Bear Mountain Bull

From Barry Ritholtz, in “How the Bailouts Could Have Gone Better”:

What would have been a better way to deal with AIG? There was a simple solution. AIG was basically a AAA-rated, conservatively run insurance company with a hedge fund hidden under its skirts—AIG Financial Products. It looked to them like they were making free money: selling $3 trillion worth of risk and taking 10 basis points [of profit] on it. It was like going to Vegas. If you play in the casinos and you win, then the Nevada Gaming Commission is going to make sure the casino pays. But if you play craps with some guys out in the alley and you win, there’s nobody there to make sure they pay. AIG Financial Products was like that craps game in the alley.

We could have done this by cleaving FP from the insurance company. So anybody owed debts by FP would have been dealing with FP alone. And if they didn’t get their money back, too bad. You’re supposed to lose money when you put it into insolvent companies. You’re supposed to suffer pain and agony when you put money into a company that’s as corrupt as that AIG hedge fund. Then we could have spun out AIG the insurance company in 30 days, as a stand-alone entity, without FP.

Then wind down FP separately. That should have been demonized and pulled out and closed. To throw $185 billion at AIG to save them, the whole thing is pointless. The best thing would have been to just rip the Band-Aid off.

Could the feds have done this in 2008? Or only earlier, before the crisis hit? Yes, we could have done it in September 2008. The problem is there’s psychological pain, and we humans always want to put off the pain. I see this all the time in investing. When people buy a stock at 80, they know they’re taking a risk, then it falls to 3 and the phone call comes asking, “What should I do?” When you ask what do they want, usually the subtext is, “I want the pain to stop.” So to make the pain stop, you just sell the damn thing. That’s what we did with AIG. We just wanted the pain to stop.

Wasn’t the Fed hamstrung? The Fed was in a position where it couldn’t do nothing, but it could have done something more creative. The way I see it, if a company blows itself up the way AIG and Citigroup did, in a capitalist system, you have to take it out back and put it down like Old Yeller.

By the way, there was a huge amount of capital in private trusts and partnerships and private investments. Not one of those blew up. When it’s a public firm, you can’t go after senior executives’ personal assets if it collapses. But if it’s a private operation, you can. And none of the guys with their own money on the line went belly up.

What would have been a better way to handle Citi? They should have been WaMued: put into receivership. The FDIC fires the board, and stockholders get wiped out. Bondholders get what’s left over, given their priority in the capital structure. The government could have said, “We’ll see how close we can come to making you whole,” but they probably would have been down 30, 40, maybe 50 percent. Then they could have spun out Smith Barney, a nice, profitable brokerage firm. The bank, Citibank, they could have spun that out as a stand-alone, with its $1 trillion in deposits. Pull out the toxic sludge. Another dozen entities within Citigroup either get spun off, if there are buyers, or just shut down. That’s what happens to bankrupt companies.

They could have done the same with Bank of America. Spin out Merrill Lynch, sell off Countrywide as a mortgage broker, and the senior management and the board—they get jack.

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Are we learning the right lessons? The American public is notorious for its short attention span. They were paying attention for a while, but if another celebrity dies or there’s an Elvis sighting, forget it.

Rahm Emanuel likes to say that you shouldn’t waste a good crisis, but I think we have. I don’t understand why the rating agencies haven’t been given the Arthur Andersen treatment. Instead, we get this bill about credit card practices that has absolutely nothing to do with what just happened. Once the markets started moving back up again after bottoming out in March, it might have been too late for real reform. The Obama administration dawdled. I don’t think they expected as much of a rally as we’ve had since March. And now the lobbyists for Wall Street have taken over. It’s on to the next issue—so now we’ve got a healthcare reform debate. They should have taken care of the first crying baby before picking up the next one.

Do you think anything good will come out of all this? No. Benjamin Disraeli said, “The one thing we learn from history is that we learn nothing from history.” My biggest fear is we revert to business as usual—until the next crisis.

“My biggest fear is we revert to business as usual”. I think we already have.

Pointer from Barry’s blog, The Big Picture. Imagine that!