by Frank Thomas and John Lawrence
Was the Congress, Fed, and Treasury Rescue of AIG the Right Decision in 2008?
Frank Thomas says "Yes." John Lawrence says "No."
David Stockman: “We Should Have Let The Market RIP, AIG Fall … and Lived With The Consequences”
In his book, The Great Deformation, David Stockman presents a broad “no prisoners taken” indictment of our systemic social-financial-political maladies or ‘deformations.’ I share his view we have descended to a gamed, distorted system where almost “nothing is working” coherently that can save it from the next Boom-Bubble-Bust implosion unless there is fundamental change.
Stockman’s Austrian libertarian advice is that government should stop governing. Back to the pre-Roosevelt Carter Glass era of financial discipline under the gold standard and the Fed operating as a passive banker’s bank, making loans and accepting deposits. Bad government and pernicious Keynesian economics are core causes of our present ills that justify a turnabout to self-correcting “unfettered market capitalism” of Hoover, Coolidge and everyone before them … this is farfetched, to put it mildly.
Stockman’s brave new world of a self-policing system of unfettered market policies free of government interventions and strict financial regulations – a radical idea with no hard numbers on the human costs, job losses, business failures – is ironic. This is just what we have had a good taste of over the last thirty years! And all it has brought us is a world of energized greedy forces and financial wizards who can burn the house down and make a fortune at it!
Given Stockman’s deep anti-government, anti-Keynesian mindset, it’s no surprise he favored letting AIG and major banks fall. In his words: “despite creating lots of job losses and lots of pain lasting for a generation … this action would create lessons, it would create discipline … new firms would grow out of the remnants of AIG, Goldman Sachs, Morgan Stanley, etc. … bank bailouts were unnecessary … the Main Street banking system was never in serious jeopardy ... the money market industry wasn’t imploding.”
These presumed ‘gospel truths’ need to be viewed against what actually took place in financial markets during the bubble crisis times of 2006-08. I shall leave it to the reader to decide whether the Congress, Fed, and Treasury acted appropriately in bailing out AIG at a point in time the economy was entering a mini-depression and the worldwide financial industry was under exceptional strains from many directions.
Why Did The Fed Recommend Rescuing AIG?
Ben Bernanke gave a ‘right to-the-point’ answer to this question on CBS TV March 10, 2009 – the essence of which he repeated to the Committee on Financial Services, House of Representatives March 24, 2009.
“Of all the events and all the things that we’ve done in the last 18 months, the single one that makes me the angriest, that gives me the most angst, is the intervention with AIG. … Here was a company that made all kinds of unconscionable bets. Then, when those bets went wrong, they had a – we had a situation where the failure of that company would have brought down the financial system. … In deciding to rescue AIG, the government worried that if it did not bail out the company, its collapse could lead to a cascading chain reaction of losses, jeopardizing the stability of the worldwide financial system .” (note: wrong says Stockman as regular bankruptcy would have worked for all the mega financial institutions … we didn’t need Goldman Sachs, Morgan Stanley, Bear Stearns because Main Street banks didn’t own toxic assets like securitized mortgages (CDOs) and credit default swaps (CDSs).In the 2nd half of 2008, global markets were experiencing unprecedented, multi-dimensioned financial pressures and a worldwide loss of confidence. In Bernanke’s words to the Committee on Financial Services March 24, 2009:
“I will describe why supporting AIG was a difficult but necessary step to protect our economy and stabilize our financial system. … The Federal Reserve and the Treasury agreed that AIG’s failure under the conditions then prevailing would have posed unacceptable risks for the global finance system and for our economy” (note: wrong says Stockman who casually dismisses as extreme fears the catastrophic implications and global ‘contagion’ from an AIG failure in 2008 – “There will be lots of pain … but let the market rip and live with the consequences”).
What were the extraordinary financial risks that had been building up during 2005-08?
