[Marxism] The Scent of Fear: Will AIG's Rotten Paper Bring the House Down?

["Fred Feldman" <ffeldman@xxxxxxxxxxxxxxxx>]

The Scent of Fear 
AIG's Rotten Paper Could Bring the House Down
September 17, 2008
By William Greider

http://www.thenation.com/doc/20080929/greider2
For the first time in this unfolding financial crisis, I felt personally
scared by the news. Not about my money, but about the potential for
catastrophe. The Federal Reserve's lightning rescue of AIG has the smell of
systemic fear. The house of global finance is on fire and everyone is
running for the exits, no sure way to turn them around. What's next? The
question itself is ominous, because there are no good answers
      
The US central bank and other nations acted with speed, and good that they
did--an emergency loan of $85 billion to prop up the failing insurance
giant, plus another $75 billion in liquidity pumped into the banking system
to calm nervous bankers worldwide who abruptly stopped lending. The
international rate for overnight lending among banks has doubled, an
expression of fear that describes the potential danger of a sudden freeze in
lending, more or less everywhere. That would deliver a deep shock to real
economic activity, not just in the United States but worldwide. This feels
ominously parallel to the financial chaos that followed the crash of 1929
and led to global economic collapse. 

Government is much better equipped this time with various safeguards to
defend the system against an implosion--including Fed Chairman Ben
Bernanke's personal willingness to act swiftly with unorthodox measures. But
the case of AIG suggests the present unwinding has a malignant dynamic to it
that might even overwhelm the authorities' capacity to put out fires. That's
scary. I hope I'm wrong. 

The reason the Fed was compelled to save an American insurance company in
order to save the global financial system goes to the source of the rot--the
"new financial architecture" developed during the last generation. These
innovations allowed banking and finance to expand their leverage
explosively, borrowing and lending far beyond the traditional limits defined
as prudent risk-taking. One gimmick that supposedly made this okay was the
creation of esoteric insurance derivatives--the so-called "credit default
swaps" that supposedly protected investors and firms against losses in
mortgage securities and other debt paper. 

Critics repeatedly warned that these derivatives were a time bomb--trillions
of dollars in risk insurance that would be exposed as meaningless if
financial markets ever experienced a sharp fall in asset values. Politicians
and regulators from both parties brushed aside the critics and led cheers
for Wall Street's fancy new ways of guaranteeing risk. 

AIG sold those guarantees in huge volume. It assumed potential liabilities
far beyond the firm's capacity to make good on the deals if something went
terribly wrong. The problem is global because AIG--an imperious promoter of
globalized finance--sold this rotten paper all around the world to big
investors and leading banks. If AIG is suddenly insolvent, the pain and loss
are spread instantly to thousands of balance sheets in Asia and
Europe--banks and corporations that must suddenly write down their own
assets. That's why the Fed could not wait to find out what would happen if
AIG was allowed to fail. 

But the system is not free of these troubles. AIG was not the only high
flier peddling false hope to supposedly sophisticated financiers and
bankers. Some of the largest, most respectable banks--led by JPMorgan
Chase--did the same thing. It was a highly profitable line of business. The
gimmick insurance was widely admired by financial economists and approved by
the supposedly objective rating agencies. It is not clear to me how
government intervention can unwind this feature of our corrupted financial
system--short of making good on the trillions in these essentially
fraudulent contracts. Not even the Federal Reserve has the assets to swallow
all of Wall Street's folly and deception. 

If my fears are right, a more fundamental reckoning may lie ahead and
Washington will have to take far more decisive action. At some point, the
new president might have to do what FDR did in the wreckage of early
1933--declare a "bank holiday" and announce emergency rules to govern
banking and finance until the crisis is broken. For the country's sake, I
think this a better approach than buying up junked banks and failed
financial firms, one by one. People have the right to ask: what exactly are
the rest of us getting for our money? 

bout William Greider
National affairs correspondent William Greider has been a political
journalist for more than thirty-five years. A former Rolling Stone and
Washington Post editor, he is the author of the national bestsellers One
World, Ready or Not, Secrets of the Temple, Who Will Tell The People, The
Soul of Capitalism (Simon & Schuster) and--due out in February from
Rodale--Come Home, America. 


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