Should the U.S. Government Be One Of The World's Largest Insurance Companies?

As frequently is the case, Mark Steyn articulates what I was feeling:

"Aside from the peripheral details (I don't quite see why American taxpayers should now be the principal sponsors of Manchester United soccer team) there's something very unsettling about the symbolism. Old-school socialist nationalization generally involved governments owning industries that actually produced something - a coal mine or an automobile. But there's something almost too creepily apt about the United States government now being, literally, one of the planet's biggest insurance companies.

"The old line on imprudent debt went something like: If you owe the bank a thousand dollars, you have a problem; if you owe the bank a million dollars, the bank has a problem. We seem to have casually accepted the extension of the paradigm: If the bank loans you a million dollars, the bank has a problem. If the bank loans you a billion dollars, the US government has a problem. But why? Short-term "turmoil" (ie, change and opportunity) in the markets would seem preferable to Washington buying a junk portfolio for every federal taxpayer."

What does it say about the legitimacy of a free-market system if investors in hedge funds and other sophisticated financial ventures, who potentially stand to make mind-boggling fortunes if their investments prosper, are bailed out by Uncle Sam if their investments fail? Isn't that State Capitalism? Isn't that exactly the system fixed for the benefit of the fat cats that the Left has always charged was the essence of the U.S. economic system?

Most of the "problem assets" in the A.I.G. portfolio are derivative contracts used to mitigate interest-rate risks and hedge risk exposures in securities and commodities markets, including credit derivatives that insure collateralized debt obligations (CDOs). In recent years, lenders raked in cash by making sub-prime loans to unqualified, or unvetted borrowers, and then immediately reselling those loans to feed a voracious secondary market. Thousands of loans were bundled and then sold to investors as collateralized debt obligations. To make the CDOs more attractive to the investors, companies such as A.I.G. would insure the CDOs against default.

Often the loan pools underlying the CDOs were sliced and diced, with the loan servicing fees going one way and the right to the interest income going another. When defaults began to occur on the underlying mortgages, it was often unclear who had the authority to negotiate a workout or restructuring of the loans. The loan pools underlying various CDOs might include parts of thousands of loans, most in good standing but many in default. It became impossible for the CDO investors or their credit insurers, such as A.I.G., to even compute their risk exposure, losses and liabilities.

So A.I.G. provided the hedge on the investment risk that helped fuel the runaway CDO and derivative market. The CDO investors chose A.I.G. to hedge the credit risk inherent in their investments. It turns out that they chose wrongly when they bought the CDOs and wrongly when they hedged through A.I.G. They took an investment risk, and lost. But instead of having the investors suffer the consequences of their risky investment choices, now the U.S. is stepping in to guarantee the performance by A.I.G. of its contractual obligations. That is just wrong.