- Derivatives allow the sharing or redistribution of risk. BUT, they can blow up in a BIG way by the high leverage and non-transparent buildup of risk inherent in derivative CDO/CDS contracts – especially when used recklessly such as tools for speculation which can lead to taking on too much risk. Non-transparency, opacity, extreme complexity, counterparty risk are the primary risks in the OTC [Over the Counter] derivatives market. The opacity and complexity caused by financial entities interlinked by a large number of non-transparent derivatives contracts means the default of one party could cause severe damage to the credit soundness of its counterparties leading to a broad market disruption. As stated in a joint Treasury and Financial Services Authority paper on CDS trading, “ The private nature of contracting with limited public information, the complex web of mutual independence, the difficulties of understanding the nature and level of risks increase uncertainty in times of market stress and accordingly pose risks to financial stability.”
- In Sept. 2008, Lehman Brothers’ default was the first example of a major counterparty failure to meet obligations on its debt and CDS derivatives. Lehman’s $600 billion bankruptcy broke all world records and led to the failure of other institutions that had substantial derivatives exposure. Financial tremors erupted globally on fears of systemic defaults becoming extreme. Lehman exposed the systemic weakness of having many counterparty credit risks that were not fully transparent nor given much attention. To correct this, CDS risk mitigation techniques have been initiated, e.g., bilateral netting and overcollateralization of swap liabilities as effective ways to address counterparty credit risks in CDS markets. Also, a “central clearing house” proposal for CDS transactions is a sound step in making these transactions more transparent.
- Fueling the fear of ‘financial contagion’ was the spreading of toxic asset risk and threat of bankruptcy to Freddie Mac, Fannie Mae, Washington Mutual, Ambac – right when employment, new jobs, disposable income and GDP growth were plummeting. The placing of Freddie Mac and Fannie Mae under conservatorship added to the tension in financial markets.
- Another factor at the root of the 2008 financial crisis were U.S. accounting rules for reporting derivative risk from mortgage securitizations (CDOs) and credit default swaps (CDSs). U.S. accounting rules, unlike those in Europe, allowed banks to report a much smaller portion of their total derivatives risk. This reporting omission enabled banks to erase trillions in assets and keep trillions of mortgage-linked bonds or derivative liabilities off their balance sheets. This intensified the non-transparency and inadequate control of derivative products. Fortunately, corrections to this reporting omission have been made. Major U.S. financial institutions are now reporting their full notional and net derivative exposure on the balance sheet. Hopefully, this move away from opaque, non-transparent financial statements will ensure banks are more cautious in using derivative instruments in a manner that doesn’t explode in their faces in times of distress.
- Mortgage securitizations kept off the balance sheet became a costly shock when banks had to repurchase home mortgage loans sold to special investor vehicles on a huge scale. Also, AIG’s derivatives contracts required large collateral payments if its AAA credit rating was downgraded as it was in Sept. 2008 – causing a massive liquidity squeeze. This and AIG’s huge CDS positions led to a reported $99 billion loss in 2008. To stabilize the situation for large Wall Street firms making markets in CDS contracts, the Treasury decided to extend to AIG a secured credit facility of $85 billion. This exploded to $182.5 billion after the insurer couldn’t pay banks on derivatives tied to those home mortgage loans. In exchange for this financial investment, taxpayers secured a whopping 92% ownership of AIG!
- AIG’s $1.8 trillion notional derivative risk exposure was intricately connected with financial parties worldwide, including 21 auxiliary holdings and millions of policy holders who were also counterparties. The insurer ended up owing multibillion dollar payments to Merrill Lynch, JP Morgan, Bank of America, Goldman Sachs, Citigroup – in all, 80 companies and municipalities including major European banks like the Deutsche Bank, Societe Generale of France, UBS of Switzerland, Barclays of Britain, etc. (Barclays and Citigroup were customers of AIG’s securities lending program, not derivatives). Government due diligence analyses of the books confirmed the potential breadth of losses were stupendous – posing a dangerous chain reaction that Stockman downplays but Congress, the Fed and Treasury did not! Officials feared the sheer market shock from an AIG failure would precipitate a global financial breakdown of systemic proportions. So this was another reason why government officials decided to bail out AIG and by doing so, its major counterparties who had taken on enormous, irresponsible CDO risks.
