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Creditwritedowns
reports that worst damage yet to come from AIG.
(emphasis mine) [my
comment]
AIG:
worst damage yet to come
Posted by Marshall Auerback on 19 March 2009 at 12:17 pm
Marshall Auerback here. I have a few thoughts about AIG and what it means
politically and for American banks.
The episode may have already made it much harder to get any support in
Congress for bailing out more banks in the future. The Obama administration,
and some outside experts, believe the economy will only get worse if big
banks start to fail. Which means the worst damage that AIG’s adventures
in high finance have caused might be yet to come.
We had a broadly similar type of situation in 1994, and as Lawrence Summers
was one of the key actors, it is worth considering the episode in details, as
recounted in “The New Republic”
In December of 1994, the Mexican finance ministry alerted
Summers’s assistant secretary, Jeff Shafer, that the country was
nearing a currency crisis. During the early ’90s, Mexico had
started down two paths that, together, proved unsustainable. First, the
country ran large trade deficits. To pay for all the goods it was importing,
Mexico needed dollars, which meant it had to sell government bonds. This led
to the second problem: To appease all the foreign investors who worried the
peso would lose value, Mexico issued certain short-term bonds–called
“Tesobonos”–that were linked to the dollar.
This worked fine for a while. Foreign money flooded in as investors snatched
up the Tesobonos. But, as the years passed, creditors began doubting that the
government would pay off its bonds at the fixed exchange rate. Many began
withdrawing their money, forcing the Mexicans to redeem the bonds for dollars.
By the time Treasury tuned in, in late 1994, the dollars had almost run out
and the government could no longer defend the peso-dollar exchange rate. The
imminent decline of the peso would make Mexico’s foreign debt more
expensive and raise the risk of a default.
Worse, Treasury itself was in limbo. Then-Secretary
Lloyd Bentsen had announced his retirement, but Bob Rubin, his
successor, had yet to replace him. It fell to Summers–whose team
included Shafer and a young deputy assistant secretary named Tim Geithner–to
figure out the consequences of a Mexican collapse. By January 10,
1995, the Summers group had a tentative answer: The fallout could be several
hundred thousand U.S. jobs and a 30 percent spike in illegal immigration. If
Mexico infected other emerging markets, it could wind up shaving a point off
U.S. GDP growth.
That same day, Summers accompanied Rubin to his Oval Office swearing in.
Once President Clinton administered the oath, Rubin recalls in his memoir, the
new Treasury secretary turned to the president and urged a massive loan
package. He then gave the floor to Summers, who briefed the president and
concluded that something on the order of $25 billion would be necessary. Surely
he meant twenty-five million, George Stephanopoulos interjected. No, Summers
said, “billion with a ‘B.’” Clinton swallowed hard
and, after weighing every angle, signed on.
The initial response from congressional leaders was also favorable. But
the rank and file was hostile. Vermont’s then-congressman, the socialist
Bernie Sanders, told Rubin to “go back to your Wall Street friends
[and] tell them to take the risk and not ask the American taxpayers.” A
freshman Republican named Steve Stockman accused Rubin of arranging a bailout
to protect the investments he’d made while a partner at Goldman Sachs [of
course it was]. Soon, even the once-supportive leaders were
either quietly backtracking (Senate Majority Leader Bob Dole) or railing
against the package outright (Banking Committee Chairman Alfonse
D’Amato). It was what High Noon might have looked like if Gary Cooper
had played a policy wonk.
As it became obvious that cooperation from Congress wouldn’t be
forthcoming, Rubin and Summers began to consider plan B. Back in 1934,
Congress had given Treasury a pool of money called the “Exchange
Stabilization Fund” (or ESF) to help smooth out exchange rates.
Sixty years later, the fund stood at about $35 billion, and Treasury lawyers
believed they had the authority to draw on it. And so, on January 30, with
no congressional help in sight, Summers, Rubin, and Clinton’s top
White House aides decided to tap the ESF to the tune of $20 billion.
Eric
de Carbonnel
Market Skeptics
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