Bob Arvanitis | Is the US Treasury Really Making Money on AIG?

rcwhalen's picture


Holman Jenkins of The Wall Street Journal reported last week that government may end up making a little money after bailing out AIG.   But my friend Robert Arvanitis of Risk Finance Advisors skewers that fallacy below.  -- Chris


Mr. Jenkins’ error rests on incomplete accounting and incorrect attribution analysis. In Frederic Bastiat’s terms, we have a confusion of what is seen and what is not seen.

Let’s see if we can unpack that a little.

The one unarguable fact is that AIG lost 95% of value. To say that taxpayers “made out” is like finding a little pig iron after the Chicago Fire, or salvaging a few brass fittings from the San Francisco earthquake.

Goldman Sachs exploited AIG’s triple-A rating to arb their own capital rules against insurer ignorance.  It was cheaper for Goldman to “insure” than to hold what bank regulators required for capital.

That’s why ignorance is the right word.  Financial guarantee “insurance” is foolish—who takes all the credit risk for a fraction of the market spread?  Who claims to be that much smarter than the markets?

AIG strayed far outside the safe world of actuarial pricing and into mark-to-market lines ofr risk taking.  Credit risk is not diversifiable like car crashes.  But the hunger for revenue drove AIG further and further away from physical risks and ever deeper into (uninsurable) financial market risks.

So when AIG suffered the inevitable bump, they were unable to react like mark-to-market players.  This is why, never forget, insurers live in the world of book value and actuarial tables.

But note that Goldman was feeding at the parent, not the insurer-level. Goldman had hedges with a non-insurer sub, NOT insurance policies.

So if the government had not intruded, Goldman may have demanded collateral and driven AIG into bankruptcy. But then Goldman would only have a claim AFTER all the true policyholders, down at the operating insurers, were paid.  The US government’s intervention put Goldman first in line.

Finally, we read in crises the “payoff is too great for politicians rationally not to act?”  Say what?

Politicians are incapable of understanding basic accounting, lack all insight into financial forces, and are NEVER economic entrepreneurs.  When politicians enrich themselves at the public trough, that is crime, not entrepreneurship…

Politicians calculate exclusively in votes, not money. Sometimes, in desperation, politicians will listen to Fed or Treasury when they are told “push this button…”  Any upside after that is sheer stupid luck.

Government can only avoid irrational and un-analyzable games of confidence and panic by not exacerbating the risks. In short, the behemoth gets into the bathtub, all the water spills onto the floor, then the behemoth decries a lack of towels.  Instead, stay out of the bathtub.