- Another system risk is that “AAA” rated firms, like AIG, were presumed to be safe. They didn’t have to post any collateral to the practically unlimited derivatives they were allowed to create out of thin air.
- Other potential risk exposures tied to an AIG failure were specified by Ben Bernanke before the Committee on Financial Services, U.S. House of Representatives March 24, 2008. In Bernanke’s words:
- AIG would have likely been put into rehabilitation by their regulators leaving policy holders facing considerable uncertainty about the status of their claims. AIG’s insurance subsidiaries had considerable exposure to AIG’s Financial Products unit that would have weakened them if the parent company went bust.
- State and local agencies that had lent $10 billion to AIG would have suffered losses.
- Workers whose 401(k) plans had purchased $40 billion of insurance from AIG to insure a stable fund value against a decline in value would have seen that insurance disappear.
- Global banks and investment banks would have suffered losses on loans and lines of credit to AIG and on derivatives with AIG’s Financial Products unit. The banks combined exposure here was $50 billion.
- Money market mutual funds holding approximately $20 billion of AIG’s commercial paper would also have taken losses, exacerbating direct effects of a default on AIG counterparties.
- Once begun, a financial crisis can spread unpredictably. For example, Lehman’s default on commercial paper caused a major money market fund to “break the buck” and suspend withdrawals, igniting a general run on prime money market mutual funds and in turn causing severe stress in the commercial paper market.
- Uncertainties about the safety of insurance policy products could have led to a run on the broader insurance industry by policy holders and creditors.
- Market financial participants knew that many institutions had large exposures to AIG. Its failure would have led market participants to pull back more from commercial and investment banks – escalating even more pressure on those institutions.
- Finally, a very critical point raised by Bernanke was that federal bankruptcy laws do NOT sufficiently insure the orderly resolution (e.g., dissolution) of nonbank financial institutions when a failure poses substantial systemic risks. Lacking this no federal agency could put AIG into conservatorship or receivership to unwind slowly to protect policyholders and impose appropriate losses on creditors and counterparties. Also, no federal agency could provide capital to stabilize AIG. However, the Federal Reserve did have the authority to lend on a fully secured basis, consistent with its emergency lending authority provided by Congress and the Fed’s responsibility to provide financial stability.
As Ben Bernanke concluded, “ It’s unlikely that the failure of additional major firms could have been prevented in the wake of a failure of AIG. At best, the consequences of AIG’s failure would have been a significant intensification of an already severe financial crisis and a further worsening of global economic conditions … conceivably resulting in a 1930s-style global financial and economic meltdown.”
Stockman downplays the dire situation and multiple interlinked global risks that would have greatly worsened in the aftermath of an AIG failure in late 2008. Is it any wonder that no economist of any standing favored letting AIG go bust and allowing the market to find its own level – knowing full well the wholesale financial chaos, millions out of work, collapse in economic activity and the housing market that was taking place? Bernanke and other officials did NOT want to save AIG … but saw it as the lesser of two evils.
Coming to AIG’s aid bought time for subsequent actions by Congress, the Federal Deposit Insurance Corporation and Treasury to avoid failures of other very important financial institutions. In spite of this effort which resulted in saving AIG, over 400 smaller banks still went bankrupt – contrary to Stockman’s claim that Main Street banks would not be unaffected by an AIG failure! The Fed oversaw the winding down of AIG’s Financial Products unit and the restructuring and divesting of risky derivative assets. AIG management was given time to execute this derivative risk reduction strategy in an orderly manner in order to find the right counterparties with offsetting exposures. This approach minimized an asset “fire sale” while AIG was eliminating 93% of its derivatives exposure!
