Isn’t it ironic that a firm such as AIG, with so many expert and professional insurance risk analysts would engage in the riskiest form of insurance ever created?
One might think that such a company, with a global reputation for professional standards and risk aversion would take extra care at everything it undertakes. Quite obviously, this is untrue, as it created the Credit Default Swap and allowed it be become the unregulated cause of at least part of the present economic depression.
Companies, as this Institute has previously written, can grow to such a point that they begin to seek every possible bypass for regulatory control and safety protocols possible, engaging lawyers, accountants and executives to identify each possible way around the rules.
When companies get that big, they pose a systemic risk to the system. This, we believe, will ultimately become the great lesson of Depression 2.0.
The company that is too big to fail, is simply too big. Such firms, like AT&T in the 1970’s must be broken apart for the protection of the company as much as the public, for in failing to do so, such companies stand a high probability of causing grave difficulties for the overall economy of the nation and indeed, the world.
Enron, which made a massive rise in valuation on illegitimately borrowed funds and false statements, collapsed wiping out billions in equity investments and individual capital. This was just the beginning of what was more than a decade of criminally fraudulent financial schemes by what appear to be companies that grew beyond the ability to be managed.
We are concerned that some of the megabanks continue to pose a serious long-term risk and that unless they are promptly dissected into individual components, they will continue to cause troubles even after a recovery is clearly underway.
Regulators, such as FDIC must be particularly cautious about transfers of smaller failed banks into the hands of megabanks. Instead, we believe failed banks should be sold to small consortiums of banks of equal or smaller size, breaking up the components of the failed institution as was done with Wachovia.
We’re also concerned by the lack of focus on this subject on Capitol Hill. These giant entities hire lobbyists to protect their interests in government, so legislators fear action that would break up the companies. It is a fear that they take seriously, but one that puts self-interest before the greater good of the nation.
Consider, if you will, that when a corporate entity grows too big, it becomes almost impossible for any individual or group of individuals (such as a board or management team) to properly and safely manage the entity. Actions by mid and lower level executives can take place unnoticed by senior management that ultimately impact the overall company and potentially, the global economy.
As we’ve also written, this is exactly the lesson of Berings Bank where a single trader operating in a back-office far flung from their London headquarters began trading to an extent far beyond his rights or responsibility, effectively destroying the company because Berings had grown too big.
We believe Edward Liddy, who graciously came out of retirement for a total compensation package of $1 a year to run AIG for the Federal Government (as principal shareholder) has more on his plate than he expected. He is properly focused on breaking AIG apart, but the timing of this could not be worse.
As long as the MBS and CMBS markets remain largely frozen, the general appetite of investors to buy individual components of AIG, whether they are profitable or not, will remain limited at best.
Curing the MBS and CMBS issues is the critical key to making sure AIG has a value equal to or greater than what taxpayers are paying for that firm. Despite the profitability of the insurance division, other divisions might drop the overall value to potential buyers and thus cause AIG to create a loss for the US Treasury. Perhaps it might be best to wait a while, using the time to clean up AIG, which is what we believe Mr. Liddy is doing.
Hopefully, legislators will maintain sufficient patience to wait so that we, as a nation, do not “take a haircut” to quote House Speaker Nancy Pelosi.
In assessing risk, legislators, regulators and Mr. Liddy must look at a longer-term picture than the media-pushed urgencies of the moment.
For the record, Mr. Liddy did a superb job in front of the Capital Markets Sub-Committee, despite the oft-times unfair and irresponsible harassment of some members who clearly were not briefed on his role in this company by their staff. Mr. Liddy certainly has much to do, but should be permitted sufficient time and opportunity to do it, rather than wasting time berating a man who is there to protect, not harm the taxpayer.
We wonder who’s advising Members about assessing the risk if Mr. Liddy were to get up from that conference table and simply resign. The job would become one few, if any would venture to take at any price. Staffers and Members should give serious consideration to that possibility and assess the other risks of AIG very carefully.