There’s a lot of righteous anger being directed at AIG today. The company took enormous risks, and its executives made hundreds of millions of dollars, and now taxpayers are paying for it.
Essentially, AIG got into the business of insuring much of the world’s financial system against the consequences of a global financial meltdown. It turned out to be incapable of delivering on that insurance—no private company could deliver on it, which is one reason why AIG’s business of selling credit default swaps was a scam. And so government has stepped in as the ultimate insurer.
That’s a pretty good example of the mainstream opinion on this. It’s fine as far as it goes. But it doesn’t go far enough. We need to direct a bit of our righteous anger at the customers of AIG, those financial institutions who bought insurance from AIG.
Why are the customers to blame? Aren’t all these banks that tried to insure away credit risk victims of AIG? No, frankly, they are not. They are truly accomplices of AIG in the scam. Many of them were well aware that AIG couldn’t possibly fund the insurance policies it was writing. But they didn’t worry about that because they were operating under the same assumption AIG was: that the policies would never have to be funded on any widespread scale. Defaults on credit products were supposed to be isolated and non-correlated.
What’s more, many assumed that a complete AIG meltdown was what we call a “Financial Armegeddon” bet. The idea was that AIG would never be allowed to default on its obligations–it would be bailed out by the American taxpayers. And if the American taxpayers couldn’t afford to bail out AIG, well then you’d be in such dire straits that your main concern would be food, shelter and ammo and not the performance of your loan portfolio.
By bailing out AIG, and therefore bailing out its counterparties, the US government is rewarding this kind of reckless behaviour. And it is punishing responsible credit insurance writing, essentially telling anyone who placed a premium on buying insurance from a solvent insurer that they were suckers. They should have bought the cheap contract from AIG instead.
And people wonder why these bailouts aren’t making us financially healthier.
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