In his excellent post on the (il)legality of the AIG takeover, David suggests a last-ditch argument to legitimize the U.S. government's action: "emergencies are emergencies, and when that happens the rules go out the window, and hopefullly regular elections mean that the officials the people trust are dealing with the emergency." This prompts the question, was this an emergency?
The problem here was with AIG's derivatives business, not with its insurance business. Consider this explanation from the lead WSJ story on the takeover:
AIG was a major seller of "credit-default swaps," essentially insurance against default on assets tied to corporate debt and mortgage securities. Weakness at AIG could force financial institutions in the U.S., Europe and Asia that bought these swaps to take write-downs or losses.
AIG's millions of insurance policyholders appear to be considerably less at risk. That's because of how the company is structured and regulated. Its insurance policies are issued by separate subsidiaries of AIG, highly regulated units that have assets available to pay claims. In the U.S., those assets can't be shifted out of the subsidiaries without regulatory approval, and insurance is also regulated strictly abroad.
Tuesday afternoon, after the market closed, AIG put out a statement saying its basic insurance and retirement services businesses are 'fully capable of meeting their obligations to policyholders.' AIG said it was trying to 'increase short-term liquidity in the parent company,' but said that didn't 'include any effort to reduce the capital of any of its subsidiaries or to tap into Asian operations for liquidity.' Asia is one of AIG's largest markets.
In short, this move is not aimed at protecting AIG's policyholders, but rather at protecting the financial institutions that purchased AIG's credit-default swaps.
Moral hazard, anyone?
UPDATE: The WSJ's Real Time Economics discusses the "rarely used legal authority under Section 13(3) of the Federal Reserve Act to lend to 'any individual, partnership or corporation' in 'unusual and exigent circumstance' provided the borrower 'is unable to secure adequate credit accommodations from other banking institutions.'" So the titular question of this post appears to be the right one. Larry Ribstein takes up the question: "But is this really 9/11? One might say that it’s more like Pee Wee Herman: a bunch of grownup companies living in a child's world in which real estate prices always go up. When they go down, should we prop up the stage set anyway?"
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1. Posted by pwb on September 17, 2008 @ 3:28 | Permalink
Interesting that AIG customers are only safe because of regulation.
Free Markets sound like such a great idea but don't work at all.
2. Posted by NonVoxPop on September 17, 2008 @ 6:41 | Permalink
Can you explain what you mean by "moral" hazard? I know it's a tangent, but I'd find it helpful in light of the discussion we were having re: biz ethics a bit back.
3. Posted by Gordon Smith on September 17, 2008 @ 7:30 | Permalink
NVP, Wikipedia captures the basic concept: "Moral hazard is the prospect that a party insulated from risk may behave differently from the way it would behave if it were fully exposed to the risk."
In that same entry, under the heading "Finance": "Financial bail-outs of lending institutions by governments, central banks or other institutions can encourage risky lending in the future, if those that take the risks come to believe that they will not have to carry the full burden of losses."
Many people were celebrating Paulsen's line in the sand on Lehman precisely because it would mitigate moral hazard, but the next day we get AIG. So I am just wondering what the message is to future market participants.
By the way, despite the use of the word "moral," it seems to me that most economists would not view this as an issue of business ethics. It's incentives all the way down.
4. Posted by Rex on September 17, 2008 @ 9:09 | Permalink
Comrade Bush?
The US is becoming a third world socialist country.
See here:
http://advocatusromanus.blogspot.com/
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