We demand to see more transparency
President Obama has promised more transparency in government. But so far, it seems we're still in the dark. Commentator Dean Baker says it's time for insurer's like AIG to come clean or taxpayers should exercise their options.
Dean Baker, co-director of the Center for Economic and Policy Research. (Center for Economic and Policy Research)
More on Commentaries, America's Financial Crisis
TEXT OF COMMENTARY
Kai Ryssdal: Ever since the banking system really went off the rails back last September -- when Henry Paulson went to Congress with a two and a half page proposal that asked for $700 billion -- there has been a certain lack of forthrightness about what the money is being spent on. And there still is. Commentator and economist Dean Baker says it's time for the Obama administration to make good on its promise for more transparency.
DEAN BAKER: There's been a lot of talk in Washington about a new era of openness and accountability, but when it comes to the bank bailouts, we'll still in the bad old days.
We know the basic story. The banks got into trouble with complex financial derivatives that they apparently didn't understand. Their losses left many bankrupt. And the taxpayers must either cough up the money or watch the financial system collapse.
Well, the taxpayers still have some options. Specifically, we have the right to demand that that money going out the door is actually used to prop up the banking system and not some well-connected hedge fund's gambling habit. At this point, we just don't know.
The secrecy problem is clearest with AIG, the giant insurer that has been largely taken over by the government. The government has already lent AIG $160 billion, and will almost certainly lend more in the future. Most of this money will not be repaid.
AIG needs taxpayer dollars because it made hundreds of billions of dollars of commitments in the form of "credit default swaps," which are a type of bond insurance. AIG has to pay out on these credit default swaps because many of the bonds they insured, which include mortgage backed securities, are going bad at record rates.
The government has no legal obligation to honor AIG's credit default swaps, but ostensibly it is choosing to do so because these swaps are held by financial institutions that could fail if the credit default swaps were not honored.
The problem is that the public has no idea if this claim is true because we don't know who holds the swaps and how much they are owed. We don't know if the Fed is only honoring AIG's credit default swaps to ensure the solvency of banks and pension funds, or whether it may be paying off credit default swaps even in cases where hedge funds or other speculators were just making a bet that a bond would go bad.
The Fed and the Treasury are asking us to trust them with our money. But these are the people who completely missed the buildup of this financial bubble and minimized the problem at every turn. Their track record does not warrant much trust at this point.
Kai Ryssdal:Dean Baker is the co-director at the Center for Economic Policy Research.
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From baltimore, MD, 03/11/2009
Atlas Bailed
The financial rescue package’s $1.5 trillion price tag (including funds from the proposed budget) is pretty astonishing but what's even more amazing is how few are questioning it. Sure, we hear grousing about the lavish pay packages and junkets the banks are paying for with taxpayer money, but our politicians and the mainstream media are not questioning the basic idea of the bailout nearly to the extent that they have opposed parts of the stimulus package. Instead we're relying on the "expert" advice of many of the same people that got us into this situation in the first place - the thought being that if we don't listen to them our financial system may collapse. But we're missing something big here. A bailout is an ineffective use of our money. It not only perpetuates a broken system and rewards those who abused it most but it also amounts to a large transfer of wealth from the middle and lower income masses to the better-off few. Moreover, if the crisis runs as deep as many prominent economists fear, the rescue package won't work; it will just forestall failure and promote "zombie" institutions, delaying our recovery.
As complex as the financial crisis can sound with all of the different instruments and interrelationships, the most important aspects of the problem are not all that difficult to comprehend. Low interest rates and lax regulation allowed our society to rapidly expand the amount of debt we use. Not only did we consumers take on more debt but so did many financial institutions. Abundant money at low rates created a money- making machine for these institutions which borrow at low rates and lend money at higher rates, pocketing the spread. While the money-making machine was functioning and the margins were large, these companies were motivated to borrow larger and larger sums to boost earnings. Unfortunately this created a dynamic where too much money was chasing too few opportunities and loans were made that shouldn't have been - thus the saying "risk was mispriced." Financial institutions financed purchases of these risky loans almost exclusively with debt, which means they simply didn't have much cushion to protect themselves or their lenders in the low probability event that these loans would go bad. So when a few over-extended borrowers could not pay some highly levered lenders, the disaster began. Fear and deleveraging are bringing us close to a self-feeding deflationary spiral which threatens our financial system.
