Below is an article from the Finnancial Times (one of the top 5 newspapers in the world) that clearly illustrates what is going on, why the bailouts have been occurring, and why they will continue.
AIG is the specidic example being shown. The numbers stunned even me, who had been paying attention. AIG, at the time of the US Government intervention, was on the hook for $2,700,000,000,000 in debt guarantees. That is $2.7 trillion, folks. It hase offered up guarantees on everything from crappy real estate loans to foreign companies to bonds issued by American cities and all sorts of other loans, bonds, debts, mortgages and derivatives. They essentially guaranteed that say, the City of San Francisco would pay the bonds put out to rebuild Candlestick Park. So if the city defaulted, bond holders would be able to come after them.
Also, they guaranteed debts owned by banks. This allowed banks to lower their reserve rations (the amount of money they had to keep in reserve (about 4%?) to cover the possibilities of defaults on the loans they put out.
So banks would be able to keep only about 2% of their loan balance in reserve (usually lent out to other banks on a short term basis, gotta get that extra 0.0000014% of interest!). The other 2% would then be lent out like normal, giving the banks all the extra interest on that money to record as profits.
Under rules set by a Democractic Congress during the Clinton Presidency, debt guarantees, credit swaps, derivatives and the potential liabilities from them do not have to be counted as potential liabilities, and the fees can be recorded as income for that period, not spread out over the life of the guarantee. Those rules made offering debt guarantees very attractive in an accounting sense, and helped the Wall Streeet Finnancial Firms show record profits year after year. This provided more money and more cushion for the banks to make ever riskier loans - some, and only some of which were being mandated by the Federal Government. (Real Estate).
So everyone in the Government (basically most of both parties) and on Wall Street were happy. More loans wanted by special interest groups, record profits, record housing prices, record home ownership, record donations to political parties, record highs on Wall Street, record bonuses to CEOs and high salary workers in New York. Everyone was happy. But the reason was that potential and real liabilities were being kept off the books. It was bad accounting, enshrined into law.
And things got so intertwined in the business world, that if one big bank failed, the ripples would start swamping other companies. If AIG were allowed to fail, the $2.7 trillion in debt obligations (as well as up to $1 trillion in other obligations) that it had would become nullified. Banks in Asia, Europe and the USA would have to earmark 4% of more than 2 trillion bucks ($80 billion) and put it away in their coffers as a reserve.
But that would be just the beginning. All CDOs, debt swaps, debt guarantees, and the rest of that ilk would have been suspect. Having a standard reserve to cover them like a normal mortgage portfolio would have been grossly inadequate. The already frozen national and international lending market would have been absolutely sucked dry of all money as banks immediately had to raise their effective reserve ratios to at least 10%, and perhaps all the way to 20%.
The effects would be wide spread, and devastating to a global economy already teetering on the edge of the abyss. Credit cards? Think of the effect on the US economy if credit card interest rates doubled and the credit lines were cut in half. Mortgages? The housing market was already in terrible shape. Double the interest rates on every loan, either new or old and adjustable. How many more foreclosures would the latter cause, and how would that effect current housing prices? Obviously the foreclosure rate would skyrocket, the housing prices would tumple further, leaving more and more homeowners upside down, further increasing foreclosure rates. New loan interest rates being double would slash the ability and inclination of prospective buyers to buy a home. That would cause prices to go down even further. A vicious downward spiral.
Businesses? Under the current business model, companies borrow money to expand, to pay for previous expansion, to buy the the goods that they then sell to the public for the money to repay their loan to buy the goods. The goal is to have zero inventory, and to only have borrowed cash working for you. Take away the borrowed money, and the business goes belly up, very often.
There are all sorts of other negative aspects as well. But this is not the place to write a book......
So a failure to maintain the illusion that the big finnancial companies are solvent and able to pay their obligations would basically cause a depression in and of itself. So I am not very concerned that at least $50 billion of the $160 billion that the US Government has already given to AIG has gone to European banks. The European banks are paying money right back to US firms and banks. Who are shuttling the money elsewhere to pay their bad debts. etc. etc. I do not care about stock prices being in the toilet, they will come back, eventually. Some companies dieing is a natural thing. Retailers dieing is a good thing.
