AIG Bailed Out Again, but Endless Fire-Drills Don't Put Out Fires

Pumping more money into the financial giant reflects rampant cluelessness and a misplaced belief that inaction is worse than action.

Note to Washington: Take Finance 101 -- STAT!

How many Washingtonians does it take to screw in a light bulb? All of them. And, they'd still be in the dark. Indeed, murkiness is a preferred bipartisan state on the Hill. That's the only explanation for consistently doing the wrong thing regarding the financial crisis, every step of the way and losing obscene sums of our money in the process.

Piecemeal fire drills don't put out fires.

One of the first things you learn as a trader is buy the rumor, sell the news. Treasury Secretary Tim Geithner missed that lesson. His latest blindfolded shoot-a-dart, save-a-bank move came on Feb. 27. That was followed by today's confirmation to dump $30 billion more into AIG, a private insurance company whose claim to public funds is that it backed Wall Street's lousy credit bets, a cry that got bipartisan belief.

Last week, after leaking the Citi stock idea for a few days (giving spec-traders time to scoop up shares to later dump), the government then announced it would convert its preferred shares in Citigroup to common stock, increasing its ownership stake in the firm to 40 percent. (A note on the structure of a bank: common shareholders have no claims to repayment, preferred ones have some. If it was my money (which it kind of is), I'd shy away from that conversion trade.)

The great part of the plan supposedly? No extra public money required! Except that Citi's stock dropped nearly 40 percent, which equates to a $5 billion, or so, market loss. In solidarity, Bank of America's stock dropped a mere 30 percent; Wells Fargo was down 16 percent. I'd have wanted to opt out of the next government investment round, into AIG's coffers this week.

But, after $152 billion has already been swallowed by AIG and it posted a $61.7 billion loss, the insanity of replenishing its funds underscores rampant federal cluelessness and desire to buy into a misplaced fear that inaction is worse than action.

And all the explanations for this nosedive in Citi's stock were painful. Which is why it's likely similar conversions will take place soon for Bank of America.

The business press said shareholders were concerned about the dilution effect on their own shares, so they dumped them. (If new shares were issued to the government, existing shareholders would own proportionately less of the new total amount.) The progressive press called it another step toward nationalization (Which it really isn't. Purchasing stock in a black hole of a risk cesspool of a financial institution is not nationalization, it's simply bad investing strategy). And, the conservative press considered it a step toward the destruction of capitalism (Which it really isn't; capitalism thrives on raising funds for assets that have no value. Ask Bernie Madoff or Hank Paulson).

My interpretation is that the savvier traders did the same thing they've been doing, unrestrained, throughout this crisis: they dumped or shorted Citigroup shares because they knew the government remains oblivious to the root cause of the decimation of the banking industry and isn't asking the right questions to quantify the potential downside still out there.

Without full disclosure, the market assumes the worst. Traders trade down. Banks don't trust each other. And credit remains in a coffin. Throwing money at this situation reminds me of the bottomless-pit scene in the old "Flintstones" cartoon.

The Real Problem

Between these punts at explanation lies the true problem. It's the same one that has been at the core of this crisis and stemmed from the complete deregulation of the industry in 1999.

It's that no one has a clue about the true nature of Citigroup's books or health, or AIG's. Nor of Bank of America's or Well's Fargo's, or for that matter, JPM Chase's, although its CEO, Jamie Dimon, maintains the best poker face. Because the banks were allowed to grow to be too big to regulate and too complex to decipher.

The very idea that the government should capitalize these convoluted institutions rather than separating out and concentrating on the specific divisions that are fully understandable and whose risks are quantifiable, defies logic. It has also proved tremendously inefficient and costly.

No amount of equity injections or Geithner's stress tests or private-public government-backed investment plans will change that. No one should think of nationalizing, as in taking over and running, anything they can't quantify. Ever. I mean, would you consider buying a car that exudes smoke from under the hood, no matter what you do to it? Of course you wouldn't.

The fact remains that whatever evaluation model you use for them, however you capitalize them and whatever "bad bank" construct you chose to go with, rounding up and dumping arbitrary amounts of toxic assets somewhere will not do more than calm the financial markets for the amount of time it takes to realize there's more where that come from.

Think about it. There were $1.5 trillion subprime loans issued between 2003-2007. About $14 trillion of asset-backed securities and collateralized debt obligations were created using those loans as collateral. Yet, we're already in the hole about $10 trillion to "fix the banks."

It doesn't compute.

Why? Because we're still not even discussing the borrowing Wall Street did on the back of those securities. Throw that into the equation under the very conservative assumption that all banks borrowed up to 10 times the amount those securities were once worth, and we're looking at a systemwide maximum loss of $140 trillion.

See, these "toxic assets" don't live in isolation. They are like weeds overrunning a lawn. You can't just remove a section and assume the lawn will automatically convert to pure grass. They have separate lives as collateral for other things -- borrowing, credit derivatives, etc. You must determine what they connect to to decipher how much loss they represent. And that entails analyzing and reconstructing the whole system.

No, the fix to this is not simple, but it's doable. It's been done before. It entails pulling an FDR. Before he backed some of the banks, and not others, he shut them all down for four days. It was critical to evaluate them before moving forward then. And, it still is.

Then, we need to dissect all banks into manageable, backable parts by bringing back a modern version of the bipartisan Glass-Steagal Act of 1933. Wall Street screwed up then, and banks were given a choice. They could deal with citizens' daily financial activities or speculate away. The government, however, would only back the non-speculators.

By separating the banking landscape into less-risky commercial banks that dealt directly with consumers (and their deposits and loans) and risky investment banks (that package, leverage, speculate and trade these loans and other complicated securities), the government capped its (and the public's) potential losses. FDIC insurance only had to cover banks whose functions were finite. It made sense.

The same should go for today. The government should only back commercial banking activities, like injecting capital directly into loan principals.

It shouldn't be providing funding for speculation on the backs of other people's money or homes or to fix the problems it creates. It should definitely not be backing insurance companies like AIG that overspeculated in credit derivatives on behalf of those banks.

Plus, it should demand transparency, not just over where our money goes, but over what banks were doing as regular practice to begin with.

Sure, no bank wants to disclose all its ugly information and breadth of potential losses. But, neither is anyone in Washington asking for it. This must happen.

It should start with the biggest, most secretive bank in the country, the Fed.

Already this informational stalemate has amounted to grand larceny, and it will continue to ooze taxpayer money until there is a complete show-and-tell of every book in the banking system. It has also frozen any confidence that once existed between banks, and as a result, credit.

We must move past the fear of the unknown. The losses sitting on the books of banks are enormous. Denying that fact, doesn't change it; all the secrecy only inflames the crisis. But, exposing the details, fixing the loans and reconstructing the banking system will.

Nomi Prins is a senior fellow at the public policy center Demos and author of Other People's Money and Jacked: How "Conservatives" are Picking Your Pocket (Whether You Voted for Them or Not).
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