Archive for the ‘limited laibility’ Category

Rot at the Core: Michael Moore says "Capitalism is evil", but rightly points to statist corporations and institutionalized theft via government

October 1st, 2009 2 comments

I haven`t seen Michael Moore`s latest film, “Capitalism: A Love Story” – it premiered in New York last week, but who knows when it will make it to Tokyo? – but I`ve been reading some of his interviews and reviews of his film.

While Moore is confused in identifying the existing U.S. statist corporate system that he criticizes with “capitalism”, it seems to me that much of his criticisms of the U.S. political-economic system are consistent with libertarian views (even if Moore doesn`t understand the libertarian criticisms).

Accordingly, while Moore may be off on both his diagnosis of what`s wrong with America and his proposed prescriptions, his film – which appears to be resonating across the political spectrum – presents not merely a challenge to libertarians, but an teaching opportunity.  I hope that libertarians will take advantage of the opportunity to engage Moore`s concerns constructively.

I note below excerpts from media coverage (in no particular order), with a few comments of my own:

Fortune interview, September 22:

– The film covers …. “a privately run juvenile prison that paid off judges to give convicts
longer sentences, and last year’s $700 billion bailout of the banking

- ”I started out wanting to explore the premise of capitalism being
anti-American, and anti-Jesus, meaning it’s not a Democratic economy.
And it’s not run with a moral or ethical code. But when the crash
happened, it added a third plot line: not only is capitalism
anti-American and anti-Jesus, it doesn’t work.”

[The weakened moral code Moore complains of is clearly visible in political corruption (the sale of government favors to businesses and investors), which is tied to the regulatory spiral fueled by the state grant of corporate status, shifting or risks to the public and eliciting efforts from citizens groups to rein in increasingly powerful corporations. I have explored this on many posts, some directly relating to the state grant of limited liability to shareholders. I note that it is apparent from Jon Stewart`s recent interview of Ron Paul regarding Paul`s new “End the Fed” book that both Stewart and Paul share Moore`s concern about the entwining of the corporation and government (h/t Bob Murphy).]

– ”this crash exposed our economic system as a corrupt scam”.

– “instead of initially giving bailout money to a General Motors that was
never going to change or to banks so they can cover losses from crazy
betting schemes, this money should be going to helping to create jobs
in places like Detroit. People need to work.”

[Okay, but the best way to “create” jobs is for government to leave tax dollars with taxpayers, and to undo counterproductive government regulation (such as grants of monopoly powers to utilities, and the “war on drugs” and on inner cities) that benefit insiders at the collective expense of the common weal.]

– “You tried to get Hank Paulson on the phone in the film, but
weren’t successful. If you got him on the phone today, what would you

“If I had a chance to talk to him, I’d want him to come
clean and tell me the truth about how he rigged this whole thing. Tell
us what happened because we don’t know the details. How did so many
Goldman people end up in the administration? How is it that Goldman- ‘s
chief competitors are left to die — not bailing out Lehman Bros., Bear
Stearns falls apart, Merrill Lynch is absorbed into Bank of America —
and look who’s left standing: the company that’s got all their boys
inside the administration.”

– “Capitalism is not only an economic system that legalizes greed, it also
has at its foundation a political system of capitalism that is, “We
have to buy the political system because we don’t have enough votes.”

Fortune article, September 4 (Richard Corliss, a senior writer for TIME):

– “To Moore, it’s the bureaucratic-industrial complex — the combined might of the West Wing, Wall street and Wal-Mart — that’s evil. That view was never clearer than in his broadly entertaining,
ceaselessly provocative, wildly ambitious new film. Not satisfied with
outlining and condemning the housing and banking crises of the past
year, it expands the story of the financial collapse into an epic of
malfeasance: capital crimes on a national scale.”

– “The movie seems to be setting up the disappointment many on the Left
have felt over the awarding of more billions to giant banks and
corporations, among other things, since Jan. 20. And Moore does note
that Goldman Sachs gave more than $1 million to Obama’s campaign.”

– “But he doesn’t go after this Democratic President as he surely would
have if John McCain had been elected. Instead, he argues for
participatory democracy: do-it-yourself do-gooding, through community activism and union organizing. That’s an optimistic and evasive answer to the financial problem.

what spun out of control because of government indulgence and indolence
needs to be repaired by government regulation and ingenuity…. In “Capitalism:
A Love Story,” Moore has cogently and passionately diagnosed the
disease. But for a cure, instead of emergency surgery, he prescribes
Happy Meals.”