Up to the financial crisis in 2008, AIG’s very poor risk management and operational complexity overwhelmed prudent and strictly enforced risk controls. By year-end 2008, AIG had at least a $1.8 trillion exposure in derivative liabilities from 35,000 to 45,000 separate contracts. As an insurer for 100,000 entities from retirement plans to major firms, AIG was drowning in mortgage-linked derivatives and gambling the entire house on a single pile of hedge fund-like casino debt. AIG was in effect insuring the banks against the default of their borrowers. Thus, it was in essence using CDS derivatives to speculate on the value and credit risk of the underlying mortgaged assets.Stockman says the government missed an opportunity to use its majority ownership to shrink AIG and eliminate its systemic risk to the financial system. This is utter nonsense as TABLES 1 and 2 confirm.
Fed oversight of AIG’s winding down of toxic assets and return to core business has considerably improved the firm’s focus and risk profile. During 2008-11, AIG unwound over 35,000 CDS trades with a notional value exceeding $1.6 trillion. All but three core businesses were sold: property and casualty insurance, life and retirement insurance and services, and mortgage guaranty business.
TABLE 1 documents the four-year dwindling of AIG’s derivatives risk exposure from $1.8 trillion in 2008 to a tiny $127 billion in 2012.
TABLE 1: Legacy AIG Derivatives Book –
Net Notional Exposure FYE 2008, and 2012 – Dollars Shown in $Billions
12/31/2008 12/31/2012 % Reduction
Market Derivatives $1,450 $101 93%
Regulatory Capital CDS $245 $0 100%
Total Legacy Derivatives $1,800 $127 93%
Total Position Count 35,000 1,600 95%
SOURCE: U.S. SEcurities and Exchange Commission (SEC)
TABLE 2 shows how the focus on risk reduction and simplification, e.g., dismantling its Financial Products unit has considerably shrunk AIG’s financial debt. The firm has also been employing more common stock in its capital structure and has returned to profitable operations in 2012
TABLE 2: AIG’s Improved Balance Sheet and Profitability
Shareholder Equity as a % of Total Capital 43.3% 79.5%
Financial Debt as a % of Total Capital 42.3% 12.9%
From Continuing Operations -$99
Billion +$9.3 Billion
AIG returned $205 billion to the Treasury including a positive – although meager – return of $22.7 billion to taxpayers. This came with the stench of some obscenely immoral, “retention bonuses” for executives totaling $165 million – paid to very ones who made most of the deals that brought AIG to its knees. AIG argued they were necessary to retain key proprietary knowhow required to unwind the more dangerous derivative contracts. Others saw it as a financial extortion by a bunch of financial engineers.
Despite this odious action, the AIG bailout did stabilize the financial system, left no loss to the taxpayer, and forced AIG to divest of its risky derivative business … a firm that had rapaciously taken advantage of the tax regulatory system to turn itself into a titanic hedge fund that nearly sank the economy. I think Stockman would call this “Reformation” as opposed to “Deformation.”
I conclude the bailout of AIG was the right thing knowing the multiple concomitant financial and economic risks culminating in 2008. The timely and orderly turnaround of AIG was a success by all objective measures. While our nation’s financial markets have normalized, the question remains … for how long?
I do not favor taxpayer bailouts of financial institutions. AIG was a unique exception. Stockman is right that the BIG banks should be gradually broken up. At least “too big to fail” legislation (section 16 of Dodd-Frank Act) was passed. This bans taxpayer bailouts for a broad range of derivative dealing and swap activities. It should put the financial institutions on risk alert when using derivative products in a reckless, speculative manner and managing them well, particularly in bad times.
Lastly, the 2005 Bankruptcy Act grants derivative claims super-priority over all other claims – secured and unsecured, insured and uninsured. This is NOT good! When derivatives counterparties have super-priority status, the claims of all other parties are thus in jeopardy. Prof. Mark Row of Harvard says that repeal of this status will induce financial markets to better recognize the risks of counterparty financial failure. This in turn would lower the possibility of another AIG-Bear Stearns-Lehman style financial meltdown.
