Did the Gummint Make Money on the AIG Bailout?

This has been the subject of some debate over the last day or so. The Treasury announced it had made an $18b profit. Watchdog Neil Barofsky and blogger Henry Blodget got into a little Twitter spat over it, leaving completely unsatisfied. Dreading the task of attempting to look into it more deeply, I instead partook of various diversions such as a the Yankees-Red Sox game and red wine.

I'm happy to report though that physicist Steve Hsu has accepted the premise (that the AIG bailout was profitable) and that's good enough for me. But that then conjures up a disturbing paradox.

Intuitively, one feels that bailing out blood-sucking financial institutions (like AIG and the banksters) is a bad thing, while bailing out actual goods-producing firms (like GM) seems rather virtuous. But it looks like bailing out the vampire squids is actually profitable - or at worse break-even - while rescuing the manufacturers has led to losses.

Hsu expected the AIG bailout to be profitable because the tendency of markets is to both overshoot - and undershoot - value. So at the depths of the depression, when the bailouts were instigated, financial assets were generally undervalued, thus providing a good buying opportunity for the Treasury. And especially in the meltdown, financial assets were in a state of complete chaos valuation-wise - no one really had a clue about their intrinsic value, as no one had a clue about what could be paid off and what couldn't. But with financial assets, liquidity in and of itself can stabilize financial assets and thus raise their value (assuming the reduced value is due to lack of liquidity).

But with manufactured goods, far more of their value is built into the goods themselves (at a minimum, scrap value). Sure, the value of any good will be depressed during a recession due to the demand curve, but the value of a car is not dependent on who has possession of it at a given time. A mortgage, on the other hand - or a CDS - is indeed entirely dependent on the specific counterparty. Thus, bailing out GM does not ipso facto increase the value of their manufacturing plant nor of their cars. By the same token,neither did the poor fiscal shape of GM affect its intrinsic value.

In a pure bankruptcy, GM's liabilities would have been abrogated and it's assets sold at auction. Assuming GM cars would have any marketability, it's inconceivable that it would not have survived as an auto-manufacturing concern. What could not have survived is the U.A.W.'s role in the new G.M. That is what Obama bailed out - not GM, but the UAW, which is why there will be no GM-bailout profit.

Rather Predictable

It's not even ironic that in the wake of a massive financial crisis driven by the Federal government's relentless pressure on lenders to relax lending standards and make more home loans to minorities, one of the few actions Eric Holder's Justice Department has taken in this sphere is to charge a bank with unfair lending practices to minorities. And not just any bank, of course, but the Typhoid Mary of minority-outreach lending, Countrywide. I'm not surprised - are you? No, I didn't think so - saw it coming a mile away.

The specific allegation - that Countrywide "steered" black and Hispanic customers to higher-fee, higher-rate loans compared to whites (with allegedly equivalent qualifications), is not entirely implausible. Given Countrywide's "$Trillion Pledge," some serious recruitment of minority candidates was needed. To really ramp up minority lending, you can't just sit behind a desk and wait for the customers to line up. You've got to go out and find them, convince them that they could indeed get a loan, and assure them that that dishwasher's salary won't be a problem, trust me. These recruits need a little heftier commissions to get the job done, so it's hardly shocking they might just convince the prospective borrower to pay a bit more in interest and a bit higher fees than a customer who comes knocking on your door with LendingTree data in hand.

Yet, despite a plausible scenario to explain it, I seriously doubt the allegations are backed up by the data. Typically these "equivalent qualifications" fail to take into account borrower's net worth. And more important, is there any data showing that minority borrowers performed better with subprime loans than white borrowers? I doubt it - if there were such data, it would have been revealed long ago. In fact, the Federal Reserve has carefully guarded any such data, leading me to believe the exact opposite is true - that minority performance was actually worse. Bank of America - which owns Countrywide - settled the complaint without a fight, of course.

Illegal? There was Nothing Illegal!