The Nation, describing Moore`s appearance on “The Jay Leno Show”, September 16 (John Nichols):

– “Americans who didn’t witness filmmaker Michael Moore’s appearance Tuesday night on NBC’s “The Jay Leno Show” missed one of those rare moments when the vast wasteland gives way to an oasis of realism.

Rarely since the days when author Gore Vidal regularly appeared on the
“Tonight” show with Johnny Carson has a popular television program on a
commercial broadcast channel provided such extended and respectful
treatment to a scathing critique of the corrupt status quo.

Leno hailed Moore’s new movie, “Capitalism: A Love Story,” as “the best film he’s done.”

The talk-show host described “Capitalism: A Love Story” as
“completely nonpartisan” — and he’s right: Moore goes after sold-out
Democrats and sold-out Republicans — before declaring: “I was stunned
by it, and I think it is the most fair film.”

– “Even more meaningful than Leno’s review of a movie he had obviously watched and considered seriously was this exchange:

LENO: Now it’s one year since Lehman Brothers
collapsed. We’ve had all, OK, we’ve handed out… Is Wall Street any
better? Have they learned anything?

MOORE: No, not at all. It’s, it’s probably worse. They’re still
doing these exotic derivatives. They’re now trying to do it with life
insurance. They’ve got all these crazy schemes. I mean, that’s what I’m
saying about capitalism, it’s like a beast. And no matter how many
strings or ropes you try and tie it down with that beast just wants
more and more money. And it will go anywhere. It will try to gobble up
as much as it can. The word ‘enough’ is the dirtiest word in
capitalism, ‘cuz there’s no such thing as enough with these guys. And
we haven’t stopped them. We haven’t passed the regulations that
President Obama has suggested. I mean, I think he’s really on top of
this. And he said yesterday, he told Wall Street, ‘That’s it, boys. No
more free ATM machine at the U.S. Department of Treasury.’ And I think
that’s something we all support, right?

“The audience responded with enthusiastic and sustained applause.”

[When Moore criticizes “capitalism” he seems to be focussing on the political influence by which taxpayers end up holding the bag for irresponsible risk-taking in the private sector. But his suggestion that Obama`s “really on top of
this” is wishful thinking that ignores both the influence of money on Obama and misses Austrian/public choice understandings of how rent-seeking, bureaucratic incentives and the information problem continue to contribute to a cycle of regulation and manipulation.]

– “The applause rose again when Moore explained that: “I’m actually
suggesting go back to our roots of this country, democracy. What if we
had an economy that you and I had a say in? Right now, we all don’t
have much of a say in this economy. What if we applied our democratic
principles and said, ‘We, the people, have a right to determine how
this economy is run.’ I think we’d be in much better shape than what
we’re going through right now.”

Bloomberg interview, September 15 (Rick Warner):

– “Warner: Several clergymen in the film say capitalism is
anti-Christian and that Jesus would have deplored such a dog-
eat-dog system. Yet you hear from the right that capitalism and
Christianity go hand in hand. Are they reading different Bibles?”

“Moore: The number one thing in the Bible is redemption. The
number two thing is how we treat the poor. All the great
religions talk about this. The right wing hijacked Jesus 30
years ago. It was all a big ruse, but people fell for it. I
don’t think people are falling for it so easily now.”

– “Warner: You’re not the most beloved person on Wall Street.
When you went down there with your Brink’s truck and empty bag
to collect money for the American taxpayer, were you concerned
about your safety?”

“Moore: Yes. When I started wrapping the New York Stock
Exchange with crime-scene tape, I thought for sure this was when
the police were going to jump me and haul me off to the Tombs
(prison). And it didn’t happen. One cop says to me, “Don’t
worry Mike, we’ve lost a billion dollars in our pension fund.”
They were like, “Go get ‘em.”

USA Today, September 23 (Claudia Puig):

– “No matter what side of the political fence you’re on or what you think
of Moore as an activist and provocateur, a film that explores the
economic meltdown and its historical roots is something most of us can
get our heads around.”