What’s Happening to Derivative Markets Now?
The derivative process of packaging many mortgage loans into one investment or collateralized debt obligation (CDO) is an efficient way to channel money to borrowers who might not otherwise get funds. But, as Stockman highlights, this proved dangerous during the 2003-2007 real estate boom because it encouraged banks, particularly at times of very low interest rates, to expand and give risky loans to people, many with weak credit; then bundle these loans into CDOs and sell them to investors; then insure them through AIG’s credit default swap contracts (CDSs).
When underlying assets supporting mortgage loans lost their value in the sub-prime mortgage bubble, this inflicted heavy unexpected losses on banks, investors, and AIG – forcing the latter to make substantial payments it couldn’t pay to its counterparties. AIG basically was insuring a speculative return to banks and investment institutions but didn’t reserve funds or properly manage and neutralize the aggregate risk in the event its CDSs went bad on a massive scale.
Are derivatives again becoming instruments of speculation where excesses creep in? When will the next blow-up occur? Or are banks taking steps to make the new generation of structured financial products safer?
There are signs we are again spewing derivatives in force. Banks are getting aggressive – especially in interest rate swap contracts, new securities issues backed by commercial mortgages for firms with “junk ratings,” and rising interest-only loans. Most of the large banks –JP Morgan Chase, Citibank, Bank of America, and Goldman Sachs – are reviving their derivative portfolios and bonus paychecks like there’s no tomorrow. This isn’t surprising as the same old players are still around pushing the boundaries of arcane structured financial risk products – helped by the dwindling effect of Dodd-Frank regulations and recent loosening of prudent underwriting standards.Dodd-Frank regulations require financial institutions to take special steps when bundling loans for backing bonds bought by investors. But I agree with Stockman that that won’t stop this inherently greedy and risky process from getting out of hand again. The IMF is very concerned about the weak underlying collateral for derivatives. (AAA rated firms like AGI don’t have to put up any capital). But banks have undermined and delayed Basel III’s deleveraging policies to 2014. And they will delay them again so nothing happens.
Here are some unsettling figures from offices of U.S. Comptroller of the Currency.
TABLE 3: Total Derivative Notional Exposure as of 12/31/2012
Notional Derivative Exposure
JP Morgan Chase $69.0 trillion
Citibank $54.4 “
Bank of America $42.4 “
Goldman Sachs $21.2 “
GRAND TOTAL $223.0 trillion = 14 years worth of GDP tied up in notional derivatives
SOURCE: “America’s Banks Are Knee-deep in Derivatives,” by G. Schultze, Forbes, 03/28/13
This Huge $223 trillion notional amount of derivative risk exposure now is greater than it was when the world almost financially collapsed in 2008!
Also disturbing is that 85% of this exposure is held by 4 firms, and 80% is tied to interest rate swap contracts to hedge interest rate risk. This could be a “financial weapon of mass destruction” (Warren Buffet’s definition of derivatives) when interest rates move higher. That is why downgrading of AIG’s “AAA” rating caused their CDS funding costs to soar … to the point that taking a huge loss and getting out of the trades was cheaper then funding them until maturity.
Bear in mind derivatives are a Zero-Sum game – for each party that makes money, another loses money. Given the $223 trillion in notional derivative bets now taking place, one can only imagine how much counterparties must be praying that nothing goes wrong in the near future. As one expert said in response to the complex, opaque, leverage-laden financial derivative pyramid creating a recurring risk of chaos in our financialsystem:
“This begs the question what’s the true value of hard assets in a world in which the only value created by financial innovation is layering derivatives upon derivatives, serving mainly to produce banker bonuses to all time highs?”
If AIG and the other Big Banks had fallen, would it have doomed the whole economy?
John argues that AIG should have been allowed to fail and that this would not have affected Main Street banks or the banking activities of average Americans. But the real question is 'If American taxpayers and the Fed had not given billions of dollars to AIG and the other large banking institutions, would they have indeed failed or would they, on the other hand, have survived quite nicely even without the bailouts?'
