Chris K. said...
So Henry, do you disagree with the CBO report (i.e, that FNM and FRE were an expense to taxpayers even before the bailout), or just that Sarah Palin actually understood that when she made the comment?
If the latter, there's a good chance that you are right. I don't know. I was just pointing out that what she said hardly qualifies as a major gaffe since the CBO said essentially the same thing.