Replacing the Anti-Capitalist AIG Paradigm
The common interpretation of the downfall of AIG is so popular that it has become accepted as unquestionable, if not axiomatic. The paradigm is as follows: AIG executives were compromised by greed. This led them to take reckless risks with their capital in an unregulated atmosphere. These risks eventually became a house of cards as the executives who did not really understand their newfangled products continued to pump them out beyond the point of prudence. When the housing bubble burst and the mortgage defaults began, the house of cards collapsed and the company was stuck with bad bets. As a result, AIG became insolvent.
Because the company was so large and had dealings with too many financial institutions, its collapse would pose a systemic risk to the banking system and economy at large. The taxpayers had to rescue AIG so that it could pay its counterparties and the banking system could remain solvent. This bailout is a moral outrage because it is a burden on the productive citizens of Main Street who did not take excessive risks. The bankruptcy and the need for a bailout are ipso facto proof of the executives’ incompetence; no bonuses to anyone at AIG are deserved. It is therefore right that bonuses be returned to the taxpayer.
But what if this paradigm is completely and totally wrong? Indeed, a moment’s reflection reveals its myriad inanities. Of what does greed consist, and how is it a meaningful causal mechanism? What exactly is meant by “reckless?” What standard determines whether a given risk should have been taken at the time or not? To what level is a CEO supposed to micromanage, what critical things did the CEO fail to understand, and how did it lead to the company’s downfall? How exactly did the mortgage bubble bursting lead to this state of affairs? Since AIG suffered virtually no credit losses on its financial products (so far), by what standard is its product array a manifestation of bad judgment? What specifically brought down AIG?
Now consider an alternate explanation, one suggested by the known facts. AIG’s financial executives rightly pursued as much profit as they could, and they were having some degree of success with this. Their products, under the watchful eyes of cognizant and totally empowered regulators, were generally making money. The company ran into serious trouble not because their products failed, but because the company was hit with sudden requirements to post massive amounts of new collateral, which it could not meet.
This requirement was triggered because the company was downgraded in its credit ratings. It was downgraded in its credit ratings because it took significant write-downs in its credit default swaps because the securities underlying them took severe write-downs, and it also took write-downs in its own mortgage-backed securities. All these securities took significant write-downs because they experienced a significant drop in market price, and market price was being used as the accounting standard by which they were valued.
Market price was being used as the accounting standard because the SEC imposed this standard on them in November 2007.
Because every other financial institution in the civilized world was also in write-down purgatory for the exact same reason, no one had any capital to lend, and AIG, although solvent, faced a liquidity crisis that resulted in the government’s decision to intervene.
Note that the entire sequence of events was started by the imposition of an accounting method. If the imposition of mark-to-market was wrong, then this is a case where government intervention caused a disaster.
If this alternate explanation is true, then how could so many people come to believe in the first version of events? The same way all myths and religions spread. In this case, people took Marxist doctrines being preached on faith.
And if the alternate explanation is true, it has some shocking implications. It means that the company executives were not in fact reckless, that their dealings were generally unproblematic and even beneficial to the economy, and that the government brought down AIG. It means that AIG was the victim and that the demonization of its executives is therefore a gross injustice.
It means that the “reckless” individuals who really are responsible for causing the damage are every Congressman who voted yea on Sarbanes-Oxley, President Bush, every public or private citizen or organization who lobbied for mandatory mark-to-market accounting, everyone at the FASB and the SEC who pushed for it and continued to defend it, the heads at the FASB and the SEC who approved it, every current member of Congress who knew about it but sat on the knowledge, and the D.C. Circuit Court majority—for its decision in Free Enterprise Fund vs. PCAOB.
It means that AIG’s CEO was telling the truth in October about the cause of his company’s problems and was not making up excuses. It means that AIG employees deserve their bonuses.
It means that grandstanding politicians—who would not recognize a CDS sitting in front of them and who are clinically indistinguishable from drunkards as they bandy about terms like “disgraceful” “appalling,” and “suicide”—are disgraceful, appalling, and should resign. It means that the underemployed protesters who bask in their envy outside opulent colonial homes are the greedy ones, and those who make death threats against the company’s executives are not misguided protagonists, but despicable criminals.
It means that those who are currently regarded as destroyers are in fact creators, and those who mindlessly seek to exact vengeance on them are the destroyers of the very kind of people on whom their lives ultimately depend.
Most important of all, it means that the paradigm that free markets are inherently flawed, requiring government intervention to preserve them, has just received yet another, perhaps lethal, blow. It means that the paradigm that free markets always function well when left alone has just received its latest, and perhaps historically decisive, validation.