Hank Paulson says the sky was falling. Do you believe him?
Article: "Lawmakers, AIG's Rescuers Spar at Hearing", WSJ
In Henry Paulson's testimony today he said that whatever was done last year for AIG was necessary:
"I believe we would have seen a complete collapse of our financial system and unemployment easily could have risen to the 25% level reached in the Great Depression," Mr. Paulson said.
I wish just once some Congressman would ask him to explain how this would have happened. They always let him get away with making that statement without challenging it. I don't understand how the dominos were lined up in the AIG case such that the whole financial system would have collapsed.
Let me try and reconstruct the scenario. AIG is an insurance company (not a bank). It sold insurance to many of the banks who bought into the CDOs that were packaged up by Fannie Mae and the Wall Street Investment Banks. The insurance was to pay off if these mortgage backed securities did not pay off on the cash flow they were designed to offer. This had nothing to do with the mortgages themselves or the homeowners or the banks that wrote the mortgages. This was a big party to big party insurance policy that AIG did not calculate the correct premiums and reserves on.
So the CDOs were shit. And when the shit hit the fan the owners went to AIG to collect on the insurance policy they had purchase. The problem is that AIG did not have the assets to pay off on the claims so they were going to have to declare bankruptcy. This bankruptcy is what the Federal Government is saying would have collapsed the financial system and so they could not allow this to happen.
So who would get hurt if AIG went into bankruptcy? I can tell you who would NOT get hurt: all the individual policy holders of Life Insurance and other individual insurance that AIG offered. That is because these were regulated by the States and there were reserve funds which were under State control to be used in this kind situation. So it is just the other big banks and institutions who would be affected by the bankruptcy.
But bankruptcy does not mean that there is no money to be paid out. It just means that there is not enough to pay 100% of the debt owed. So this means that the counter-parties (Goldman, et. al.) would get some money paid out on there policy.
So where is the "complete collapse of our financial system"? I don't see it. Would it be painful? Yes. Would it be deadly? I don't see how. This whole thing has always smacked of the same fear mongering that got us into Iraq ("Weapons of Mass Destruction") and enabled domestic spying through FISA ("There are Terrorists who are planning to kill us") and many many other instances that turn out to be trumped up flat out lies.
The next time someone says that the whole financial system was about to collapse ask them to explain how that would happen. I am pretty sure they can't tell you. Nor could Hank Paulson.
