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So the first domino was still the subprime loans going bad?
I'm not so sure. That would imply it really caused the mess, where IMO, the real problem is further down the line. If the mortgages themselves just went bad without securitization, then the owners of those mortgages would be in bad shape, aka, Fannie Mae/Freddie Mac. But the damage would largely be limited to them. The securitization, IMO is really where things went horribly wrong. The ratings agencies like S&P and Moody's essentially sold ratings. They took mortgages that were rated triple C (terrible) and took the best of the triple Cs and re-rated them as As (excellent). How they haven't gotten shutdown is really something I'd love to know. Arthur Anderson got shut down partially for selling audits. Why didn't the ratings agencies get shutdown for selling ratings? But that's another thread. Then groups like Citibank bought these securities thinking they were good (gotta to wonder who was in charge of that). And the rest is history.
Mortgages as social policy can be somewhat blamed as a reason for the mess, but it's hard to put much blame on them. CRA loans never exceeded $20 billion at any one time and were profitable for over a decade. The Republican removal of obstacles to getting a mortgage also were partially at fault but those I think never exceeded something like $30 billion. $50 billion in a market of trillions in real estate is a drop in the bucket.
And the companies that owned the loans not only lost the value of the loan but are also saddled with the debt they incurred to purchase the loan. So essentially, if I'm understanding this right, AIG failed to manage its risk exposure and exposed itself to too many high risk loans and compounded that mistake by borrowing money to facilitate that overexposure to risk. Wow, they deserve to go belly up.
Well, not quite. AIG I don't think borrowed money. They insured all kinds of loans. When the firms that gave out the loan went bad, AIG had to make good on insurance to the loan holder. What AIG, or more accurately, AIG's London Financial Products department which apparently is like 30 to 20 people over exposed themselves. Rumor has it that the deal between that office and Corporate was that the London FPD got to keep 50% of whatever it made. That's massive incentive to sell, sell, sell. The sad thing is that AIG insurance is pretty solid and does a good job. One over seas department numbering fewer then Corporate Office's cleaning staff has done them in.
Which brings me back to the point of my previous post, by bailing them out, we're not letting them suffer the market consequences of the gross miscaluclations. Which means they have no real incentive to stop taking such wild risks since they know the government will be there to bail them out.
That is the problem of a moral hazard. But it doesn't seem right to let insurance based employees get hammered for the failure of the financial products division, which is the reason I'm for giving the insurance executives who brought in billions in profits to get their bonuses. They are helping keep AIG alive. That deserves a reward.
So let me ask you this, is it true that AIG is "too big to fail"? It seems to me from your earlier reply you also favor breaking them up. Anything else you'd do? I take it we don't have any regulations on leveraging ratios, it that something worth looking into?
I'd favor breaking up AIG into insurance and financial products. The insurance is largely okay. And we can't let that go belly up. The mere fire sale on those policies would destroy the balance sheets of every other insurer (due to mark to market) and we'd be an even deeper hole.
The problem with regulations on leverage is that every firm is different. Some firms handle leverage better than others. A hard a fast rule would probably do more damage then good. What I'd support is more disclosure requirements on public audits about leverage, specifically what the leverage is tied to and potential risks on what was borrowed for. If they got $500 million in leverage on an asset, I want to know what the risk on that asset is. Given the latest Financial Accounting Standards Board exposure draft, we might be getting there pretty quick.