L'Ombre de l'Olivier

The Shadow of the Olive Tree

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16 March 2009 Blog Home : March 2009 : Permalink

Rich Galen Spouts Idiocy

I get Rich Galen's Mullings email every few days. Normally they are good. Sometimes excellent even. However today's one can best be described as pile of $#!+. He's going on about the bank bailout etc. and in particular about the federal rescue of AIG. First the retention bonuses
Now if any of those bonuses are for future years then I'm in agreement that they shouldn't be paid, and indeed I'm not clear why the folk in question haven't joined the dole queues. But bonuses for 2008 have to be paid because its basic contract law and governments really really do not want to go there (see Fred the Shred commentary). If governments start unilaterally canceling terms in contracts then the world learns not to trust government contracts, which means they start charging govermnents more if they want to borrow money (as a risk premium) and things like that. And in turn this probably leads to the financial collapse we've all been desperately trying to avoid.

As an anarchist kind of person I don't have too much of a problem with that but people like Rich Galen who think government is a good thing (OK he's a small government person but small government is not the same as no government), would probably prefer it if the US dollar were not considered to be about as trustworthy as the Zimbabweaon one.

However that bit of populist rabble rousing is not the worst.
Let me explain this as simply as I can.

The "I" in AIG stands for "Insurance". AIG wrote policies that these banks bought. When the US housing market (note country) went kersplat these banks (and many others) discovered that they weren't getting all the payments they were due from the mortgage backed CDO thingies they'd bought. Fortunately for them, they'd taken out insurance against this eventuality with a company called AIG. This insurance didn't necessarily pay out their entire investment but it did underpin the losses they would make.

So they asked AIG to make the payments it was contractually obliged to make. Now it turns out AIG insured rather too many of these CDO thingies because it's mathematical geniuses got their sums wrong when they predicted that the chances of simultaneous mass default was highly unlikely. The US government bailed out AIG specifically so that it could make these payments because if AIG didn't have to pay out on these insurance claims it would not in fact be bust. And if AIG went bust then all sorts of other insurance claims etc. would suddenly need to be paid out and the whole house of cards which is the current financial system woulf collapse. This was why the US goverment bailed out AIG in the first place.

If the US markets had not sold a bunch of these CDO thingies and insurance to foreign banks then all these CDOs would have been bought by the US financial sector alone, which as Rich Galen is well aware, is practically bust. With these added it seems likely the US banking system would have collapsed, thanks to globalization some of the risk was spread onto banks in Europe and some of those banks in Europe spread some of the risk back onto AIG. The European banks have all made terrible losses, even with these insurance claims, and many have been bailed out to some extent by their taxpayers. However, not unreasonably, the European governments don't see why they should pay their banks money that they are owed by AIG and which replaces mortgage payments that US residents should have been making.

Let me add here that the US really wants foreigners to continue to buy US bonds, particularly government bonds. If foreigners don't buy these bonds then it is not clear who will and if no one does then the US joins countries like Argentina and Zimbabwe in the "economic failure" category. I'm pretty sure Mr Galen does not want this because it will mean that everything he buys that is imported from abroad (from wine to gadgets) will cost a LOT more and the US will likely experience inflation and other economic dislocations that mean that all his savings will be worthless.

I could go on and explain protectionism, which is next on the slippery slope this column starts out on, but I won't. I'll just say note that the list of bad things that would come from having governments meddle in commercial contracts is extremely long and that I'm not aware of any nation actually benefitting from this kind of action.