The Right Kind of Bailout

Today’s NYT has an article about the enormous obstacles facing any Detroit bailout bill between now and October, with Senator Richard Shelby of Alabama saying that "the financial situation facing the Big Three is not a national problem but their problem," and

John Boehner, the Republican leader, saying that a bailout would not be "sound fiscal policy".

The NYT also, however, has a pointed column from Floyd Norris, who notes the double standard being applied here: while the government is disinclined to give Detroit any help at all, it’s much more well-disposed towards companies like AIG and Fannie Mae which are coming back for second helpings of bailout money, after having made clearly insufficient changes the first time around.

What’s really needed here — and what we obviously aren’t going to get before January — is a clearly-explained and internally-consistent government fiscal policy which sets medium-term strategic objectives and then puts both TARP and any forthcoming stimulus plan to work in achieving those goals. Hank Paulson hasn’t come close, and neither he nor George Bush seems inclined to work with Barack Obama’s transition team and put in place policies which could be acceptable to both the present administration and the coming one.

Instead, we get bailouts for Wall Street which have undoubtedly increased the job security of thousands of bankers on seven-figure salaries, while creating only the most nebulous positive effects for Main Street. I’m getting a bit fed up with Paulson’s "trust me, things would be so much worse for you if we hadn’t done this": frankly, I don’t trust him at all any more.

The much-vaunted accountability provisions in the TARP legislation seem to have been forgotten about entirely, even as the government fights to keep details of the Fed’s liquidity provisions secret. So I have limited sympathy for those who suddenly find themselves overly concerned about the costs and benefits of a Detroit bailout, as compared to, say, an entirely hypothetical multi-billion-dollar "retraining and job placement" program the likes of which the US has never successfully implemented since the WPA and which in any case would have precious little immediate effect on the devastated Rust Belt.

To be clear, I am not averse to bankruptcy protection for troubled automakers — but I do think that if GM is to declare bankruptcy, it should do so with the support of the government and a clear plan to come out of bankruptcy with at the very least its warranty obligations intact and its parts suppliers still operating. GM deserves government support; GM’s bondholders do not. And the government might well find that its support is best put to use within the context of bankruptcy, rather than with an eye to preventing bankruptcy.

A chaotic descent by General Motors into forced bankruptcy with no pre-packaged way out and no hint of government support, however, is most emphatically not in this nation’s interest. I’m all in favor of creative destruction, but not for some of the biggest and most symbolically-important companies in the country, in the middle of the worst recession in living memory.

Yesterday, I got an email from Ken, a loyal reader, asking about the AIG bailout:

What have they been spending the $100+ billion they have received from the govt on? Paying off swaps? What damage has this prevented? Why doesn’t AIG have to report what it’s doing with all those funds? And when will they start auctioning off their allegedly profitable and valuable insurance subsidiaries to pay off that bailout?

These are good questions. Most of the money has been spent to put up collateral against CDS contracts written by AIG Financial Products; a large chunk of the rest was used to cover completely unnecessary losses associated with AIG’s securities-lending program. AIG was meant to start auctioning off their insurance subsidiaries immediately, but now its new CEO has persuaded the government to give it a few more years.

But the biggest question of the lot is the one which is hardest to answer: what damage has the AIG bailout prevented? I don’t know, and I haven’t seen anybody at Treasury or elsewhere give a good answer to that question. The idea, I think, was that if AIG hadn’t been bailed out, it would have defaulted on its credit default swaps, which generally insured CDOs held by big US banks. In turn, the big US banks would have had to take enormous write-downs on their CDO portfolios — yes, even bigger than the ones they’ve taken already. And that could have raised serious concerns about the US banking system, causing financial meltdown.

But it would be really nice if someone could quantify exactly how much of this kind of exposure the US banking system had to AIG. After all, US banks are reasonably adept at juggling counterparty risk, and Goldman Sachs, for one — which seems to have had more CDS outstanding with AIG than anybody else — has consistently claimed that its exposure to AIG was well hedged.

The other reason to bail out AIG was to shore up the CDS market more generally: if AIG were to default on its CDS obligations, that might start a chain reaction of other CDS defaults. Again, I haven’t seen anybody make this case very explicitly. AIG wrote very particular CDS, which weren’t and aren’t traded: it wasn’t really part of the CDS market, so much as a bespoke provider of tailored CDS, situated at one remove from the market as a whole. The huge edifice of traded CDS on single names and indices might well have emerged largely unscathed from an AIG collapse, since it never had much connection with AIG in the first place. Again, I don’t know, but I am a bit upset at the fact that nobody has really spelled anything out for the taxpayers who have now twice bailed out AIG with very little to show for it.

Compared to the effects of the AIG bailout, then, the effects of a GM bailout would be much more tangible, and would include not only saved jobs in one of the most depressed areas of the United States, but — if it was done right — the first steps towards a coherent energy and security policy. I just hope that by the time Barack Obama comes into power, it won’t be too late; there seems to be no chance that the present administration is willing to go down that road.

This entry was posted in bailouts, fiscal and monetary policy. Bookmark the permalink.