I Didn't Mean For It To Be THAT Interesting

When I titled my last blog "an interesting week" I was referring to my personal experiences, but you could certainly say it was an apt, if understated, description of what happened on Wall Street last week.

I said a few months ago that I thought we'd bottom out around late September/early October. This is not quite what I meant. I did at least put in the caveat that "another financial or international crisis between now and then and all bets are off." I'm pretty sure this qualifies.

I have been meaning to blog about my thoughts on it since late last week, but I keep finding that I don't quite know enough to put together a coherent overall opinion together. And it's one of those where everytime I find out a new piece of information it just leads me to 2 new questions.

One issue I can speak to a little bit is the specific bailout of AIG. A lot of people have wondered why the government seems to be picking and choosing who it is going to let fail. Why was Lehman brothers allowed to go bust but not AIG? Well, to put things simply, you flat out cannot allow an insurance company to just "fail". I got some up close and personal experience in this while working for Kemper Insurance until they went bankrupt in 2002. When people invest money in a particular company or investment bank, it is with the understanding that the reason you are going to expect higher returns than you can get from a CD or T-Bill is that there is some element of risk involved. So, in a sense, by getting into the market you've signed up for that (even if you didn't know that you did when you got in). Insurance is exactly the opposite. You are not ever expecting to profit from an insurance deal. Instead, you are paying someone so that you can project your future more accurately and not have to contemplate all the "what ifs" of potential catastrophes that could befall you. If you just let an insurance company fail you remove that safety net and now you have thousands of companies (many of whom paid tens of millions in premiums) left completely uncovered. So not only would they need to immediately dump additional untold amounts of cash into new insurance during a time when they can least afford to, but in the interim they are left completely exposed and subject to unlimited liability. It's not hard to see how this could lead to a domino effect of potentially hundreds of companies (from the biggest to the smallest) becoming insolvent in short order. That is why when an insurance company goes bankrupt what you usually see is the state or federal regulators come in and "wind up" the business (meaning they don't write any new policies but honor all the existing ones by paying claims using whatever is left in the coffers, then selling assets, and then finally having the taxpayers foot the bill). Now, that didn't exactly happen with AIG, largely because it is unprecedented for an insurance company this large to go under. So what happened instead was a loan at a high interest rate, which is backed by ~80% ownership of the company. In theory, this means that AIG is not finished, IF they can pay back the loan. Former AIG CEO Hank Greenberg doesn't think it's going to happen though. He believes that the only feasible way AIG is going to be able to make their loan payments is to begin selling off their assets. If this continues, eventually you reach a point where you have sold off too many of the vital parts of the company and you will no longer be able to continue profitably even if you manage to pay off the loan. So he believes the government is in effect basically making AIG wind themselves down instead of having the government do it. Personally, I think that since the only real alternative is that the regulators would already be in shutting it down he should feel lucky they got the deal they did. If AIG can prove to potential investors that its troubles are now behind them, they should be able to attract new loans that will allow them to trade the high government loans for more favorable terms and that should allow them to continue. What is perhaps most extraordinary about the AIG situation is that even though its financial products division accounted for only a fraction of its overall revenues, it was able to write enough of these complicated derivatives to destroy the firm. That is some extremely poor risk management. Nevertheless, the remainder of the company has been well-run and profitable and thus I still give them a 50-50 shot of pulling out of this.

As for where the other $600 billion plus are going, I really don't have any specific thoughts yet. So instead I'll just post a couple of general thoughts and questions that have occurred to me:

• I think that by and large, Treasure Secretary Paulson has done a good job in explaining why this type of drastic action is required while still not panicking people. However, he's a bit naive in his request for the Congree to pass this as quickly as possible and to have absolutely no committee oversight to answer to. In an election year where just about nobody trusts the current administration anymore, going to the "trust me" well one more time seems a tad . . . optimistic. I understand that time is of the essence, but we have 3 branches of government for a reason. If we didn't want checks and balances, we'd just have a monarchy. Writing a $700 billion check seems exactly the right time to kick the tires and take a test drive instead of simply buying straight off of craigslist.
• When you start talking in terms of the hundreds of billions of dollars, what are the rules for rounding? If you decide that a particular company needs "~$50 million", do you just round up to $100 million?
• It's funny how 6 months ago everyone was watching the presidential race and no one was paying attention to Bush, and now no one is paying attention to the candidates. People are basically saying "I'm not nearly as concerned with what you would do if you were in there as I am with what the guy that's currently in there is doing." That's appropriate, I think.
• McCain can't have it both ways. You can't paint yourself as someone who is "anti government regulation" and then say that the reason this crisis happened is because we need better regulation. And I don't care how you paint it, saying "the fundamentals of our economy are strong" was a political gaffe no matter how you try to change the meaning of the word "fundamentals".
• Anyone who is in favor of this bailout must give up this whole "the Democrats are socialists" line forever. If you don't like a particular social program, say "I don't want the government involved in that" and not "the government should not be involved in that because it shouldn't be involved in anything because that's for socialists." If, however, you are against the bailout then by all means you can continue the "socialist" slander, but I'm going to call you an "anarchist" from now on..

Leaving for Vegas in a few hours, so wish me luck. I don't expect to win; I am just hoping to navigate around the isolated pockets of massive cash hemhorraging that I usually run into on at least 2-3 occasions per trip. With luck, I will also finish Hot, Flat, and Crowded, which is the phenomenal new book by Thomas Friedman (author of The World is Flat) on the plane ride over. I will have an extensive write-up on that (hopefully) next week sometime, but I'd highly advise anyone looking for a good non-fiction book to pick it up immediately.

And yes, it will involve me being preachy on climate change again. You have been warned.