Your Lying Eyes

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12 September 2012

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.

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Anonymous Tertius Lydgate said...

If you examine it closely, Tax payer/Federal government profit is an even more confusing concept, perhaps an oxymoron.

The more government spends - taxes collected, the greater the financial savings of the private sector is, so you could just as easily name it "private sector loss" driven by government revenu increasing. After all, I doubt anyone will see a tax decrease in response to this news.

In a broader sense, you have to look at the real vs., nominal consequences. The money spent on bailing out AIG et. al. was, of course, all nominal -- numbers marked up in a spreadsheet.

To access the real profit or loss effects of the government action, you have to compare the potential real consequences of complete economic disintegration faced in 2008 -- as AIG threatened to bring down numerous (a majority?) of US financial institutions -- with the real costs we face now: those same institutions that dramatically failed the free-market test are still consuming real resources, likely still inefficiently, with no threat of market failure due to a government backstop.

In contrast to the financial sector, many in the bubble driven real estate sector have been forced to find new jobs.

September 19, 2012 9:41 PM  
Blogger ziel said...

I agree - any "profit" is beside the point - the real issue is the damage done by the act of the bailout vs. the damage prevented. The damage, though, seems to me to be limited by loss of liquidity, which can be corrected any number of ways that do not involve making failed institutions whole. Liquidating a failed institution while pumping liquidity into the system via other means will make lots of people flat broke but shouldn't lead to systemic failure.

September 19, 2012 9:46 PM  

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