Like some horror film franchise, AIG is back. After getting $85 billion credit last September, increased to $123 billion in October, then to $150 billion in November, AIG earns $30 billion in TARP money by its record-breaking $62 billion loss. The US Treasury now will have huge equity stakes in AIG and two life insurance subsidiaries. Moreover, per the WSJ, the government may have to finance buyers of AIG's aircraft leasing business.
So, taxpayers, what do you think about the government ponying up a quarter trillion for an insurance company, with a little aircraft leasing on the side? As I said about last September's AIG bailout:
Was this an emergency? * * * One might say that it’s more like Pee Wee Herman: a bunch of grownup companies living in a child's world in which real estate prices always go up. When they go down, should we prop up the stage set anyway?
The rationale, of course, is that this is about protecting from future systemic risk. So rather than thinking about what can't he helped, we should focus on whether this is the best plan going forward. And that's what has me really worried.
As I suggested last September, the real danger here is that AIG’s new owner, the government, may be no better, or even worse, than AIG’s old owners and managers. Consider that we got to this point in part because of the government -- specifically, because the government was asleep at the regulatory switch.
AIG was supposedly insuring risky paper for both banks and money funds. AIG got fees, the banks and the money funds got to look better. The problem is that AIG's plan for covering the risk was to assume, along with everybody else (as I discussed last September) that real estate prices would only go up. In other words, everybody was living in a Pee Wee Herman-like fantasy world.
Joe Nocera described this as a huge “scam” that existed with regulators' consent:
Here’s the crux: It’s not as if this was some Enron-esque secret, either. Everybody knew the capital requirements were being gamed, including the regulators. Indeed, A.I.G. openly labeled that part of the business as “regulatory capital.” That is how they, and their customers, thought of it.
* * * A.I.G. helped create the illusion of regulatory capital with its swaps, and now the government has to actually back up those contracts with taxpayer money to keep the banks from collapsing. It would be funny if it weren’t so awful.
In fact, its even worse. The government is bailing out AIG because AIG undermined a system that the government was supposed to be, but wasn't, protecting. And now who's in charge? The government, of course.
And that's not all. How are we going to pay for all this? In (very small) part by taxing an important solution to the corporate agency costs that got us into this mess – venture capitalists who we hope will fund new jobs, and the private equity fund managers that we hope will help clean up the existing companies' mess. The Obama plan is to have them help pay down the deficit by raising the tax on their carried interest from 15 to 39%.
As discussed here, venture capitalists are properly incensed:
The capital gains rate essentially gave firms a buffer to weather failures while waiting for something like Google or Genentech to hit the bigtime. According to VentureBeat, this has been the general consensus among investors, who say the industry will probably place its bets on safer, less innovative concepts if the Obama plan is implemented — and the results will run counter to the administration’s other major goals, namely energy efficiency and cost-effective health care.
Many are also concerned that V.C.s will be less inclined to invest as much time working alongside portfolio companies to help refine their business models and foster growth, the publication says.
[Mark Heesen, president of the National Venture Capital Association] told VentureBeat, “We are involved in long-term job creation, and if that’s not worthy of capital gains taxes, I don’t know what is.”
And how much will we get from the tax raise? According to the administration, $2.7 billion in 2011 and $4.3 billion in 2012. Compare that to $250 billion for AIG alone. And that assumes that the venture capitalists and private equity managers actually will pay the tax, instead of shifting their structures and incentives to avoid it.
In short, the AIG bailout is in part the price we're paying for government failure. The plan will "solve" that by putting government in charge. At the same time, we're going to pay for a pitifully small part of this by diluting the incentives of the market actors who could get us out of this fix.
As Nocera says, it would be funny if weren't so awful.
The logic of the comment is, at best disingenuous, and at worst, intellectually dishonest. The basic argument of the comment is that "the government" was asleep at the regulatory switch and this in turn allowed the AIGs of the world to run a huge scam. Now, thanks to the bailout, the selfsame "government" will be in charge of AIG.
The implicit assumption in the argument is that the government is some type of unchanging monolith. Correct me if I am wrong, but as far as I know, we have had a dramatic change of regime ushered in by the November 2008 election. Prior to that change the executive and independent regulatory branches were dominated by those who were strongly committed to the idea that free markets, totally unfettered by government regulation, were self correcting and in any event, governmental action, such as the enactment of SOX, was more likely to make things worse rather than better. The were cheered on in this view by a coterie of academics, including Professor Ribstein. It should come as no surprise that the government regulators were asleep at the proverbial switch. They believed that the switch was either unnecessary, or if it were needed, the regulators were more likely than not to get things wrong.
As President Obama stated in his speech to the Congress last Tuesday, that "era is over." The government that mandates that recipients of federal bailout money must allow shareholders a say on executive compensation, is not the same "government" as the one which says that the securities or executive employment markets will take care of any problems of excessive executive compensation. The SEC of Chair Mary Shapiro is not the same agency as the SEC of Chair Christopher Cox.
The irony is not that "the government" which allowed AIG's exploits will now be running AIG. The irony is that those who urged the government to take a hands off attitude toward regulation are now blaming a more activist government for trying to rescue us from the disaster caused by a previous government staffed by persons who followed their advice.
Posted by: Harry Gerla | March 02, 2009 at 11:33 AM
Whoops. I forgot that government is different. Incentives are different and everything. Thanks for reminding me.
Posted by: Larry Ribstein | March 02, 2009 at 11:41 AM
I am also extremely grateful for the unparalleled wisdom of Harry's wisdom because we know:
1) While the government is not an unchanging monolith, it is a monolith of unity. That is, Obama's decrees and policies undoubtedly represent that of each and every employee of executive agencies that will faithfully implement such initiatives.
2) The problems of the financial crisis appeared sui generis due to Bush administration policies.
3) Rent-seeking politicians and interest groups have been thrown out of Washington under the Obama adminstration (except for the several that are actually in the cabinet and previously tapped to health care reform, and the entire Democratic Congressional leadership.
Posted by: Federalist 10 Bastard Baby | March 02, 2009 at 11:23 PM