Looting Goes Mainstream: The Trouble with Government-Backed Risk

By James Kwak

A week ago, Simon wrote his “Confusion, Tunneling, and Looting” post, which argued that the confusion created by crises helps the powerful and well-positioned siphon assets out of institutions and out of the government. The revelations that much of the AIG (AIG) bailout money has gone straight to its large bank counterparties in the form of collateral could fall under this heading.

The looting theme has gone mainstream, with David Leonhardt in The New York Times. I think Leonhardt’s article is good, but it describes looting (taking advantage of implicit government guarantees to take excessive risks) as a cause of the mess we are now in - and as something we’ll need to worry about in preventing crises in the future. But, as Simon argued, it’s also something to worry about right now. As long as the Too Big To Fail doctrine holds, the banks’ implicit government guarantee is more explicit than it ever has been. So whatever perverse incentives helped bring on the crisis are even stronger today.

Comments

[Richard Leader:]

Absolutely correct!!!

Add to this what's going on, as we speak/write, with the Gov't financed "off balance sheet" deals with large private investors that will take toxic assets off the hands of banks, allowing huge medium term profits to be taken from from banks we are bailing out because of marked to market rules and given to private investors with easy financing from Uncle Sam.

Outrageous.

Mar 12 12:04 PM

[JohnL:]

Looting has become endemic, even in good times, for many years. When banks can legally borrow a large portion of their funding from the central bank at a low interest rate and then loan it out to the public at high interest rates, that is looting -- plain and simple. It is a huge transfer of wealth from the public to the bankers and it's been taking place in plain sight for decades. There is not a word from the press, politicians or academia. The public is almost entirely ignorant of the whole scheme. I'm sorry, but looting went mainstream a long time ago.

Mar 12 12:13 PM

[Haigh:]

Looting is firmly institutionalized and applauded with the Social Security system. A younger generation is looted for the benefit of an older generation. That bubble is still being inflated.

Mar 12 12:32 PM

[morph366:]

Thanks for the link to the “Confusion, Tunneling, and Looting” post which I have just read and which is right on the money (so to speak).
Complexity and spin are two key ingredients that enable elites to preserve their power and influence - and it sure helps to have many in the financial technocracy who are just as mystified by the complexity of it all as the average citizen.
Only through putting these issues into the mainstream media is there even the remotest hope that another Too Big to Fail fiasco can be avoided. Alas I am not too hopeful.

Mar 12 12:57 PM

[Tesa:]

Kudos to the author for telling the truth. New York Times article is very accurate.

All the cries about socialism and Communism is designed to cover the fact these private institution were colluding to pass their losses to the public and governments.

Passing the losses to the public while those that benefit can live the life of luxury is name of the game. Giving massive bonuses to managers of failed institutions was about collusion. Rating agencies that produced fake ratings did in fact collude.

Mar 12 01:05 PM

[Tesa:]

Haigh, your argument is not valid at all and those that claim this often do so to cover up for private institution fraud by avoiding the real topic.

Those Social security are not looting anyone, they are merely receiving the results of their labor agreements and their contract with the government.

If any population declines, each generation receives less social funding than the previous generation till population decline stabilizes otherwise there should not be funding issues. Other countries have managed with far more server population decline.

Mar 12 01:18 PM

[Tesa:]

Richard Leader, that correct. That completes the life cycle of looting till the next pass.

Mar 12 01:19 PM

[Chris B:]

1)There is a conflict of interest when risks can be passed on to others. Aggressive managers can take risks that drive a bank to insolvency, costing investors and taxpayers billions, and still walk away with tens of millions of dollars in "performance incentives." This is where rules are supposed to exist to prevent risks from being passed on to others, while benefits are accrued for oneself. As those regulations (a dirty word, I know) were reduced or went intentionally unenforced, we saw more of this looting behavior, as we should have expected. The repeal of The Glass-Steagal Act in 1999 is my favorite example.

2) If executives have engaged in looting, taxpayers AND shareholders have been the victims. Ask anyone who bought Citigroup at $25. Of course, it is not the responsibility of taxpayers to reimburse shareholders, who got ripped off by their executives. Any assistance from taxpayers should come at the price of dilutive equity, which can later be sold to reimburse the taxpayers. If taxpayers can assure the bank's survival, they should be able to get their money back by selling their equity, probably at a profit. These revenues should then be applied directly to the national debt.

3) The "too big to fail" phenomenon is real. Andrew Mellon thought that the economy would do just fine if all the country's big banks went under. Wrong. The result was the great depression. Ten years of depression would cost a lot more than buying bank stocks and bonds to prop them up and guarantee their success. Those are the lessons of experience.

Mar 12 01:27 PM

[Haigh:]

Tesa,
Nothing in my post aims to cover up all the fraud of private institutions.

>>Those Social security are not looting anyone, they are merely receiving the results of their labor agreements and their contract with the government. <<

What you describe is a Ponzi scheme, and any Ponzi scheme that is involuntary is looting. If Social Security's inflows were preserved in a trust, and the outflows paid from that trust, then it would no longer be looting. As part of the fraud that is Social Security a Trust is occasionally mentioned, but everyone knows there is no Trust.

We all know in the end Social Security becomes a poverty prevention program when the retirement of the baby boom overwhelms the tax paying capacity of the baby boom's children and grandchildren. The looted will begin to vote against the looters.

Mar 12 05:05 PM

[Dirk McCoy:]

Our whole economic system of debt is a bit of a Ponzi scheme- the Fed creates money, the banks loan it, companies are formed, production undertaken, cashflow then goes into paying back debt and growing companies and paying employees, who buy the produced goods. As global competition increased, the margins shrank. Soon, we had a very lean system where people were taking points to insure against potentially larger losses due to disaster, death, and default.

Wether we let the pyramid grow too tall, or just didn't keep enough money in the economy to account for growth in production (or fraud), the bottom line is that when the whole thing started collapsing, the pressure fell fully on AIG as the largest insurer. They clearly did not correctly model (or care about) the losses that could occur as the Fed increased short term interest rates.

The Fed and government have stepped in to relieve the pressure. Now, mark to market changes could relieve it further. I'm interested in finding out if the combination of this pressure relief with economic recovery and AIG's strengths in their traditional insurance markets could add up to a significant recovery in the stock price. It's up 20% today.

Disclosure: Long AIG

Mar 13 02:55 PM

[hap:]

Baby boomers are not looters as they have paid and paid for years into SSI. The Federal govt. has repeatedly re-allocated much of these monies for other issues.
Clinton opened the door to China to take away many of our industrial productions jobs. When you add to that the cost of EPA restrictions it should be no surprise that a major downturn is occuring. Now we have an inept president openly allowing greed to take place with taxpayer money. We need to get rid of the free trade agreement, and bring our jobs back home where they belong.

Mar 15 04:35 AM

[Haigh:]

Knowingly supporting an involuntary Ponzi scheme is tantamount to looting. The baby boom is guilty as charged.

Just wait till baby-boomers living in million dollar homes, with a large percentage of equity, begin drawing Social Security, paid for by the younger workers living on far less means. Those younger workers are going to feel they are being looted and vote accordingly.

The money the baby-boom put into Social Security is as gone as the money handed off to Bernie Madoff. It's a damn shame, but the baby-boom has to be responsible for their own failure to manage their retirement responsibilities. The inability to confront this reality is part of the problem.

Mar 15 08:56 PM