– “Capitalism is as entertaining as Roger & Me, and its critique skewers both major political parties, calling into question the economic policies of Bill Clinton as well as Ronald Reagan.
This is quintessential Moore, with a clear-cut
agenda: Capitalism has superseded democracy, encouraged corruption and
greed, and failed our nation. Political bigwigs and wealthy executives
may love it, but it’s not working for the majority of Americans.”

– “His rallying cry is simple: The country needs to return to its democratic roots.”

– “The recurring theme: The rich have gotten richer, and everyone else has suffered.”

– “Moore has the rare ability to present economics and history in an
engaging and comprehensive fashion. Consequently, his movies draw large
audiences and spur debate. And films that inspire contemplation and
elicit discussion are welcome relief in a medium increasingly dominated
by formulaic and mindless diversion.”

Variety, September 16 (Ted Johnson, managing editor):

– “His latest movie tries to tap into populist outrage from the left, at a
time when that anger has been channeled much more visibly by the right.
The outrage that we have seen, the town halls and the tea parties and
the birthers, have been over the fear of big government, not that there
won’t be a safety net. “They are very good at it,” he told me, adding
that conservatives’ ability to “own the bailout” is for “entirely
different reasons from me.” It is also one of the reasons he was so
anxious to get his movie out.”

– “this movie has a much larger scope, taking on the notion that
capitalism was never enshrined in the Constitution, but was sold to us
as the best possible system. In making his point he turns not just to
workers who’ve been left behind, but to Catholic priests and bishops,
who preach of capitalism as no less than evil.

“There’s ample fodder:  … Citigroup draws up a
memo for select investors, proclaiming a world “plutonomy” that can be
foiled by that pesky thing called the right to vote.

“Republicans, Ronald Reagan and George W. Bush all take their lumps,
which is to be expected, but so do House and Senate Democrats and even
President Obama, as Moore treats his election as a turning point yet
notes Goldman Sachs and Wall Street showered him with contributions,
resulting in Larry Summers and Timothy Geithner. Special mention is
reserved for Chris Dodd, who is hammered for accepting VIP treatment
from Countrywide in the form of better terms on home interest rates,
reaping $1,175,133.

“On the other hand, Rep. Marcy Kaptur (D-Ohio) is treated as a hero for
speaking out against the bailout bill, and footage is shown of her
impassioned plea, before it passed Congress. “This was almost like an
intelligence operation,” she says of the timing of the bailout so close
to the 2008 election.”

BBC Interview, September 7 (Kelly Oakes); “Michael Moore takes aim at money men”:

– “I had been wanting to do a movie about capitalism and about a year
and a half ago, I finally started,” he says. “I saw a lot of things
happening in terms of people losing their jobs and foreclosures.

“So I decided to get going on this film because I thought we had an economy built on sand, a house of cards.”

– “I think that we must change the fundamental things about how our
economy is run and how it works or we are going to continue to have
problems and it is going to get worse.”

– Capitalism: A Love
Story takes a look at the government’s multi-billion dollar bank
bail-out, and compares it with how workers in small companies found
themselves out of jobs without severance pay.

– “Moore is adamant that capitalism is not the way forward, but
struggles to offer a real alternative for how the economy could be run,
or a way to convince people they do not need so much money to buy

He does advocate shared ownership of companies in the
form of co-operatives, showing a handful of businesses where this has
been a success.

So with so much information thrown at the
audience in the film, and giving only his side of the argument, what
does Moore hope people will take away from the movie?

“I hope
the people will start to wake up a bit and see that they are
participating in something that is causing them a lot of harm.”

Politico, September 28 (Michael Calderone):

– “While Michael Moore remains a scourge of the right, the filmmaker says he’s gaining some conservative fans.

“Our own testing has shown that Republicans are interested in coming
to this film more than my other films,” Moore told POLITICO by phone
this afternoon. In Capitalism: A Love Story, Moore said, “you see for the first time Republicans inviting me into their homes asking for help.”

It’s actually not too surprising, given that the government’s
taxpayer funded bailout of the banks has attracted critics on the left
and right. And along with Washington and Wall Street, Moore also
targets the media, which he describes as “major enablers” of the
financial crisis and part of the “ruling elite.”

“They have celebrated this culture of making money off money, as
opposed to making money by making things,” Moore said. “That has been
detrimental for everyone, for society, bad for the economic system.”

– “The difference is that the other side of the political fence is
trying to take advantage of people hurting now,” Moore said. “They work
to manipulate them and get them afraid. And they’re blaming all the
wrong people.”

