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Monday, September 15, 2008

AIG Crisis: AIG asks Fed Help. Is AIG Insolvent? Rough times for Capitalism

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Rough times for Capitalism. Now the AIG Crisis: Is AIG Insolvent? Wall Street Journal is reporting that AIG is asking Fed Help. AIG is a leader in insurance business. I hope that it will come out of this crisis well.

I recall reading an article on the nakedcapitalism blog, which they attributed to a AIG's Connolly. Now AIG is itself under pressure. The June article follows the excerpts from the Wall Street Journal.

The effects of leverage and credit crisis continue to test the financial system. We hope that these rough times will end soon. It is a miracle that the economy is doing ok given the circumstances.

excerpts From the Wall Street Journal:

"Insurer American International Group Inc., succumbing to relentless investor pressure that drove its shares down 31% on Friday alone, is pulling together a survival plan that includes selling off some of its most valuable assets, raising more capital and possibly going to the Federal Reserve for help...."

"During a weekend scramble to shore up its finances, AIG turned down a capital infusion from a group of private-equity firms because it would have effectively given them control of the company....."

NakeCapitalism Attributed the following article to AIG's Connolly:

We have lost count of how many notes we have, in the past few years, written with some reference to a crisis of capitalism. Tragically, that crisis is now upon us, and the pace of unravelling seems to be accelerating. The next highly foreseeable development is that there will be a worldwide crimping of central bank independence as the political process increasingly sees -- rightly or wrongly, but in our view largely rightly -- central banks as having fouled up.

The yob culture of Britain’s streets seems to have spread to several of the central banks. Those banks are behaving like gangs of brutish, feral fifteen-year-olds who egg each other on, claiming “respect”, by knocking down elderly passers-by and kicking the life out of them. So far, governments have saying that we have to let these young people express themselves. But the tide may be turning...

The ultimate fons et origo of the present mess is, arguably, the very existence of central banks, for that existence is a token of a decision taken by society, in virtually all countries, that financial risk must be at least to some extent socialised and that central banks are necessary to prevent or alleviate financial crises. Moral hazard is thus inherent in all, or virtually all, our societies. But the proximate reason for the mess, ironically enough, is that central banks have reinterpreted their mission, largely perversely, and have fallen prey to the totemism of inflation targeting. That totemism is essentially imposing on the world a version of Bundesbank philosophy that is proving highly malignant in the moral-hazard-ridden but innovative and, in most circumstances, beneficial financial system we actually have...

One implication worth stressing from the very outset is that while Trichet told us all last week that he will, if he is allowed to get away with it, impose 1930s-like conditions in the euro-area cads, the Fed has, in its recent pronouncements, come close to saying that it is prepared to impose some aspects of 1930s conditions -- and not least a stock market crash -- on the US. And while Trichet can argue that he is only doing what the politicians have, through the treaty, told him to do, however stupid or destructive that may be, the Fed will have only itself to blame.... In our note of a month ago, "The Fed: Damned If It Does and Damned If It Doesn't?", we argued that while the vicious circle posited by Fisher might well exist, another, and more dangerous, vicious circle would be created if the Fed were to give the impression of being constrained by the dollar...

But who has won the argument in and about the ECB? Our understanding is that Trichet sprang his announcement on surprised ECB Council members at the real Council meeting -- the dinner on the Wednesday evening preceding the formal meeting2. We further understand that even those who welcomed Trichet's announcement -- such as Weber -- were taken aback by it (though not as taken aback as banks' exotic rate structures desks, which were ripped up and torn into shreds by the sudden reversal of the shape of the euro curve; one presumes that Trichet did not anticipate the wild movements in the curve, for those movements were very unwelcome from the point view of a global financial system which in some ways looks even more vulnerable than before the Bear Stearns rescue). Many others were appalled by it. Significantly, it seems the Irish said (as we suggested last Friday) they could accept Trichet's decision, but not this month -- in other words, not until after today's referendum.

