The end of American capitalism as we knew it?

From Willem Buiter’s blog

This is what I read this morning on “The US Federal Reserve announced that it will lend AIG up to $85bn in emergency funds in return for a government stake of 79.9 per cent and effective control of the company – an extraordinary step meant to stave off a collapse of the giant insurer that plays a crucial role in the global financial system. Under the plan, the existing management of the company will be replaced and new executives will be appointed. It also gives the US government veto power over major decisions at the company.”

I almost decided to go back to bed, convinced I must be dreaming.The proximate cause of the demise of AIG as a private firm were its ‘monoline’ activities, its exposure to massive amounts of credit risk derivatives like CDS, many of them linked to the US real estate sector. The largest insurance supermarket in the world, with a balance sheet in excess of $1 trillion nationalised because it was deemed too big and too globally interconnected to fail! The fear that drove this extraordinary decision is that AIG’s failure would increase counterparty risk, actual and perceived, throughout the financial system of the US and the rest of the world, to such an extent that no financial institution would have been willing to extend credit to any other financial institution.Credit to households and non-financial enterprises would have been the next domino to fall, and voilà! , financial Armageddon.

Professor Buiter knows about this stuff. He used to be on the Bank of England”s Monetary Policy Committee and he has a Chair at LSE. Next to Paul Krugman, he’s the most astute economic commentator I know.

He goes on:

If financial behemoths like AIG are too large and/or too interconnected to fail but not too smart to get themselves into situations where they need to be bailed out, then what is the case for letting private firms engage in such kinds of activities in the first place?

Is the reality of the modern, transactions-oriented model of financial capitalism indeed that large private firms make enormous private profits when the going is good and get bailed out and taken into temporary public ownership when the going gets bad, with the tax payer taking the risk and the losses?

If so, then why not keep these activities in permanent public ownership?There is a long-standing argument that there is no real case for private ownership of deposit-taking banking institutions, because these cannot exist safely without a deposit guarantee and/or lender of last resort facilities, that are ultimately underwritten by the taxpayer.

I’ve often wondered what it was like to live through the (first) Wall Street Crash. Now I have some idea. What’s strange is the way, at each stage in the crisis, there’s a feeling that perhaps it has bottomed out. And then it gets worse again. Today we’ve seen the unthinkable happen — the US Treasury is running out of cash, and the markets are beginning to contemplate the possibility (still deemed extremely remote, but still…) of the US government defaulting on its loans.

And it’s coming closer to home. Most of my savings, and some of the money I hold in trust for the kids, is held in funds managed by Lloyds. What happens if it turns out that the proposed Lloyds-HBOS ‘superbank’ in turn becomes vulnerable? Should I be moving the money into something safer? And if so, what? Gold bars? Government bonds? If the latter, which government? China? Dubai?

Years ago, I decided that I didn’t want to have a mortgage from a bank and went to an old-fashioned well-managed Building Society instead. Boy am I glad that I made that decision.