For instance, Moore considers Fox’s Glenn Beck — who once said on the air he’d like to kill the filmmaker —  to be “a sick puppy.” …

Still, Moore said he doesn’t disparage the right for flocking to town
halls this summer, and thinks liberals should be getting out there

“I admire those Republicans who even though they’re in a small
minority now, they do not give up,” Moore said. “They have the courage
of their convictions.”

TIME interview, September 26 (Bill Saporito)

– “You’ve called the TARP program part of a financial coup d’etat. But if we
get our money back, with interest, and the banking system reverts to doing
what it should do, haven’t the citizens won?

“If you give me $700 billion per year, hey I have some good ideas. I can make
some money with that, for me and for you. I’m going to have my best quarter
if you gave me that money. I wonder how many people in the inner cities
would love a little bailout money to get out the hole they are in and have
one of their best years ever. This wasn’t a gift; it was a theft. They stole
the people’s money by gambling with it. They took the pension funds of
working people and gambled away their money, and went back to the same
working people and asked for $700 billion more of their money.”

– “But aren’t you really a model capitalist? You raise money. You hire people.
You create a product and sell it to the public, bearing the risk and gaining
the rewards that goes along with it.

“Capitalism would have never let me be a filmmaker, living in Flint, Michigan
with a high school education. I was going to have to make that happen
myself. My last movie, I gave it away for free on the Internet: Slacker
Uprising. If I were a capitalist I would not give my employees health
insurance with no deductible, which I do, including dental, and paid
pregnancy leave. That’s not called capitalism, that’s called being a
Christian and someone who believes in democracy, so that everyone should get
a fair slice of the pie.”

[Moore doesn`t understand what “capitalism” really is.]

The Nation, September 23 (Naomi Klein):

CNN interview, September 21

New York Times interview, September 23 (Cyrus Sanati, DealBook)

– “In “Capitalism: A Love Story,” which had its New York premiere
this week, Mr. Moore contends that capitalism has failed to create the
kind of just society the country’s founders envisioned, and that the
big banks have essentially co-opted the government.”

– “In your film you point out the deficiencies of capitalism. What economic system do you think is best and why?

“Well, we haven’t invented it yet. Here’s what I don’t think works:
An economic system that was founded in the 16th century and another
that was founded in the 19th century. I’m tired of this discussion of
capitalism and socialism; we live in the 21st century, we need an
economic system that has democracy as its underpinnings and an ethical

[Sounds like he could be talking about a more libertarian society – somebody get ahold of Moore and start talking with him!]

-“There is a scene in the film where you mention that Goldman
Sachs employees were a big source of President Obama’s contributions
during the last election cycle. Do you believe the President was wrong
to take that money?”

I really see an audience of one for that scene (President Obama). I
want him to know that we know that Goldman was his single-largest
contributor and what he does with that is his choice – he can choose to
side with them or with us.

– “It seems that a lot of the anger over the bailout and the
crisis has eased as the markets have recovered. Are you concerned that
the government will not step up and reform the financial system?

First, the market recovery is a bit of an illusion because the
other shoes haven’t dropped yet like the massive credit card debt that
can never be repaid and the commercial real-estate bubble.

Of course they are not going to revamp the system. The banking
industry and these financial institutions have been lobbying and
spending millions of dollars in the last year to guarantee that no new
regulations have been put in place.

Real change will only happen when the people demand it and the
people are going to have to demand more than a few new rules at this

– “So how can the people ‘rise up’ in your view?”

By electing representatives that have this one piece in their
platform: The removal of money from our political system. You literally
have to take money out and publicly finance elections like other
western democracies. When we remove money, our political leaders will
listen to us and not Wall Street.

– “You mention in the film that the United States may have experienced a financial coup d’etat. What did you mean?”

Wall Street, the banks, and corporate America, has been able to call
the shots here. They control our members of Congress and they get what
they want. I mean, 75 percent of this country wants universal health
care, but it looks like we aren’t going to get it again — how does that
happen? Well it happens when the health care industry spends a million
dollars a day on lobbyists. That’s how it happens.

So until we get the money out of politics, the coup d’etat that has
taken place by those with the money are really running the democracy.