Eventually the economy will come back, and everything will get better economically. Unless we stupidly allow our major finnancial institutions to go belly up, infecting every aspect of the economy of the world.
On a personal note, I would love to see the board of these major companies, the CEOs and all the VPs, and all their ilk stripped of every cent - even their trust funds - and sent to Devil's Island for the rest of their lives. Ditto with the politicians of every stripe that gleefully helped it happen. And especially the government beaurocrats who were principals in this whole mess. All these people are as culpable as the idiots who took out mortgages they could not afford on houses they should not have bought.
Finnancial Times Article:
AIG publishes counterparty list
By Julie MacIntosh in New York and Alan Beattie in Washington
Published: March 15 2009 23:25 | Last updated: March 15 2009 23:25
AIG caved in to political pressure Sunday and released a list of some of the financial counterparties that benefited from its $160bn US government rescue, including some of Europe’s largest banks.
The list’s publication came after weeks of mounting anger on Capitol Hill that lifelines of public money had been extended to AIG without a clear indication of where the money had gone.
EDITOR’S CHOICE
Summers ‘outrage’ at AIG bonuses - Mar-15List: AIG counterparties - Mar-15AIG letter to US Treasury - Mar-15Greenberg attacks US over AIG - Mar-08AIG set to get new $30bn lifeline - Mar-02AIG still facing huge credit losses - Mar-03Lawmakers have said that without full disclosure of AIG’s counterparties, Congress would not vote for more money for stabilising the financial system.
AIG has sold hundreds of billions of dollars of credit insurance through AIG Financial Products – the unit that contributed most heavily to the company’s near-collapse in September.
The insurer, which is now attempting to unwind that financial exposure, issued details Sunday on some of the payments it had made to counterparties using emergency government loans.
AIG paid out $22.4bn of collateral related to credit default swaps, $27.1bn to help cancel swaps and another $43.7bn to satisfy the obligations of its securities lending operation. The payments were made between September 16 and the end of last year.
Goldman Sachs, which has also accepted US government support, received payments worth $12.9bn. Three European banks – France’s Société Générale, Germany’s Deutsche Bank and the UK’s Barclays – were paid the next-largest amounts. SocGen received $11.9bn; Deutsche $11.8bn; and Barclays $7.9bn.
Many European banks used AIG’s credit insurance to keep from having to hold capital against their long-term securities holdings. Wall Street banks also used swaps to hedge their subprime mortgage-backed securities portfolios.
A spokeswoman for the US Federal Reserve said Sunday that AIG’s collateral payments were based on “contracts that don’t differentiate domestic versus international companies”. She said the Fed’s aid to AIG helped all of its counterparties, which range from global banks to individual insurance policyholders.
In a fractious hearing on March 5, senators criticised Don Kohn, Fed vice-chairman, for failing to push for publication of the list.
At the time, Mr Kohn said: “I would be very concerned if we started revealing lists of names of companies that did transactions” with AIG. Such publication could rebound not just on the counterparties but on other US financial institutions operating in the same markets, he said.
Under pressure from lawmakers, the Fed went back to AIG and worked out a compromise schedule of publication.
Now that the list is public, the large number of foreign banks that have received money as a byproduct of AIG’s rescue has the potential to cause fresh anger on Capitol Hill. Congress has expressed concern at allowing taxpayer money to leak abroad or to foreign workers.
Nick Ashooh, AIG spokesman, said the group has made headway in its attempts to reduce its exposure to credit default swaps and other derivatives. The notional value of its derivatives exposure has dropped to about $1,600bn from about $2,700bn a year ago, and its CDS exposure has been cut from $433bn to $302bn.
AIG stoked more ire in Washington over the weekend when it became apparent the company would pay $165m in retention bonuses Sunday to employees of AIG Financial Products.
AIG chief Edward Liddy said the bonuses represented “legal, binding obligations”, but said AIG would make a range of compensation cuts in the unit this year.
Mr Liddy also expressed concern that AIG could have difficulty attracting and retaining talent if “employees believe that their compensation is subject to continued and arbitrary adjustment by the US Treasury.”
Copyright The Financial Times Limited 2009
<<<<
Author
Topic: The Reasons behind the Bailouts (Read 188 times)