Taunter Media

Simon Johnson at Baseline Scenario on the dangers of the piecemeal government intervention:

Boris Fyodorov, the late Russian Minister of Finance who struggled for many years against corruption and the abuse of authority, could be blunt. Confusion helps the powerful, he argued. When there are complicated government bailout schemes, multiple exchange rates, or high inflation, it is very hard to keep track of market prices and to protect the value of firms. The result, if taken to an extreme, is looting: the collapse of banks, industrial firms, and other entities because the insiders take the money (or other valuables) and run.

This is the prospect now faced by the United States.

Actually, it is already happening.  It is called AIG.

Look at it this way: if Goldman Sachs went to the government and asked for a capital infusion of tens of billions of dollars, the government might well ask for something in return: straight equity, preferred with warrants, even the common courtesy of being considered a debtholder.  If, however, Goldman Sachs has tens of billions of dollars of claims on a worthless counterparty, and the government simply pays those claims on behalf of the counterparty, we the taxpayer get absolutely nothing for the privilege.

What an ingenious mechanism.  It works even better when you refuse to disclose AIG’s counterparties (on the offensive grounds that a firm that has lost hundreds of billions of dollars and threatened the economic system has to protect its reputation for discretion).  Convenient.

From a different page of the same playbook, just implement the original Citigroup plan and offer to insure Citi’s worst assets.  They fail weeks or months later and the money is paid far away from the press conference touting the modest size of the intervention, and again, for absolutely no stakeholder position.

Professor Johnson is onto something important – it is not only the direct financial impact of the bailout that matters, it is the corrupting influence it has on whatever parts of the financial system survive the initial storm.

UPDATE:

Some more details at Talking Points Memo:

To avoid booking a loss on the Fed’s balance sheet, because the Fed had some legal problems if either of these Maiden Lanes lost money, and because of a reporting requirement that Dodd had put into TARP which actually required the Fed to report to the Congress and the public about the cost to taxpayers from ML I, the Fed did some creative accounting.

They still paid all of the investors off at full value (par), so that they didn’t lose anything. But they booked the loss on AIG’s balance sheet and kept Maiden Lane clean. This is the hidden story behind how AIG went from losing $38 billion during the first 9 months of 2008 to losing $61 billion in the 4th quarter.

I am sure there are some financial criminals who plan everything from the beginning.  But most white collar crimes seems to be incremental sins – a bit of trade loading here, an amended portfolio statement there, and one day you wake up and you’re Bernie Madoff.  The lies the Fed has told in the name of preventing panic have perverted it.  If nothing else, that would be reason enough to pull the plug on AIG and let the chips fall where they may.