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AIG Bailout: Did the Government Overpay?

It is possible that the government might have overpaid a number of banks during its initial rescue attempt of American International Group (AIG). The company was in such big trouble that the Federal Reserve Bank of New York – previously headed by Treasury Secretary Tim Geithner – that the US government had to wind down its relationships with business partners.

The Federal Reserve Bank had paid the full face value of securities so that these businesses would cancel the insurance handed out by AIG. This was an attempt to relax the AIG’s liquidity trouble. However, reports leaked that at least one company had offered to cancel the contract at less than its face value. According to Neil Barofsky, the Special Inspector General, what it means is that the government might have paid billions more than what was necessary to cancel debt insurance contracts.

Why Was AIG Bailed Out at Any Cost?

Despite these findings, some analyst cannot blame the actions of the Fed during the crisis. AIG is too interconnected with other financial and non-financial firms that its failure could push the global banking system over the edge. As it neared collapse, officials decided to step up and bailout the company with billions of dollars and government guarantee to prevent a deepening of the crisis.

Whether the bailout is good for the long-term future of AIG and the government remains to be seen. This is because after several bailout attempts, the company now holds up to $180 billion in government commitments. The Treasury Department owns about 80 percent of AIG.

The Government Still Getting Some Criticisms

Critics though aren’t content with the government’s actions. They note that AIG’s trading partners knew full well what risks they are taking when they got insurance for credit-default-swaps. These partners showed willingness to take risks based on these actions. They should have been forced to take than 100 percent value of their contracts.

Neil Barofsky said that taxpayers are unlikely to recover the money infused into AIG.

Financial Overhaul Weakens as the Economic Shock Fades

About a year after the Lehman Brothers collapse, its shock waves across the globe seemed to have subsided. It can be remembered that the investment bank’s problematic demise intensified the deep recession in the US economy. In addition, it helped pave the way for the government’s significant role in managing the economy through corporate bailouts and other programs.

The Lehman Brothers is also significant because previous to its demise, the public relied mainly on markets to right themselves. Its failure made government intervention not only acceptable; it was also seen as a necessity. However, even if the impact of Lehman Brothers in terms of regulatory reforms is big, to a surprising degree, there are a lot of aspects in the financial industry that hasn’t changed. Because of this, many people are looking for bargains through comparison shopping.

Banks are Still Taking Risks

Major US banks cannot let go off their old habits. As profits got off their lows, executives are regaining their swagger. Right now, a lot of banks and other financial institutions are selling exotic products that pushed the economy on the brink of collapse last fall. In fact, their appetite for risks has even grown.

Collectively, the top five banks in the United States can potentially lose more than $1 billion any day in the second quarter of 2009 if their bets go sour. According to Peter Solomon, a former vice-chairman from Lehman Brothers, “there’s no fundamental change in the way banks are run or regulated…there’s just fewer of them.”

On the Regulatory Front

Even as financial industry is regaining its footing, lawmakers cannot seem to keep up. Democrats are getting bogged down by the infighting between bankers, federal regulators, and even other lawmakers who believe that expanding the government’s control on private firms might create more problems over the long term.

Washington officials say they heartened that the financial market seems to be healing but at the same time, they realize that new rules need to be established. It is important for them to get out of the current limbo to get the economy back in shape.

Banks Bracing to Fight against Strict Government Regulations

Since October last year, the nation’s largest banks were holding marathon telephone sessions every day amid the darkest economic crisis. As the momentum for the
financial regulatory overhaul gathered in Washington, Wall Street was gearing up for the fight. Bank executives knew that their once profitable credit-default swap and other types of derivatives will be reined in by the government. Originally designed to minimize risk, it pushed the economy on the brink of collapse.

The nine largest institutions involved in the derivatives market – Bank of America, Citigroup, JPMorgan Chase, and Goldman Sachs – formed the CDS Dealers Consortium after they came into an agreement on November 13. The lobbying organization was created merely a month after five of its members got the government bailout fund.

The consortium even hired an influential Washington power broker to oversee their agenda. Edward J. Rosen, from the Cleary Gottlieb Steen & Hamilton Law Firm, previously helped stopped the regulation in the derivatives market more a decade ago. Now, the confrontation between legislators and Wall Street promises to be a repeat of what happened in the past.

But the fight today is no longer about whether regulation is required or not. It is easily apparent that the public will demand nothing less than stricter regulation in the financial industry. At the core of the argument will be how much regulation is really necessarily. From every front, this is a very difficult question to answer. Every party has their own agenda they want to push.

Those who want more regulation will state that early warning signals are necessary to prevent catastrophe in the financial market. For example, industry giant American International Group, had received over $170 billion in taxpayer money because of its gaping derivatives losses. Meanwhile, the banks are concerned that if the regulations become too tight, economic growth and innovation will be stifled.

In the end though, the argument will come down to two things: disclosure and transparency in the markets. Legislators want an open exchange – akin to the stock market. On the other hand, banking institutions unsurprisingly want some of its financial products to be privately traded in clearinghouses where less disclosure is required. Only time will tell which party will get its way.

Big Banks Ready to Repay the Bailout Money

After months of severe economic downturn, lay-offs, and high foreclosure rate, it hardly seems possible but a significant number of US banks will pay back the bailout money they previously received from the government. After regaining some level of financial stability and some of their old swagger, the nation’s largest banks now want to pay back billions of dollars back to the taxpayers.

Very few people in Washington and perhaps those from the financial industry themselves expected such a quick turnabout. Most legislators believed that banking institutions will need to rely on the government’s help for years because the subprime crisis and their other troublesome assets were dragging them down. But now, a number of banks say they will repay the government by year’s end.

Two weeks after the stress test results came out, several banks including JP Morgan Chase, Morgan Stanley, Goldman Sachs, Bank of New York Mellon, and US Bancorp, and State Street have talked with regulators about repaying part of the $700 billion rescue package they received. Regulators are trying to identity when the banks should be allowed to return the bailout money and whether such measure will leave these institutions vulnerable in case another crisis occurs in the near future.

A few details have emerged about these developments. For example, it is believed that regulators will not let any major bank repay first because it will give some institutions “bragging rights”. Instead, the Federal Reserve will organize the banks into a group that is ready to pay first. The Treasury Department will be assigned to handle the repayments.

For many ordinary Americans, the repayment scheme is a welcome development. After several months of multi-billion dollar bailouts that are given to the financial industry, auto industry, and other industries, the breathing space this will allow is good for the economy. However, it is also important to recognize that repayment the bailout now carries some risks.

Right now, many major banks have plugged crippling losses but the industry is still vulnerable. The continuing troubles in real estate as well as the high number of credit card defaults will surely be felt by the banks. In addition, if the government allows the banks to pay back the bailout money so soon, they will cede authority over the same institutions that caused the economic crisis.

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