New York Times, September 23 (Manohla Dargis, movie review):

– “America, in other words, is headed straight down the historical toilet, along with Nero and his fiddle (or rather Dick Cheney,
who’s anointed with a throwaway reference to the “emperor”), a thesis
that Mr. Moore continues to advance if not refine with another hour and
a half or so”

– “In the end, what is to be done? After watching “Capitalism,” it
beats me. Mr. Moore doesn’t have any real answers, either, which tends
to be true of most socially minded directors in the commercial
mainstream and speaks more to the limits of such filmmaking than to
anything else. Like most of his movies, “Capitalism” is a tragedy
disguised as a comedy; it’s also an entertainment. This isn’t the story
of capitalism as conceived by Karl Marx or Naomi Klein,
and it certainly isn’t the story of contemporary American capitalism,
which extends across the globe and far beyond Mr. Moore’s sightlines.

is it an effective call to action: Mr. Moore would like us to vote,
which suggests a startling faith in the possibilities of social change
in the current political system. That faith appears to be due in some
part to the election of President Obama.

“As it happens, the most galvanizing words in the movie come not from
the current president but from Roosevelt, who in 1944 called for a
“second bill of rights,” asserting that “true individual freedom cannot
exist without economic security and independence.” The image of this
visibly frail president, who died the next year, appealing to our
collective conscience — and mapping out an American future that remains
elusive — is moving beyond words. And chilling: “People who are hungry
and out of a job are the stuff of which dictatorships are made.”

Block/Huebert/Kinsella revisit corporations, beg Qs of grant of limited liability towards persons involuntarily injured and resulting fight to influence state action

September 10th, 2009 No comments

I left the following comment at a recent Mises Blog post by Stephan Kinsella, but the number of links included apparently triggered the spam filter and held up the comment.  According, I post it here, so I can re-comment with a cross-link here.

Stephan, we have extensively discussed this matter previously, focussing mainly on the point that Vincent Cook raises, namely, the consistency with libertarian principles of the state grant of limited liability as against parties who become unwilling “creditors” of the firm as a result of being injured by the actions of the firm.

You continue to dodge this point just as Block and Huebert have explicitly begged the question in their latest effort (emphasis added):

“As long as there is no fraud, as long as all those who deal with corporations know full well that in case of any dispute, they will only be able to sue for an amount up to the full capitalization of the corporation and not have access to the shareholders’ personal assets, there can be no problem with the libertarian legal code.”

It goes without saying that injured persons don`t choose ahead of time who will injure them, much less the whether the liability of their tortfeasors will be limited to corporate assets. [IOW, when it comes to limited liability corporations, there IS a fairly glaring problem with the libertarian legal code.]

Our previous discussions on the Mises Blog took place here and here

And an earlier related discussion on the Mises Blog was here:

I have commented extensively myself on the consequences of this grant – which I see as fuelling risky corporate behavior and a cycle of “rent-seeking” fights with private interests seeking to use the state as a check against corporations – in a number of blog posts, such as the following:


"Clear-sighted" panic; the role of the corporation in the tragedy of the commons

August 30th, 2009 No comments

This is my fourth follow-up post to “Grist and the tragedy of the panicked enviro“, where I try to clarify the institutional frameworks for understanding and addressing resource problems, in response to confusion in comments by others.

Here is my most recent comment:

Cyberfarer, thank you for your response [here], which is well-intentioned, but both perceptive and blind.

First, I see you’ve adopted a page from the climate “skeptics” playbook, by
applying the self-deceptive ad hominem device of labelling those you
disagree with as “true believers” in something.  This is a partisan
tactic that lets you treat others as enemies, and spares you from the
trouble of listening to them, trying to figure out what they’re saying
and responding the them, as opposed to a black and white strawman that you’ve conjured
up.  Congratulations on mirroring those whom you dislike most.

Second, with all of your clear thinking, like Mr. Sacks, you offer us no
practical advice, just reasons for despair.  Lezlie, who follows you,
at least provides an agenda.

Third, of course, you’ve got me all wrong; I’m not an ideologue, a “true believer” or even an apologist of
any kind the status quo; I’m a concerned human being, a fellow
traveller on Planet Earth and a pragmatist. You’ve been misreading me,
and certainly have not troubled yourself to consider the very pragmatic
analytical tools that I’ve offered to help you figure how to diagnose
and attack the problems that you perceive.

