Famed shareholder advocate and Harvard Lucian Bebchuk explains in today’s Wall Street Journal why AIG is not too big to fail.
“The company claims any failure by the government to do so would have catastrophic consequences. This claim is exaggerated. Serious consideration should be given to forcing AIG’s partners in derivative transactions — which are mainly buyers of credit default swaps from the company — to take a substantial haircut,” he writes.
Larry Ribstein at Ideoblog does a great job of summarizing Bebchuk’s points. Here are the three reasons why AIG can be allowed to fail. The short version: the allegedly catastrophic effects of an AIG failure last September no longer exist.
- Insurance Holder Protected. Insurance policy holders are protected by their insurance subs (though ironically I recall AIG advertisements from just a couple of years ago selling insurance based on the supposed strength of the overall company).
- Counter-parties Rescued By Government. Losses to derivative counterparties would be “best addressed by the U.S. government (or foreign governments in the case of their banks) infusing capital directly — in return for shares — into the banks that need it.” (Could it be that this whole thing is about avoiding a direct payment to Tim Geithner’s former employer, Goldman Sachs?).
- Banks and Money Market Funds Proected. Depositors in financial institutions, including money market funds, are now protected, as they were not when Lehman failed.
Ribstein goes on to explain that not only can we let AIG fail, we should:
- Moral Hazard Has Real Life Costs. We cannot continue to both encourage risk-taking and to bail out failed bets. Moral hazard is not just a theoretical concern here. I wonder how Lehman and AIG would have been managed in the months preceding September 15, 2008 if Bear Stearns had not been bailed. Let’s not compound that horrendous mistake.
- We’re Creating A Fannie Mae Style Implied Guarantee Of Everything. Bailing out AIG would contribute to a building assumption, which may become official if we get a “systemic risk regulator,” that a huge swath of our investment industry is backed by the government. If you like Fannie and Freddie you’ll love this.
- Market Processes Are Being Undermined. Our market-based economy demands accepting the market’s judgment on which firms should fail.
- Government Control Is A Disaster. We cannot tolerate additional US government control of financial institutions. Even if Treasury’s investment would be nominally debt, surely it would have actual or implied powers comparable to equity. AIG – and all the firms that would have to be bailed after AIG – would effectively become government institutions.
Let’s add to that the fact that our political process and tax code are being badly distorted by the AIG bailout.
Enough is enough. Let this daying monster die.