Obama has received characteristically little grief for his claim that the fraud that drove the Wall St. debacle wasn't illegal. For Obama and the left, such quaint, common-law legal concepts like "fraud" are irrelevant in a modern state. Regulations are the way to go - the government establishes detailed regulations and legions of regulators micro-manage firms actions. Fraud - a charge that requires detective work, witnesses, forensic accounting, etc. - is just too messy, too unpredictable to bother work.

Regulations, on the other hand, could prevent these bad actions before they occur, plus direct commercial activity towards achieving policy goals, such as financing for favored projects. Of course that was all tried before - the S&L crisis, the Enron scandal (which begat Sarbanes Oxley, arguably the most burdensome regulatory regime ever) - and it happened anyway.

Fraud prosecutions in this scandal might not have been all that difficult. You start with the borrowers who lied on their applications, and then go right up the chain to the brokers, their managers, the financiers who put together the CDO's and on up to the top. Sarbanes-Oxley itself, which effectively criminalizes incorrect earnings statements, should have been able to bag a few CEO's all by itself. But apparently no one in the Justice Department has found this massive web of fraud anything but an impenetrable morass.

I must confess, though, to having some sympathy for the banksters. Though I have no doubt they engaged in out-and-out fraud, I'm also convinced they're behavior was essentially foisted upon them by the government's minority-lending mandates. Starting early in the Clinton administration and then amped up by W. himself, banks faced the choice of stagnating or aggressively pursuing minority lending. But of course at the same time they are being pressured by the government to take on less profitable business (less profitable because the loans are riskier), the banks are under tremendous pressure by shareholders to be more-and-more profitable.

Well the only way to avoid losses on riskier assets is to increase leverage. So they appealed to the authorities for relaxed leverage rules, requests which the authorities all too willingly accommodated since it was towards a noble cause. But as we all know now, pumping up leverage is like being a mule-skinner transporting nitroglycerine - the pay's good but one bump and it's all over. The CDO's were an effort to share the risk - like paying the other wagons to each take a bottle or two of nitro - but then what happens of course is that when one blows, all the other wagons go up with it.

On the other hand, the banks could have showed some courage and fought back, insisting that no business model could withstand this kind of debasement of best practices. They could have insisted that bank lending is too fundamentally critical to the nation's economic health to be subject to politically correct mandates. But such courage is nowhere to be found in the business world. Indeed, the Diversity Doctrine is so deeply entrenched in corporate culture that almost certainly those in charge actually believe it.

Young People Saving Money - What a Disaster!

The madness behind Keynesianism can be found in an article today in the Times ("As New Graduates Return to Nest, Economy Also Feels the Pain") featuring uber-Keynesian Mark Zandi of Moody's. Saving money is bad, you see - and squandering it on useless frills is what the economy needs. What Zandi wants young people to do when they get their first job is to get their own place and start spending that money.

Every year, young adults leave the nest, couples divorce, foreigners immigrate and roommates separate, all helping drive economic growth when they furnish and refurbish their new homes. Under normal circumstances, each time a household is formed it adds about $145,000 to output that year as the spending ripples through the economy, estimates Mark Zandi, chief economist at Moody’s Analytics.

Clearly Zandi has learned nothing. That he didn't foresee what was coming is rather unfortunate, given that he's chief economist of a corporation charged with rating risk. But not to have learned from what happened is unforgivable. Zandi, Krugman and their ilk seem to believe that some weird event happened in the heavens - like a supernova that lights up the night sky - that spooked people and has led them to irrationally withdraw from the economy.

 But as we all know what happened was that people learned - when the bubble burst - that debt must actually at some point be repaid and can't be perpetually rolled over, that future high incomes are not guaranteed, that the amount of disposable income available is not infinite, and that future expenditures cannot always be paid out of current income.

 So what these young people are doing (at least according to this article's narrative) is staying a few more years with Mom and Pop to maybe save a few bucks for one of those down-payment thingies that used to be so popular back in the Middle Ages for buying houses. But apparently Zandi, on the other hand, is aghast that they're not frittering their incomes away in the expectation of landing a negative-amortization loan for a home costing twice what they can afford. Yeah, that's how a society builds wealth, Zandi - by spending.