Implicitly, what Trichet did at his press conference was something along the lines of, "Forget anything you thought you knew about the euro: it is from now on going to be a hard, Germanic currency. The ECB is the Bundesbank and the euro is the DEM. The value of the euro and the level of interest rates will be no more affected by the fact that countries such a Spain, Portugal, Greece, Ireland and Italy are members of the euro zone than were the dollar and US rates affected by the fact that at various
times countries such as Nicaragua were dollarised." If Trichet were allowed to get away with that, the status of the euro would be radically transformed. Even more important, Trichet was in effect announcing a coup d’état in EMU. The question of whether the euro would be hard or soft, and whether the ECB would respond to conditions in the area as a whole, to conditions in weak countries or to conditions only in Germany – at bottom, the question of whether France or Germany would
predominate in EMU – was the subject of many years of detailed – and, it has to be said, inconclusive – political discussion and negotiation, though admittedly not politically accountable discussion and negotiation. Now Trichet, a jumped-up civil servant, though admittedly the high priest of the caste of civil servants, or at least of énarques, appears to be saying, “I don’t care about all that: This question is not being decided by my personal diktat, and my decision is in favour of Germany.”

Will Trichet be allowed to get away with it? Does he want to get away with it (recall our suggestion made last Friday that Trichet, who is known to have been worrying about divergence within the euro area for the past couple of years, may in effect have decided to force the politicians to make the decisions about the future of EMU before an uncontrollable economic and financial crisis develops, knowing as he must that the ECB cannot resolve the problems and contradictions now so clearly exposed within it). The stakes are now very high indeed. Lagarde's implication that the G8 would force Trichet to change his mind represents a very considerable upping of the ante. If the ECB goes ahead and hikes, Lagarde (and Sarkozy) will look foolish. If that were to happen, the rumours that have been swirling for some months, to the effect that Sarkozy might threaten Merkel that France could withdraw from monetary union, might begin to have some substance. But if Trichet backs
down, he will have made a political -- though entirely unaccountable -- forum, the G8, the arbiter of ECB policy. ECB independence will be gone. Thus the G8 is shaping up to be potentially as climactic as the famous Bath Ecofin meeting of September 1992. Then, the pressures on Schlesinger, and his reaction to them, precipitated the ERM crisis.

What might the line-up at the G8 be? The belief in the market that the US government and the Fed were disconcerted and discommoded by Trichet's announcement seems credible. For what that announcement did, coming immediately after Bernanke's comments on the dollar (to which we shall return in Part 2 of this note), was potentially to re-create the conditions of the summer and early autumn of 1987. Then, the market perception that the Fed would be obliged by the Louvre Agreement to support the dollar, by following Bundesbank rate moves, was very definitely a factor ccontributing to
the Wall Street Crash of October of that year (true, the US stock market had gone parabolic in the months preceding the 1987 crash and was thus very vulnerable; but the factors of vulnerability now, though different from those of 1987, are very considerable; more obviously, the parabolic variable recently has been the oil price -- a sharp fall in that price would reduce equity vulnerability, but, as noted earlier, we defer substantive discussion of the oil/inflation/dollar/rates/stocks nexus to Part 2).

We suspect that the US, or at least the US government side, will want to make it clear to Trichet (or perhaps in reality to Weber) that it will not look kindly on any attempt by the ECB,.... to push up not just euro rates but dollar rates. Equally clearly, the Italians will side with the French. So, too, will the British government, which has troubles of its own with the turbulent monetary priest of Threadneedle Street. The Canadian government, too, will not wish to endorse an ECB role as global rate-setter. The Japanese -- including, we suspect, the BoJ – will have been aghast at what one can consider the collective loutishness of some of the other major central banks. So Trichet and the Germans may well be isolated.

That said, we cannot predict the G8 outcome with any confidence whatsoever. But Lagarde has ensured that its outcome -- whichever way it goes – could be dramatic. The politicians will strike back against the central banks, whether at Osaka or later. The central banks (again with the exception of the BoJ, for reasons we hope to develop in a subsequent note) have, in putting the entire global economic and financial system at risk in pursuit of “respect”, over-reached themselves.


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