Move Over AIG, There’s Plenty of Outrage To Go Around

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There is a much bigger issue that has barely been touched upon by Congress: the way tens of billions of dollars of taxpayers’ money has been funneled to A.I.G.’s counterparties — at 100 cents on the dollar. How can it possibly make sense that Goldman Sachs, Bank of America, Citigroupand every other company that bought credit-default swapsfrom A.I.G. should be made whole by the government? Why isn’t it forcing them to take a haircut?

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What’s worse, some of those companies are foreign banks that used credit-default swaps to exploit a regulatory loophole. Should the United States taxpayer really be responsible for ensuring the safety of European banks that were taking advantage of European regulations?

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Bottom line: covert subsidies were given to bank via AIG. Remember, Henry Paulson, who had perilously few inhibitions about shoveling money at banks, even when the pretexts were often dubious and the checks non-existent, nevertheless was afraid to overpay openly for dud assets, which is why he retreated from his original conception of the TARP as as way to hoover up bad debt.

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But AIG? No problem. CDS are arcane, and these were bi-lateral contracts (while the dud TARP asset were in most cases securities, so in many cases, third parties could formulate a rough view as to where they might trade).

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Wake up and smell the coffee. The public purse is being looted and we the great unwashed are being fed pablum. Just because the perps work for once esteemed institutions and are typically treated with deference does not change the nature of the undertaking.

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To this end the plan proposes to create funds in which private investors put in a small amount of their own money, and in return get large, non-recourse loans from the taxpayer, with which to buy bad — I mean misunderstood — assets. This is supposed to lead to fair prices because the funds will engage in competitive bidding.

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But it’s immediately obvious, if you think about it, that these funds will have skewed incentives. In effect, Treasury will be creating — deliberately! — the functional equivalent of Texas S&Ls in the 1980s: financial operations with very little capital but lots of government-guaranteed liabilities. For the private investors, this is an open invitation to play heads I win, tails the taxpayers lose. So sure, these investors will be ready to pay high prices for toxic waste. After all, the stuff mightbe worth something; and if it isn’t, that’s someone else’s problem.