Table of Contents
In part I (AIG: The One-Way Bet Behind the 2008 Financial Crisis?), we explained the events and actions leading up to the AIG bailout and 2008 financial crisis. Financial institutions were handing out tranches with subprime loans, and AIG allegedly insured these predatory lending practices.
In the second half of the story, we will delve deep into the details about the recovery effort of the Federal Reserve Bank and the Treasury. Trillions of taxpayer money could have gone to paying off investors who knew they were contributing to the economic collapse. In short, with the CDS insurance, they might have got paid back by the government for lucrative investments doomed to fail from the start.
AIG Home Loans and the Economic Fallout
In March 2008, with the housing bubble close to bursting and companies floundering, the bailouts began.
But amid the rubble and ruin of the economy, allegedly caused in major part by AIG FP’s actions, inquiries into why these big companies deserved saving started to emerge. They had seemingly dug their own grave but brought much of the public down with them. The London subsidiary of AIG should have just gone out of business, no?
The Dissolution of Lehman Brothers
AIG, along with other large banking institutions, was verging on collapse one by one. It would take billions of dollars in taxpayer money to help claw themselves out of its self-made ruins. Between the Federal Reserve and the Treasury, the regulators were saving Bear Sterns, Fannie Mae, and Freddie Mac. The thought was the collapse of these financial institutions would have an immeasurable deleterious impact on the economy.
Nevertheless, one investment banking company fell through the cracks. Lehman Brothers were teetering on the edge, and the financial community banded together to devise a way to save the company. After much deliberation, the group found that the only feasible option was for British bank Barclays to buy out Lehman. However, the British Financial Services Authority rejected the deal, claiming it would put the UK’s economy at risk.
The Reason Foundation, a libertarian non-profit organization, reported this quote from then-British finance minister Chancellor of the Exchequer: “We are not going to import your cancer.” Lehman filed for Chapter 11 bankruptcy after the failure of the deal.
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As it pertains to the AIG bailout, the Reason Foundation’s article goes on to say: “The day after Lehman filed for bankruptcy, AIG looked like it was going to fall apart. The decision to bailout out AIG was largely reflexive by the embattled treasury secretary [Henry Paulson]. The harsh negative reaction to letting Lehman fail seemed harder to bear than being known as the bailout secretary. The fear of systemic risk won the day, and AIG—along with every major company afterward until CIT in November 2009—was bailed out.”
Money manager Michael Lewitt wrote in an NYT op-ed: “[AIG’s] collapse would be as close to an extinction-level event as the financial markets have seen since the Great Depression.”
Time magazine chimed in, claiming: “There’s also the fact that through its insurance policies AIG touches far more regular Americans (and consumers around the world) than Lehman Brothers did. Plus, AIG’s insurance businesses make so much money that they could conceivably pay off the cost of the bailout within a few years.”
Troubled Asset Relief Program Funds
As alluded to before, the Treasury Secretary was scrambling to prevent total economic collapse. Paulson introduced the Troubled Asset Relief Program (TARP), and then-President George W. Bush signed it into law on October 3, 2008. To pay for the bailout and stimulus, the government had to lend, adding to the national debt that had long been mounting, increasing the interest payments due.
TARP initially gave the Treasury $700 billion in purchasing power, although it would be reduced to $475 billion due to the Dodd-Frank Act. The program’s purpose was to mitigate potential losses of troubled institutions by buying their MBSs. This is to say, those who had invested in MBSs received payouts for their supposedly high-risk investments. Regardless, TARP had the effect of increasing the liquidity of money and secondary mortgage markets. Eventually, the program’s aim shifted slightly in order for the government to purchase equity in banks and other financial institutions.
ARTICLES ON WASTEFUL/UNETHICAL SPENDING
Per the Harvard Business Review, “Measured by decrease in per capita United States GDP compared to the pre-crisis trend, by 2016 the crisis had cost the country 15% of GDP, or $4.6 trillion.” Even though much, if not all, of TARP, has been repaid, the damage to economic productivity should not and cannot be ignored.
The following is an excerpt from a report published in 2018, by the Federal Reserve Bank of San Francisco:
“A decade after the last financial crisis and recession, the U.S. economy remains significantly smaller than it should be based on its pre-crisis growth trend. One possible reason lies in the large losses in the economy’s productive capacity following the financial crisis. The size of those losses suggests that the level of output is unlikely to revert to its pre-crisis trend level. This represents a lifetime present-value income loss of about $70,000 for every American.* ”
Are the American citizens being ripped off when companies rig the economy to the point that it crashes? It is unethical for investors who ‘gambled’ on bad investments (more akin to a guaranteed payday) to have their losses paid off with taxpayer money.
Too Big to Fail Banks and Other Companies
Here is a partial list of companies that have received bailouts from the U.S. government:
- Fannie Mae and Freddie Mac, $400 billion
- AIG, $182.3 billion
- Citigroup, $50 billion
- Bank of America, 45 billion
- Bear Stearns, $30 billion
- JPMorgan Chase, $25 billion
- Wells Fargo, $25 billion
- General Motors, $13.4 billion
- Goldman Sachs, $10 billion
- Morgan Stanley, $10 billion
- PNC Financial Services Group, $7.579 billion
- U.S. Bancorp, $6.6 billion
- GMAC Financial Services, $5 billion
- Chrysler, $4 billion
- Capital One Financial, $3.555 billion
- Regions Financial Corporation, $3.5 billion
- American Express, $3.389 billion
- Bank of New York Mellon Corp, $2.5 billion
- State Street Corporation, $2.5 billion
- Discover Financial, $1.23 billion
Peak Prices for Poor Investments?