And what have I offered? Nothing more or less than the rather obvious observations that
resources that are not owned and managed – whether privately or by
groups (including, obviously, by communities and native peoples) tend
to be trashed, and that similar problems are experienced where
resources are formally “owned” by governments but essentially used by
elites for their own benefit. I have NOT argued that private property
is the cure-all, nor have I condoned theft nor the manipulation of
governments by elites. In fact, I have rather clearly pointed out that
both theft and misuse of government have been and remain very much a
part of the problem.

Fourth, you continue to misunderstand the nature of our problems, and want to lay everything at the foot of
“capitalism” and “markets”, when the real problem is either the lack of
ownership of resources or government fiat/theft.  Western capitalism is
not responsible for extinctions and environmental devastation that
preceded capitalism and markets, or that has taken place under
state-directed economies. This gets old, but look at the prior
extinctions, messes of the former USSR (and at the Aral Sea today),
Hanford and Rocky Flats, Haiti, and China.

Sure, the consumer and industrial supply demands of markets (not merely in the West) continue
to pull chains of destruction elsewhere in the world, but destruction
only occurs with respect to resources that are not owned and protected
(or where theft by those more powerful occurs). Tofu and meat eaters
alike are indirectly responsible for rainforest destruction, mainly
because governments “own” most the rain forests and don’t prefer to
protect native title where it is recognized, so the conversion of such
land into soybeans (or palm oil to feed government-mandated demands for
biofuels) continues.

In any case, is it more effective to wail about the evilness of corporations that compete to provide us ever more
cheaply things that we choose to buy, or to demand better property
rights protection abroad, pay closer attention to where our food comes
from and end domestic mandates that drive destruction? You’re welcome
to your rants against true believers like me, but I’m personally more
disposed towards trying to be practically effective.

Fifth, you are very right to criticize corporations; Mr. Sacks has had a history
of doing that. Not only do I agree with much of his analysis (which he has not provided here), but I’ve devoted a fair amount of time to examining the entanglement of corporations and government:

Our state governments were wrong to get into competition with each other to
grant corporate status to investor-owned enterprises, in exchange for
fees and later taxes. Corporate status freed investors from down-side
risk, by limiting liability to the amount of capital contributed. This
incentivized: investors to encourage corporations to embark on risky
activities that shifted costs to innocent third parties; the
concentration of wealth in corporations; the corruption of the court
system that once protected third parties from damages caused by others
(by replacing strict liability with balancing tests); and the ensuing
battle – that you noted – over legislatures to regulate corporations
(and courts to enforce regulations). Is there a takeaway on this. other
than continuing to fight political battles to block legislative sweet
deals and theft, including working to revise our corporate order?

Anyway, I wish you well in your tirades.

Rot at the Core: Contaminated Kansas town begs for EPA buyout; where are owners of abandoned mines?

July 11th, 2009 No comments

Surely there`s no reason for the Ameriican people as a whole to be bailing out the last residents of this lead and zinc mining Kansas-Oklahoma border town, but do the original mining firms really get to skip town so easily, leaving everyone else holding the bag?

Isn`t that precisely what the state grant of limited liability is for, anyway?

Categories: limited laibility, pollution Tags:

Rot at the core: Fed Vice Chair Don Kohn`s Senate testimony reveals the Fed’s moral hazard maximizing strategy (h/t Willem Vuiter at the FT)

March 7th, 2009 No comments

The March 6 Financial Times has a great piece by Willem Vuiter, professor at the LSE and former chief economist of the EBRD, that completely rips the Fed`s bailout of AIG`s credit default swap counterparties, as emblembatic of the epidemic of moral hazard that has rotted out our financial system. 

Vuiter doesn`t focus on the dynamics that led to the problem (limited liaibility by shareholders, which has led to a vacuum in risk management, as no one had enough “skin in the game”), but correctly notes that the Fed`s actions incentivize further irresponsiblity – and that the Fed and Congress themselves don`t have enough skin in the game, as they are playing with taxpayer money, not their own.

The article is worth reading in whole; here are excerpts of the parts that resonated most with me (emphasis mine):


The reports on the evidence given by the Vice Chairman of the Federal Reserve Board, Don Kohn, to the Senate Banking Committee about the Fed’s role in the government’s rescue of AIG, have left me speechless and weak with rage.  AIG wrote CDS, that is, it sold credit default swaps that provided the buyer of the CDS (including some of the world’s largest banks) with insurance against default on bonds and other credit instruments they held.  Of course the insurance was only as good as the creditworthiness of the party writing the CDS.  When it was uncovered during the late summer of 2008, that AIG had nurtured a little rogue, unregulated investment banking unit in its bosom, and that the level of the credit risk it had insured was well beyond its means, the AIG counterparties, that is, the buyers of the CDS, were caught with their pants down.

