Moral hazard...

AIG was bailed out by the Fed yesterday. AIG has over 1.1 TRILLION in assets and needed a bridge loan of $85 Billion to keep the cash flowing since it's being called on the "insurance" it wrote for the mortgage backed securities that have all failed. The Federal Reserve thought it prudent to keep this company going along instead of letting it fail.

Both Senators McCain and Obama have denounced the bail out wherein the Fed had originally decided not to help the insurance giant, but then changed it's position when AIG couldn't obtain the tens of billions required from the private sector (seems like no one has that kind of money these days).

Now in this case, the Fed got something in return - some 80% of the company and they got to fire all of the leadership plus they have veto power for large decisions. And AIG has to repay the loan within the next 24 months. Basically this infusion of cash allowed AIG to gain more time to tap it's huge asset base and sell enough to pay off the Fed's loan. If AIG can stay solvent in this time period, the taxpayers who fronted this (all of us, by the way) will gain a positive return on our investment.

If AIG fails to become liquid enough to pay off this loan, then we've basically took $85 Billion and burned it in the street (in comparison to the Iraq War: we have dropped as taxpayers around $3 TRILLION on Iraq with estimates of around $5-7 Trillion if you include Afghanistan - Bush sold us on Iraq with a prewar estimate of $50-60 Billion - that's off by a good 100 times - figures courtesy of the Huffington Post - March 19, 2008 http://www.huffingtonpost.com/2008/03/19/iraq-casualties-iraq-cos_n_92303.html)

Like they say, a Billion here a Billion there - sooner or later you've got real money.

The problem isn't in that we don't have the money (well hell, we'll just print more!), it's that we've sent a very clear message to corporate leaders in that your company is deemed too big to fail, we've got your back. Lehman Bros. wasn't large enough so we let that one go (Merrill Lynch was purchases by B of A). But what about GM or Ford or United? We're telling those companies that there IS a chance that we'll cover you if you get too far into a corner - and that causes the moral hazard.

The motivation to keep your choices as a CEO above board and taking the appropriate risks is greatly diminished by bailing out another company. Basically we've told American corporations that you can enjoy the fruits of your risk taking and the taxpayers will pay for your losses.

Golden parachutes, hand picked board of directors, inbreeding of rock-star CEO's that have made several lifetimes of fortune in their "leadership" positions yet seem to have no obligation to the thousands of investors who have placed their faith and their money with their tenure.

Sometimes tough love is what we need to offer and we should have let AIG feel the brunt of its decision making. It would have sent a clear message to GM and others who are contemplating their own financial woes - get your shit together or it's over.

Capitalist markets require everyone to face the consequences of their actions - it's actually what regulates the industry by staying within the rules. If some companies find themselves above the law (or rules in this case), then with consequences suspended the tone of the decisions are forever changed. It's a place where we cannot let our country go.