What's clear in the financial crisis of 2008 is that Washington rescued Wall Street while abandoning Main Street. The government under the direction of Treasury Secretary and former CEO of Goldman Sachs, Henry Paulson, and later Treasury Secretary Timothy Geithner (former President of the privately owned Federal Reserve Bank of New York on whose Board Jamie Dimon CEO of JP Morgan Chase sat) held the most reckless casino contracts made by rich investors inviolable paying out 100 cents on the dollar to them while considering the contracts entered into by homeowners and small business owners mere irrelevancies. Neil Barofsky, former Inspector General in charge of Oversight of TARP, the $700 billion taxpayer funded bailout, has accused the whole Wall Street enterprise of fraud. He has said that he focused on criminal rings made up of corrupt lawyers, mortgage brokers, notaries, loan officers, appraisers, and various and assorted other insiders, virtually the whole Wall Street crowd.
Mortgage brokers lied to potential borrowers about the amounts of their payments and what they would be when their ARMs (Adjustable Rate Mortgages) reset. Brokers were paid incentives to get borrowers who qualified for a prime loan to instead take a more expensive higher-interest-rate subprime loan. The worse the mortgage was for the borrower the better it was for everyone in the mortgage business. Regulators had abandoned any pretense of regulating and looked the other way.
When this edifice built on fraud started to collapse in 2008, Treasury Secretary Henry Paulson serving under George W Bush ran around Washington with his hair on fire and demanded that Congress pass a bill immediately giving him $700 billion to be used at his own discretion with no strings attached. In addition to taxpayer money the Federal Reserve ponied up $7 trillion of fiat money that it just created out of thin air with a few mouse clicks.
On October 13, 2008 with Bush still in office, Paulson called a meeting of nine big Wall Street banks and forced them to take $125 billion which he parceled out to them even though some of them didn't want it and didn't need it. Richard Kovacevich, CEO of Wells Fargo, didn't want to take the money. Paulson forced him to take it. Can you imagine if your banker called you in and said "We are going to pay off your mortgage whether you like it or not." That would never happen but here was Hank Paulson forcing CEOs of big Wall Street banks to take billions of dollars. Kovacevich said "I believe the TARP decision of forcing people to take money they didn't want or didn't need was one of the worst economic decisions in the history of the US."
The biggest recipient of TARP cash, Goldman Sachs, has maintained it had no exposure to AIG. Between the collateral AIG posted and other assets on their books, Goldman claimed to have fully hedged any counterparty risk.
Was it necessary to save these institutions by throwing money at them? And was it worth it not to bail out the homeowners underwater on their mortgages insuring that all contracts between homeowners and banks should be honored in order not to encourage moral hazard? Moral hazard is simply the fear that letting people off the hook will encourage shoddy behavior in the future. As it turned out, the moral hazard incurred was on the part of the fraudsters on Wall Street who were showered with money and allowed to get right back to the business of screwing people secure in the knowledge that they would never be held accountable because they were 'too big to fail.'
AIG was essentially a huge insurance company insuring that all the bets that Wall Street was making on derivatives were good. When these bets turned out to be bogus, AIG had to pay up and couldn't. It was similar to a run on the bank. Should AIG have been allowed to fail? David Stockman, Reagan's former budget director, says that that isn't even the point. He maintains that they wouldn't have failed even if TARP and the Fed hadn't bailed them out. Certain investors would have taken a haircut but AIG could have withstood those blows and remained in business. Paulson's 'hair on fire' bailout at taxpayer expense had more to do with saving investors' and speculator's hides than in saving the banking institutions themselves.
