This is what I read this morning, 17 September
2008, on FT.com: "The US Federal Reserve announced that it will lend AIG up to
$85bn in emergency funds in return for a government stake of 79.9 per cent and
effective control of the company - an extraordinary step meant to stave off a
collapse of the giant insurer that plays a crucial role in the global financial
system. Under the plan, the existing management of the company will be replaced
and new executives will be appointed. It also gives the US government veto
power over major decisions at the company" (see "US to take control of AIG", Financial
Times, 17 September 2008)
Willem Buiter is professor of European political economy, London School
of Economics and Political Science; former chief economist of the European Bank
for Reconstruction and Development (EBRD); former external member of the
Monetary Policy Committee
Willem Buiter writes the Maverecon blog in the Financial Times's ft.com
website, where this posting was published on 17 September 2008
I almost decided to go back to bed, convinced
I must be dreaming.
The proximate cause of the demise of AIG as a private firm was its "monoline"
activities, its exposure to massive amounts of credit-risk derivatives such as credit default swaps (CDS), many of them linked to the United States real-estate sector.
The largest insurance supermarket in the
world, with a balance-sheet in excess of $1 trillion nationalised because it
was deemed too big and too globally interconnected to fail! The fear that drove
this extraordinary decision is that AIG's failure would increase counterparty risk - actual and perceived, throughout the
financial system of the US and the rest of the world alike - to such an extent that
no financial institution would have been willing to extend credit to any other
financial institution. Credit to households and non-financial enterprises would
have been the next domino to fall - and, voilà!,
financial Armageddon.
I cannot judge the likelihood of the disaster
scenario, but if there ever was a case for applying the precautionary principle
in economic analysis, then this is it. It was also done in the right way, by insisting on controlling
public ownership, i.e. nationalisation, of the company.
The existing management is gone - again as it
should. We will find out whether they left with golden parachutes or with just
a cardboard box packed with their personal belongings. The precise
implication of the deal for the old shareholders will also matter for the
ultimate judgment on its fairness and on what it does to incentives for future
risk-taking. Since the existing shareholders were obviously not completely wiped
out by the deal, they do well out of it - probably too well. The public
takeover appears to imply that all creditors other than the ordinary and
preferred shareholders will be made whole. From the perspective of incentives
for future excessive risk-taking, this is regrettable. A charge on the
creditors, modulated according to the seniority of the debt, would have been
preferable.
But perhaps my concern about incentives for
future risk-taking is moot, because it assumes that private, profit-seeking
enterprises will again, in the future, pursue the kind of financial activities
engaged in by AIG. If financial behemoths like AIG are too
large and/or too interconnected to fail but not too smart to get themselves
into situations where they need to be bailed out, then what is the case for letting private
firms engage in such kinds of activities in the first place? Is the reality of
the modern, transactions-oriented model of financial capitalism indeed that
large private firms make enormous private profits when the going is good and
get bailed out and taken into temporary public ownership when the going gets bad, with the taxpayer taking the risk and the
losses? If so, then why not keep these activities in permanent public
ownership?
Also in openDemocracy on the global financial crisis of 2007-08:
Ann Pettifor, "Debtonation: how globalisation
dies" (15 August 2007)
Robert Wade, "The financial crisis: burst
bubble, frayed model" (1 October 2007)
Avinash D Persaud, "The dollar standard: (only the)
beginning of the end" (5 December 2007)
Ann Pettifor, "Globalisation: sleepwalking to
disaster" (11 December 2007)
Fred Halliday, "Sovereign Wealth Funds: power vs
principle" (5 March 2008)
Ann Pettifor, "America's
financial meltdown: lessons and prospects" (16 September 2008)The logic of
collapse
There is a long-standing argument that there
is no real case for private ownership of deposit-taking banking institutions,
because these cannot exist safely without a deposit guarantee and/or lender of
last resort facilities, that are ultimately underwritten by the taxpayer. Even
where private-deposit insurance exists, this is only sufficient to handle
bank-runs on a subset of the banks in the system. Private banks collectively
cannot self-insure against a generalised run on the banks. Once the state
underwrites the deposits or makes alternative funding available as lender of
last resort, deposit-based banking is a license to print money. That suggests
that either deposit-banking licenses should be periodically auctioned off
competitively or that deposit-taking banks should be in public ownership to
ensure that the taxpayer gets the rents as well as the risks.
The argument that financial intermediation
cannot be entrusted to the private sector can now be extended to
include the new, transactions-oriented, capital-markets-based forms of
financial capitalism. The risk of a sudden vanishing of both market liquidity
for systemically important classes of financial assets and funding liquidity
for systemically important firms may well be too serious to allow private
enterprises to play. No doubt the socialisation of most financial
intermediation would be costly as regards dynamism and innovation, but if the
risk of instability is too great and the cost of instability too high, then
that may be a cost worth paying.
These are issues that must be pondered not
just in Washington but everywhere modern financial intermediation has taken
root or is threatening to do so - in the financial heartland (Wall Street, the
City of London, Frankfurt, Zurich, Tokyo and Dubai) and in the emerging markets
that until recently were having their ears bent on the desirability of
precisely the kind of financial institutions and markets that have now turned
into trillion-dollar collapsing dominos.
From financialisation of the economy to the socialisation of finance. A
small step for the lawyers, a huge step for mankind. Who said economics was boring?
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