I realized that I had promised to, in a future post, discuss what led to AIG's failure. The news over the past couple days has given me a chance to revisit the problems that led to AIG's bailout.
AIG, formerly the world's largest insurer, had more problems than its own bad mortgage investments. Like Lloyd's of London, who are famous for insuring things like J-Lo's legs or whatever because they will insure anything, for the right price, AIG began finding new products to insure. They had entered into a number of credit default swaps (CDSs), which are, like, complicated and stuff, but so far as I can tell, they involve insuring companies against losses on investments. Let's say I have a bond (AKA, an IOU) worth $1 million from Bear Stearns, and I begin to doubt if I'm ever going to get my money back. So I call up my buddies at AIG, who, like any good casino that benefits off of more bets, are desperate to find another insurance policy to sell. They will, in exchange for premiums, promise to, for example, guaranteeing that they will give me $700,000 if my bond/IOU becomes worthless.
So, in effect, AIG was doubly exposed to the subprime mortgage crisis. In addition to their own direct ownership of bad investments, they were on the hook for lots of insurance claims, like my fictional $700,000. If AIG goes out of business, I and everyone else who has a similar agreement gets screwed, which the government would like to avoid because EVERYONE has similar agreements with the giant insurer. And that, in a nutshell, is how a company goes from being one of the 30 companies chosen to make up the Dow Jones Industrial Average to selling 85% of itself to the government to keep from disappearing.
What is it that brought AIG to mind today? House Republicans' response to the Paulson plan (previously discussed before John McCain read it!) was a plan in which the Treasury would sell insurance to the banks to protect them from losses on mortgate investments. The House Republic plan is.... wait for it.... Credit Default Swaps! The very thing that killed one of the 30 strongest companies on Wall Street! THAT'S THEIR PLAN!!!
Oh, actually, there is a little more to their plan. They are also pushing for an end to an accounting practice called "mark-to-market". This rule requires that a company count an asset (say, a package of mortgages) to have whatever value it would currently fetch on the open market. This is in contast to how things were accounted for before this rule, which basically let companies assign whatever value they wanted to an asset. Because they could, before mark-to-market, assign whatever value they wanted, they would sometimes LIE (gasp!) by inflating the apparent value of investments in order to make their bottom lines look better. In other words, mark-to-market keeps banks from lying, so Republicans want to get rid of it.
That, ladies and gentlemen, is their plan to solving the financial crisis; credit default swaps, and letting banks lie.
How is it people are still wondering if it's time to let the Democrats have a chance for a while?