But did the Federal Reserve pay peak market prices for these mortgages (particularly MBSs) in order to pay off investors in the wake of the AIG bailout. In essence, so they could profit off with their insurance (CDS) on a failed investment?
The Federal Reserve published a report assessing the efficacy of the MBS program:
“Once the Federal Reserve’s MBS program started purchasing MBS, we estimate that the abnormal risk premiums embedded mortgage rates decreased roughly 50 basis points. However, observed mortgage rates declined only slightly because of generally rising interest rates.
After May 27, 2009, fairly normal pricing conditions existed in U.S. primary and secondary mortgage markets; that is, the relationship between mortgage rates and their determinants was similar to that observed prior to the financial crisis. After the end of the Federal Reserve’s MBS purchase program on March 31, 2010, mortgage rates and interest rates more generally were significantly less than they had been at the beginning.
In sum, we estimate that the Federal Reserve’s MBS purchase program removed substantial risk premiums embedded in mortgage rates because of the financial crisis. The Federal Reserve also re-established a robust secondary mortgage market, which meant that the marginal mortgage borrower was funded by the capital markets and not directly by the banks during the financial crisis-had bank funding been the only source of funds, primary mortgage rates would have been much higher.
Lastly, many observers have attributed part of the Federal Reserve’s effect from purchasing MBS to portfolio rebalancing. We find that if portfolio rebalancing had a substantial effect, it may have had its greatest importance only after the Federal Reserve’s purchases ended, but while the Federal Reserve held a substantial portion of the stock of outstanding MBS.”
Federal Reserve Printing Money to Pay Back MBSs
The damaging effects of predatory lending practices on the GDP aside, what about the trillions of dollars printed in order to resuscitate and bailout these companies? While TARP has been paid off, the trillions of dollars that the Federal Reserve bank printed in order to buy the MBSs and pay those who might have knowingly invested in CDOs in order to get a massive payout.
The New York Federal Reserve Bank reported:
“The MBS program completed its purchases on March 31, 2010, but will continue to settle transactions over the coming months. In connection with this activity, the Federal Reserve continues to use dollar roll and coupon swap transactions to facilitate an orderly settlement of the program’s purchases…The FOMC [Federal Open Market Committee] directed the Desk to purchase $1.25 trillion of agency MBS. Actual purchases by the program effectively reached this target.”
Do American citizens get ripped off when the Federal Reserve prints trillions that go straight to the pockets of crony capitalists? Companies that can’t pay their debt go out of business. Investments that fail result in losses, not gains.
Hester Pierce, former senior research fellow at George Mason University’s Mercatus Center, analyzed the fallout of the AIG bailout and the financial crisis in general. She came to three recommendations/conclusions that we can take away from the tragedy to hopefully prevent such events in the future.
- “The markets themselves are the most effective regulators if the government allows them to be. Sparing AIG prevented the markets from meting out discipline on the company. Regulatory reform efforts should aim to make companies more accountable to the markets.”
- “Relying on regulators to spot problems and solve them is not an effective alternative to corporate risk management. There is no reason to expect that a regulator like the Federal Reserve would have been more effective as a systemic regulator than the Office of Thrift Supervision.”
- “The additional layer of systemic regulation to which companies like AIG are now subject could increase the risk to the financial system. The new regulatory framework effectively outsources risk management to regulators. Companies worried primarily about pleasing their regulators will not think strategically about their own risks.”
The key regulator, according to Price, is the market itself. Just as we are told in our youth that actions have consequences, banking institutions and investors who took the economy to near ruin should have been left alone to face the damages they caused. Instead, the government saved them and potentially handed investors trillions in profits.
Eradicate the Rigged Layer of the Economy
$ 70,000-lifetime income lost per American on the GDP damages alone. That’s more than a year’s worth of college tuition, a significant sum that could have gone to paying off debt, money that would have aided single mothers to care for their children. And that number does not even factor in the trillion-plus dollars the Federal Reserve printed to pay off MBS investors.
Consider just how much money we could have had if the 2008 financial crisis had not occurred.
But now, we pass on the case to all of you, the citizen investigators. We have just provided a foundation for you to start your own case exploring the potential theft involved in the AIG bailout and mortgage crisis. There’s much more to find (for and against, perhaps), and you can contribute to finding the truth that will expose those rigging the economy against the public.
The rigged layer on top of our otherwise ethical economy continues to allow crony capitalists and corrupt officials to rip us off of trillions of dollars. That’s what has caused the fifty years of wage stagnation and fixed prices, seemingly disproving the Kuznets curve.
By exposing the bad actors and eliminating the rigged layer, we, the public, will leave the profitable, ethical layer of the economy intact. Only then can we benefit from higher wages across the board, markets that involve genuine competition for our business, and a government that legislates based on our interests. We can achieve this, but we need you to join our movement for an ethical economy.
We must end the corporatocracy and restore our democracy.
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Terms like ‘steal,’ ‘theft,’ and ‘crime’ will frequently appear throughout the article. ZeroTheft will NOT adhere strictly to the legal definitions of these terms (since congress sells out). We have broadly and openly defined terms like ‘steal’ and ‘theft’ to refer to the rigged economy and other debated unethical acts that can cause citizens to lose out on money they deserve to keep.