Now the financial institution managers representing lenders, stock holders, and employees come to us with one outstretched hand asking for money while the other wields a hammer, ready to bludgeon us with the threat of system-wide failure. The hammer makes it difficult to press the matter but we need ask the question more forcefully, “why should we taxpayers bail out lenders and what happens if we don't?” Understand that a bailout in any form essentially involves giving taxpayer money to lenders who made bad loans. Taxpayers, who on average are not particularly well-off, will be rescuing relatively wealthy people who lost money buying securities that carried some risk. If the taxpayer doesn’t comply, these managers tell us that the entire financial system is at risk.
But is that really the case? If it is, what does that mean to the average taxpayer? Because financial institutions engage in many transactions with one another, there is the potential that a couple large failures could bring down many more banks - the domino effect. While this is a serious concern, we've had many bank failures in the past (534 in a single year - 1989) and this didn't destroy our financial system. So what would mass bank failures mean? Is the answer so awful that taxpayers should write a blank check to the financial industry to avoid it?
The federal government can allow banks to fail in a controlled manner. Equity holders would be wiped out and creditors would divvy up the remaining assets. The FDIC would be named a receiver and the insured depositors would keep their money. Most front-line employees could keep their jobs, and the bank could be run by the government until a private buyer is found. The federal government could even take care of deposits that are over the insurance limit – recognizing that doing so would be much less expensive than pumping enough new capital into these institutions to keep them solvent. Although mass failures would be disruptive, they wouldn't necessarily be disastrous to most taxpayers. The people who would suffer most are the equity and debt holders of these institutions.
Failure is part of capitalism. It’s the free-market's "self cleaning" function rewarding smart risk-takers at the expense of those poorly positioned. Letting institutions fail means that the government will not have to decide winners and losers -- or help manage solvent institutions. And just as weeding out the weak wildebeests keeps the herd healthy, so it goes with financial institutions. On the other hand, a bailout can prolong the economic downturn as strong institutions don't want to lend because they don't know who is solvent and the "zombie" banks the bailout has created won't lend because they're too precariously positioned.
The biggest irony, and one that seems to have escaped notice, is that the "Masters of the Universe" from Wall Street are asking us to take leave of free markets and capitalism because the markets have moved against them. Indeed, these "sunshine capitalists" scoff at the notion of nationalizing the banks as anti-free-markets while supporting financial "handouts" as a means to rescue ailing institutions. They've become confused (it probably has something to do with self-interest) but the (temporary) nationalization we're referring to is just the end result of market forces. When a large bank fails, the government can intervene to calm fears before reconstituting the institution and privatizing it with new owners. But what the Masters of the Universe propose is truly offensive to any real free market proponent: lenders enjoy the benefits of taking risks while the economy is humming but taxpayers bear the downside when the environment turns ugly.
We're in the midst of one of the more severe economic downturns in this country's history. How we respond to this crisis is a real test of our dedication to the ideals of free markets and capitalism. It is a defining moment in our history. If we continue propping up failing institutions whether auto manufacturers, insurance companies, investment banks or commercial banks -- we not only prolong our pain and weaken our future prospects, but we risk undermining investors' faith in the ability of our markets to determine economic outcomes. Economic downturns promote the reallocation of the productive factors of an economy – basically, society redirects resources into new opportunities. Let's not let our government prevent one of the few benefits of an economic downturn in the name of preserving the status quo. Let's take these awful lumps as quickly as possible and get on with enjoying the best, most flexible and responsive economy in the world.
03/10/2009
Dean, what's the next step? What can we do? When my house is being looted by crooks with big guns and the cops are on their side, what can I do?
Thanks Dean for being coherent and congratulations for being accurate for a long time. It still baffles me that the "experts" didn't see it coming.
From San Francisco, CA, 03/10/2009
Wow, I was wondering why I heard so little about the credit default swap crisis that was supposed to explode. Now I know why, because the taxpayers are likely bailing the holders of speculative CDS's out via the money we are dumping into AIG.
With lack of transparency on the governments part, we can only assume the worst, that the money being dumped into AIG is a waste and we are bailing out people that don't deserve it.
