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Bill Sharon

What Needs To Go Right by Bill Sharon

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09/17/08 Taxpayer Bailout by Bill Sharon

This morning (September 17, 2008) the Associated Press published an article entitled “ Government steps in again, bails out AIG with $85B”.  Within the first paragraph it stated: “The U.S. government stepped in Tuesday to rescue American International Group Inc., one of the world's largest insurers, with an $85 billion injection of taxpayer money.”  The New York Times made similar statements saying that the plan “…puts taxpayer money at risk…”  A survey of other major news outlets shows similar statements.  

Here’s the good news; the bailout of AIG did not use taxpayer money.  The money came from the Federal Reserve which is not and never has been funded by taxpayers.  That’s not a state secret.  The charter, history and purpose of the Federal Reserve are available on its website.  All banks that are chartered by the federal government are members of the Federal Reserve and those banks are private institutions.

Here’s the no so good news.  This is a depositor funded bailout.  The banks that are members of the Federal Reserve are required to own stock in one of the 12 regional Federal Reserve banks.  The Fed can access money by either using the reserves backed by the stock or by simply “printing” money (actually money can just be created on a computer screen).  So the banks in which we all put our money are using the money to preserve the system.

Where this gets confusing is that when the Treasury Department took over Fannie Mae and Freddie Mack and guaranteed a credit line to cover losses and any necessary operating capital that was taxpayer money.  The Treasury Department is part of the federal government, the Federal Reserve is “independent, but in the government”.  Perhaps that is where the confusion lies for so many of us; the government approves the chairman and directors of the Fed but the money comes from private banks.  It may be confusing for the average person, but surely it is not confusing for reporters at the AP and the New York Times.

These facts raise two fundamental questions.  First, what does it mean to have a depositor bailout?  The financial system is trying to save itself.  A classic understanding of a banking system is that it takes deposits and makes investments and obtains revenue from the difference between what it pays in deposits and what it makes on its investments.  The problem that we are experiencing is that banks (and I use the term “banks” to cover a broad range of financial institutions) came up with a whole range of investments that had nothing to do with investing in businesses.  One of those investments is called a credit default swap or CDS.  These are essentially insurance policies on bonds.  In theory, when the bond defaults, the holder of the CDS does not loose any money because he is covered for the loss.  Sounds like a plan; but the problem is that CDS’s are traded like securities and you can buy one without owning the underlying bond.  This is the problem at AIG; apparently it wrote a huge number of CDS’s, AIG’s bond rating was reduced and it needed to put up collateral as a requirement of the securities that it wrote.  Collateral it did not have.

How bad is this problem?  No one really knows but the fact that the Fed was able to secure nearly 80% of a global conglomerate said to be worth nearly a trillion dollars would indicate that it is really big.  So much wealth was created by selling insurance policies without any thought to how they would be paid off that it will take a while to calculate what the looses are and how they will eventually, if ever, be paid.

The second question is: Why do major media outlets keep referring to the AIG bailout as funded by the taxpayers?  It could be that reporters are lazy and simply accept what politicians and pundits tell them.  There is certainly ample evidence that the media doesn’t get its facts right and focuses on minutia rather than truly informing the public.  But as one who is regularly dismissive of conspiracy theories I’m having some trouble not seeing calculation in the reporting.

The dimensions of the problem with the global financial system are almost too big to get one’s brain around.  It has not been widely reported, but the Russian stock market crashed yesterday and closed.  The Chinese stock market has lost half its value this year.  The collapse is global and the efforts to stop it by having central banks inject cash and now, in an unprecedented move, invest directly in a private company are likely only to slow that collapse.  Concern for the maintenance of civil society is being expressed in private conversations that will likely become public concerns in the near future.

Telling everyone that their taxes have gone to fund a bailout raises some ire but it is something that the average citizen can comprehend.  We can mutter “more money down a rat hole” and move on.  When the entire system is frantically trying to save itself and using what little savings we all have to do it, the response would surely be different.  Our free press is in for a mea culpa that will dwarf their love feast with the administration before the Iraq war.  While the current crisis is frightening, working through the fear now can only help to make us clear eyed in dealing with what is surely coming very soon.


It has been brought to our attention that Margaret is being portrayed as a psychic on $1.99 sites. These sites are doing so without Margaret's permission. Margaret has not claimed she is a psychic. - MW