In his book, "The Great Deformation", Stockman says, "For me, AIG was the skunk in the woodpile. After twenty years on Wall Street I knew that the giant, globe-spanning AIG and its legendary founder, Hank Greenberg, had once been viewed as not simply the gold standard of finance, but as sweated at the very right-hand of the financial god almighty. And then, in a heartbeat, AIG needed $180 billion - right now, this very day, to keep its doors open? Worse still, this staggering sum of money - the size of the Departments of Commerce, Labor, Energy, Education, and Interior combined - had been ladled out as easy as Christmas punch: Bernanke just hit the "send" key on his digital money machine." And Hank Greenberg even threatened to sue the Federal government because he didn't think the terms for the bailout were favorable enough to AIG!
Stockman maintains that Main Street banks were never in any jeopardy. Small business loans would still have been available, and ATMs would have continued to function. Frank argued that some 400 small banks failed during this crisis, but that only represents about 5% of the total number of banks in the US. The large preponderance of banks and credit unions remained in business and would have remained in business even if no bailout occurred.
"There was never a remote threat of a Great Depression 2.0 or of a financial nuclear winter, contrary to the dire warnings of Ben S. Bernanke, the Fed chairman since 2006. The Great Fear — manifested by the stock market plunge when the House voted down the TARP bailout before caving and passing it — was purely another Wall Street concoction. Had President Bush and his Goldman Sachs adviser (aka Treasury Secretary) Henry M. Paulson Jr. stood firm, the crisis would have burned out on its own and meted out to speculators the losses they so richly deserved. The Main Street banking system was never in serious jeopardy, ATMs were not going dark and the money market industry was not imploding."
John Carney argued in 7 Reasons AIG Should Be Allowed To Die that insurance policy holders were protected by AIG's insurance subsidiaries. Also losses to derivative counterparties would have been best addressed by infusing capital directly into the banks that needed it. Serious consideration should have been given to forcing AIG's partners in derivative transactions, which were mainly buyers of credit default swaps from the company, to take a substantial haircut. Not allowing AIG to fail created a moral hazard that as much as guarantees that any large banking institution is for all intents and purposes a branch of the Federal government.
After Lehman Brothers failed in September 2008, the government decided to draw the line at AIG which was next in line to go under. Stockman maintains that, if AIG had been allowed to fail, it wouldn't have caused a chain reaction or a financial doomsday. "In fact, none of the bailouts were necessary because the meltdown was strictly a matter confined to the canyons of Wall Street." The failure of these Wall Street institutions would not have infected the Main Street banking institutions; the 'contagion' had no basis in fact. Moreover, Stockman maintains that even without a bailout AIG would not have gone out of business.
AIG's assets were parceled out to subsidiaries all over the globe. Its $800 billion balance sheet consisted of high grade stocks and bonds that were domiciled in a manner that invalidated the "contagion" theory. The crisis had nothing to do with AIG's assets i.e. its survival as an institution; it had to do with AIG's CDSs (credit default swaps) which could have been readily liquidated in bankruptcy without affecting AIG policyholders. Grandpa's life insurance policy would not have been affected. The money given to AIG was not designed to save the masses from harm but in reality to save the asses of a few dozen speculators.
So the huge amount of taxpayer money given to AIG was not to protect Main Street; it was to bail out speculators 100 cents on the dollar. The evidence shows that each and every Wall Street institution that received money could have withstood the AIG hit so that the bailout was all about protecting short term earnings and current-year executive and trader bonuses.
Stockman sums it like this: "In short, there was no public interest at stake in preventing AIG's demise. Indeed, the bailout's primary effect was to provide a wholly unwarranted private benefit at public expense; namely the shielding of highly paid bank traders and executives who had exposed their institutions to embarrassing losses from taking the fall that was otherwise warranted."
And even though the big speculators recouped a hundred cents on the dollar, homeowners were wrongfully foreclosed on and forced to take a settlement of as little as $300 in return for losing their homes. The TARP program was supposed to help troubled homeowners struggling with their mortgages by writing down the principals, lowering interest rates, lowering monthly payments or all of the above. However, only a small fraction ($1.4 billion according to Barofsky) of the $50 billion allocated to help homeowners avoid foreclosure was actually spent while the funds expended to prop up the financial system totaled $4.7 trillion.