From Farmers Branch, TX, 03/09/2009
I fully agree with Dr. Baker. I could not agree more. The US government is under no obligation to honnor AIG's obligaitons from Credit Default Swaps. They should not be repaid by taxpayers. Furthermore, they should be made illegal again. They were outlawed once after the Panic of 1907. Essentailly Credit Default Swaps are side bets on stocks, betting on the price of a stock without actually buying the stock. It's not clear why these off track bets are so bad except that the actual corporations don't get the 'vig'.
From Bethel, CT, 03/09/2009
The administration's proposed mortgage assistance program means to exclude those who bought recklessly and speculatively. Fair is fair - apply the same rule to the financial-industry bailouts. And that requires that we know who the counterparties to AIG, Citigroup, etc. are, and what their roles and actions were. Far more than individual homeowners, they had a duty to understand the investments they made, and to act prudently with their shareholders'/owners'/beneficiaries' money.
From Pittsburgh, PA, 03/09/2009
Dean is starting to pull back the covers on this ripoff. He should be more honest, "these people" didn't just "minimize the problem", they may have masterminded it. Who else, but those who were "present at the creation", could possibly expect to solve the problem over a weekend and set its price higher than anything has ever been priced before, with a business plan merely 2 1/2 pages long. Who else would expect to raise $300 billion per page of their business plan??
From Twisp, WA, 03/09/2009
Dean Baker - Thank you for inserting some common sense into the discussion over AIG and the bail out of the financial sector. It is insane that we are using taxpayer funds to try and fill a financial hole that likely cannot be filled. According to the OCC (Comptroller of the Currency Administrator of National Banks), the third quarter report for 2008 showed the notional value of derivatives held in U.S. commercial banks at $175.8 trillion - "99% of these credit products were accounted for by "credit default swaps" that are dragging AIG under; 97% of those are held by five banks" (see http://www.huffingtonpost.com/howard-schweber/geithners-dragon_b_170790.html ).
By contrast, the GDP of the entire world in 2008 was something like $70 trillion. We cannot possibly fill this hole but could very well bankrupt the nation trying.
We would be much better off if the government took over insolvent banks in order to get credit flowing and protect tax payer deposits, and used the money that we're throwing away on AIG and the rest of the financial sector, to provide some basic economic security to the American people in the form of a strong social safety net, so we can weather the transition before us. The nation can survive the collapse of some parts of the financial sector. But if the economy continues to collapse, our social fabric could be severely strained. That will be harder to survive. We need to save the nation's people first and let the markets deal with AIG and their own financial excesses. Otherwise they could drag us all down with them.
From FL, 03/09/2009
Dean Baker just sound my thoughts. Why the problem which Mr. Bernanke less then 1 year ago described as $100 billion or $200 billion in the worst case scenario, grows within 9 month to 2 trillion dollar problem and now became unlimited. It seems that the crooks just decided that this is a great opportunity which they can't let go. And FED prove themselves at best completely incompetent and negligent or criminally complicit at worst. In any case the whole FED board of governors must resign.
From huntington beach, CA, 03/09/2009
Thank you Dean Baker! At long last someone is raising this issue. It seems crazy to me that we would be paying off CDS's to people who don't own the bonds, hedge fund managers who correctly anticipated a bond's collapse. Maybe AIG could simply refund the premiums which the hedge funds paid. To me it seems best to let AIG go Chtr 11 to void all of these contracts. From there you could transfer the contracts you want to cover, to another institution to be paid by the govt. AIG is a bottomless pit.
From alameda, CA, 03/09/2009
I am glad to hear an economist, Dean Baker, raise the AIG credit default swap liability as a factor in the bail-out. Aren't there "sunshine laws" for the U.S.
Treasury?
From Brentwood, NH, 03/09/2009
Dean Baker is right, as usual. We're way past the point where we should care if revealing the counterparties will in itself weaken their financial creidibility. We certainly have a right to know where our taxpayer money, every cent of it, is going.
From Brentwood, NH, 03/09/2009
Dean Baker is right, as usual. We're way past the point where we should care if revealing the counterparties will in itself weaken their financial creidibility. We certainly have a right to know where our taxpayer money, every cent of it, is going.
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