Commentary: AIG ‘Profits’ an Insult to the Concept

By | December 13, 2012

To say taxpayers made money from their investment in AIG is to libel the very concept of profit.

Come to think of it, it may well be a gross insult to the idea of investment too.

The Treasury Department announced on Tuesday it would get $7.6 billion from the sale of its remaining government-owned shares in American International Group, taking it to what was widely reported to be a profit of $22.7 billion on the bailout.

That’s $182 billion well invested, is the clear implication, though even the Treasury seems wary of calling the bailout bucks profit, using the more bureaucratic “positive return” in its press release.

You can quibble with the figures — for example that math takes no account of the value of tax breaks AIG received as part of the deal — but the real problem is with the very concept of the government investing in public financial companies which would otherwise go bust.

In financial services, companies take risks with the time value of money, hopefully creating value in the process. Banks, or crypto-banks like AIG was, borrow money for short periods and lend it out at higher rates for longer periods. Interest rates, the ability to inspire confidence and thus command access to credit, and credit risk management — how well you choose who to lend to — are the three cornerstones of profit and survival in banking.

In a fiat currency regime, one in which the government can create money at will, banks are essentially creatures of the state, with the government controlling both regulation and, in essence, interest rates. Those are two important determinants of financial services profitability, but the U.S. went a huge step further when it injected capital into AIG, a move that had the effect of bailing out the insurer’s counterparties in the banking industry.

When the U.S. bailed out AIG, and for that matter the other banks, it at a stroke removed the issue of confidence, making them immediately better risks because of the perception that they had a backer with unfathomably deep pockets.

That makes a nonsense of the concept of profits, much less of investment; AIG was owned by an entity that had enormous control over most of the forces which determined how profitable it was: interest rates, regulation and access to and cost of capital.


So sure there was a “positive return” on the deal but the real measure of the wisdom of the bailouts has to be a much wider accounting of the costs, and on this front the AIG deal, and the banking bailout as a whole, has to be deemed a failure.

There are two strong arguments against the effects of the bailouts. The first, and most commonly cited, is that the bailouts may have made things easier in the short term but that, by creating the belief that the too big won’t be allowed to fail, has set the stage for an even more damaging and costly crisis in the future. Every bank counterparty in the world lives in full expectation that should their exposures to a big U.S. institution turn sour they, like AIG’s creditors, will be paid in full. That moral hazard suppresses volatility but also suppresses risk measurement by financial markets.

The second, and in some ways more compelling argument, is that we are already paying for the bailout, in the form of an artificially large financial sector which serves as a private tax on the rest of the economy, misallocating capital wildly as it goes along.

If you want more of something, then subsidize it, and that is exactly what we’ve been doing with financial intermediation for years, culminating in the bank bailouts, of which AIG was a key piece. The financial sector’s share of U.S. GDP almost quadrupled between the end of World War II and the peak just before the crash, despite there being almost no evidence that all this furious intermediation and maturity transformation was producing anything of value.

So when we bailed out AIG we may have helped to move it, and the banking industry more broadly, back to profit, but we’ve entrenched a system which is over-banked and in which many of the individuals within it have an inherent conflict of interest with the public good, with the steady and stable growth of the economy and even with the good of shareholders.

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