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Wednesday, September 17, 2008


AIG nationalized; who's next?

after reversing course late yesterday, late last night AIG was effectively nationalized by the federal reserve bank, which granted an $85bn loan to the dying polytechnic insurer in return for warrants giving it claim to 80% of AIG.

there will be unforseen ramifications to the bailout, and much analysis in the aftermath. but the first question to answer seems to me to be simply, "who's next?"

as the IRA pointed out yesterday, these are the opening courses of a long meal. washington mutual might be our first taste of the main dish -- regulators are trying to find a buyer today. chances are good the FDIC will be running wamu by friday evening.

but sidelight disasters are surely queueing up for government aid, now that it is becoming apparent that the fed and treasury intend to try to save every substantial systemic threat as it approaches them in crisis, whether or not the firm itself is strictly financial or falls into the normal regulatory purview of these institutions. one might say that lehman was shoved off the cliff precisely because it had neither behaved rashly enough nor grew itself large enough. not every firm has that problem.

as such, beyond banking, i can think of several candidates. general motors and ford are two of the largest debtors in the world, and their bankruptcy after decades of profligate debt issuance could send shock waves around the world. both have large finance arms that are suffering severely, presenting enough financial pretext to intervene. general electric houses GE capital, one of the largest financial companies in the world, and is suffering terribly. and one would be remiss not to mention morgan stanley and goldman sachs, the two remaining investment banks which have seen their three bretheren swept away. reliant as they are on overnight funding, as the crisis deepens they too may find themselves pushed to the wall, perhaps in suprisingly short order.

my sister wrote asking me about what was happening -- itself a sign of widespread public fear -- and after explaining what AIG does and why its failure was prevented, i wrote:

so i think they did have to save it. but here's the problem:

after the crash of 1929, government spent all of 1930 and some of 1931 trying to force credit into the system -- just like we're doing now -- to keep people from selling stuff to raise money to pay debt. eventually, it became clear to the government that, if they tried to save all the "necessary" parts of the system, they would end up irretrievably damaging the balance sheet of the government of the united states, making it impossible for the government to borrow money. so they took the prudential step of building a firewall between the private sector and the government, and let the private sector fail.

going into the 1930s, the american government was a lot smaller, relative to the private sector, than it is today. but its balance sheet was a lot stronger -- back then it was a massive international creditor. today, the united states is the largest debtor on the planet and needs $700bn in chinese money every year just to keep going. (something neither john mccain nor barack obama will talk much about.)

all these bailouts cost money -- chinese money. and if the united states isn't careful, it will find out why the government was smart not to risk the quality of the american government balance sheet in 1931. there has to be a limit on the bailouts at some point, or we will suffer much bigger problems resulting from a dollar collapse that would render our money pretty much worthless.

i don't know where the line is -- no one does. but we sure as hell better not cross it, even accidentally.

meanwhile, the warnings from china are getting louder and louder. not to mention s&p.

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