Instead of saying, “how sad, too bad” to these counterparties, the Fed decided (in the words of the Wall Street Journal), to unwind “.. some AIG contracts that were weighing down the insurance giant by paying off the trading partners at the full value they expected to realize in the long term, even though short-term values had tumbled.”

An LSE colleague has shown me an earlier report in the Wall Street Journal (in December 2008), citing a confidential document and people familiar with the matter, which estimated that about $19 billion of the payouts went to two dozen counterparties between the government bailout of AIG in mid-September and early November 2008. According to this Wall Street Journal report, nearly three-quarters was reported to have gone to a group of banks, including Société Générale SA ($4.8 billion), Goldman Sachs Group ($2.9 billion), Deutsche Bank AG ($2.9 billion), Credit Agricole SA’s Calyon investment-banking unit ($1.8 billion), and Merrill Lynch & Co. ($1.3 billion).  With the US government (Fed, FDIC and Treasury) now at risk for about $160 bn in AIG, a mere $19 bn may seem like small beer.  But it is outrageous.  It is unfair, deeply distortionary and unnecessary for the maintenance of financial stability.

Don Kohn ackowledged that the aid contributed to “moral hazard” – incentives for future reckless lending by AIG’s counterparties – it “will reduce their incentive to be careful in the future.” But, here as in all instances were the weak-kneed guardians of the common wealth (or what’s left of it) cave in to the special pleadings of the captains of finance, this bail-out of the undeserving was painted as the unavoidable price of maintaining, defending or restoring financial stability. What would have happened if the Fed had decided to leave the AIG counterparties with their near-worthless CDS protection?

“I’m worried about the knock- on effects in the financial markets. Would other people be willing to do business with other U.S. financial institutions…if they thought, in a crisis like this, they might have to take some losses?”

Let’s step back a minute and ponder this.  US banks and shadow-banks (like AIG’s Financial Products Division) took on excessive leverage and excessive risk.   There was not only too much careless lending by US banks, there was too much careless lending to US banks.  When this crisis is over and when, in the fullness of time, the real economy has recovered, we want to see less lending by and to US banks than we saw in the years 2004 – 2006.  How do we get those who provided US banks and other financial institutions with too much funding at too low a cost to behave with greater prodence and caution in the future? Presumably by making sure that they pay the price for there (sp) reckless financial decisions.  The counterparties of AIG who had been unwise enough to buy insurance against default on debt instruments they held, by acquiring CDS written by AIG should have been told to eat it.



Unless the counterparties pay the full price for their hubris and recklessness, they will be back for more.  It is therefore tragic that central banks and governments everywhere are going out of their way to protect and shelter the unsecured creditors of the banks (holders of junior and senior debt among them), by raiding the tax payer or the credit and reputation of the central bank.  Significant mandatory debt-to-equity conversions and large write-downs of (haircuts on) the claims of other unsecured creditors should be an integral part of any financial assistance package. …

While the demise of Lehman and the destruction of most of its unsecured creditors was an unnecessary surprise, it was still the best option available to the authorities, given the absence of an SRR [Special Resolution Regime].  Markets and market participants are educated only by painful example.

The cardiac arrest followed the realisation, well after Lehman went kaput, that (1) most of the internationally recognisable US banks were insolvent or would be but for past, present and anticipated future government financial support; that (2) many other non-bank financial institutions (AIG) and shadow-financial institutions (GE) were either insolvent or at death’s doorstep; and that (3) the government was not on top of the issues and the Congress was deeply divided and irresponsible.

The logic of collective action teaches us that a small group of interested parties, each with much at stake, will run rings around large numbers of interested parties each one of which has much less at stake individually, even though their aggregate stake may well be larger.  The organised lobbying bulldozer of Wall Street sweeps the floor with the US tax payer anytime.  The modalities of the bailout by the Fed of the AIG counterparties is a textbook example of the logic of collective action at work.  It is scandalous: unfair, inefficient, expensive and unnecessary.



Well said!