In stringing together the daisy chain of flawed risk analysis in which we are now all entangled—I am reminded of poor daft garlanded Ophelia drifting downstream to her sorry end—no one played a more heinous part than the rating agencies. That they are still in business, let alone regarded as minimally credible, I find amazing, yet even as I write, WNYC is reporting market apprehensions that AIG may be further downgraded and that this will unleash further torrents of default and ripples of crisis. One would think that, by now, Mr. Market would have come to his own conclusion as to what an AIG promise-to-pay is worth. Whatever two cents the raters might throw in at this point would be useless: an unneeded grace note of negativity with zero investment enlightenment, unless you happen to define the latter as “covering one’s own ass.”
Still, I suppose others were as interested as I to see whether Warren Buffet, in his annual letter to Berkshire Hathaway stockholders released this past weekend, would offer some kind of moral and intellectual elaboration with respect to his 20 percent stake in Moody’s. He didn’t: He merely glossed over the way B-H carries this holding on its balance sheet. Given the Sage of Omaha’s propensity to opine on any subject under the sun, I was disappointed, notwithstanding that I grasp he’s in a classic rock–hard-place trap. But he’s partially owned Moody’s since 2000; surely, along the way, he must have thought to ask them what the hell they thought they were up to, especially since by 2003 he was railing against short-fused derivatives of the type that has pulverized AIG.
One wonders how many people in streets other than Wall know that Moody’s, Standard and Poor and a couple of others are federally licensed purveyors of faulty judgment (anyone who is interested in learning exactly how faulty is directed to Felix Salmon’s indispensable article in the latest Wired). It is Uncle Sam’s arms draped over their shoulders that give them their respectability and their clout. America is famous as the land of second chances, but this is ridiculous! If any institutions in this country should be punitively shut down and their executives prosecuted for reckless endangerment, the rating agencies should be. They were the prime enablers of this mess, since their actuarially based Triple-A ratings let every marginal mortgage-peddler imaginable into the game. In AIG’s case, the agencies’ original AAA rating of the big insurer’s credit default swap guarantees was extrapolated onto every instrument on which AIG wrote protection. Thus was created one of the great Wall Street paradoxes of all time: AIG sold CDS protection on paper rated AAA, but the AAA rating was its own—merely loaned, as it were, to the counter-party for the purpose of legitimating the trade. The big insurer in effect had doubled down on itself.
Anyway, it seems academic, now that AIG appears en route to seizure and dispersal, or what is called “nationalization,” the inescapable buzzword of the last fortnight. As it happens, I’m of an age to have lived through, as a teenager, the last real nationalization of private-stockholder-owned companies: Harry S. Truman’s 1952 seizure of the steel companies to forestall a strike that threatened the public interest as he saw it, an action that was within weeks overturned by the Supreme Court.
The Truman “nationalization” kept the Bessemer converters fired up and running. The fact is, what Truman did was not so much the nationalization of an industry than it was the conscription of that industry: At no time was there the suggestion of a transfer of ownership or of investment of public capital. Insolvency wasn’t on the table. In the here and now, however, it is a whole or partial transfer of ownership that is contemplated, which raises different questions.
Start with one phrase seldom heard these days: “lender of last resort.” That is what the Fed’s—and by recent extension, the Treasury’s—mission statement reads in part. Lenders of last resort traditionally and logically demand an arm and a leg for committing capital to troubled situations. If you don’t believe me, have a chat with your pawnbroker.
In all the clamor about “nationalization,” this has been lost sight of. It becomes a matter of simple equity. When the Public Capital is invested to rescue a bank, even if that rescue is deemed to be in the “public interest,” the public (the taxpayer) is entitled to a fair deal—although that deal need not extract the last basis point of arm or leg that a private lender would demand. After all, the public’s money is to some extent being committed in the public’s interest, namely the avoidance of economic Armageddon. To carry the day on this point is the banks’ trading advantage. Timothy Geithner and Ben Bernanke’s task is to make an equitable trade-off.
So what to do? How are these competing-yet-coalescent interests to be balanced? One solution might be to recompense bailout investments of Public Capital with claims on operating cash flow and not with shares of voting stock. Give Uncle 80 percent of Citi’s or AIG’s earnings before interest, taxes, depreciation and amortization or proceeds from asset dispositions until he gets his bait back. Another might be to freeze settlement of “naked” derivatives, notably CDS trades that weren’t written against real positions, but merely represented wagers pure and simple on future defaults and insolvency. Let these latter be dealt with outside official circles, in the way that bookies have settled with deadbeats throughout history. Perhaps the government should test the market by running a $25 billion Dutch auction for toxic assets in order to see what people will take for this stuff. A cheap price for what might be meaningful price discovery. When Thain unloaded Merrill Lynch “toxics” for 20 cents on the dollar, nobody—starting with Bank of America—screamed.
Most of all, what needs to happen is for everyone to step back, take a deep breath, clear their heads and try to sort out what is public and what is private in terms of interests and objectives. Of all the many disservices Alan Greenspan rendered this nation and its taxpayers, it was in this sphere above all: notionally charged with defending the Public Capital, he worked tirelessly to enrich private money spinners. The confusion he thereby created may be with us forever. He should be beaten with a stick.