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Montana Viewpoint©

TOO BIG TO FAIL

March 30, 2009

One of the sore points almost everyone has about the bailout of the banks and
companies is that they “are too big to fail.” That was probably the most unfortunate
choice of words that Bush’s Secretary of the Treasury, Henry Paulsen, could have
used when he decided to bail out AIG; so what are we? “too small to matter?” People I
talk with feel that there is a perfectly legitimate way to handle those companies
and that is the bankruptcy route. If it’s the only recourse for the little guy, it should be good enough for the big guys.

Bankruptcy is a business choice made when a company has more debt than assets and no
reasonable expectation of being able to pay it off. The procedure allows creditors a
shot of getting at least something back on their loan or unpaid bill when the
bankrupt company’s assets are sold. Bankruptcy works best when there are assets for
a company to liquidate. General Motors for instance, has real estate, factories, a
trained workforce, and an inventory of cars and car parts. There is something
tangible there, there is something that can be sold and used. A bank or insurance
company has little real estate, but does have a skilled workforce and money, but
when they go belly up they will have more debt than money and  the only hope a
creditor has is to be able to recover a percentage of their loan.

Bailing out AIG is, to put it mildly, distasteful to most of us. Here we are, the
innocent bystanders, being asked to fork over billions of tax dollars to a company
that almost singlehandedly created the most serious world financial crisis in eighty
years. It is as distasteful as watching a government prosecutor letting a mafia
kingpin go free in return for information that leads to the arrest of other Mafioso,
but it has a similar purpose. The thinking is; we can let AIG fail, as we did Lehman
Brothers and Bear Stearns, but if we do it will probably trigger a worldwide
financial crisis that will hurt us even more.

The scheme that has brought us to this dreadful place is the Credit Default Swap
(CDS) game created by AIG's Financial Products Division. I am not even going to
attempt to explain CDSs in a short article (which covers up neatly for the fact that
I couldn’t explain them in a long article anyway). It’s enough to say that they are
very complex insurances policies that evolved into a $62 trillion market worldwide.
AIG felt that they were so safe that they didn't bother to keep sufficient reserves
to pay out claims, and this worked fine…until it didn’t. And when it didn’t, it
didn’t all at once. Banks and others both in the U.S. and worldwide who had bought
CDSs wanted payment for their losses, and AIG didn’t have the money.

If AIG couldn’t cover the losses of the banks that held the contracts, then the
banks couldn’t cover their own debts, and the people they owed money to couldn’t
cover theirs, etc. Because the banks are facing great uncertainty, they have been
hoarding what money they do have and cutting back on making loans. You and I borrow
money to buy a home or car, or toys. We can get by without borrowing if we have to.
But today’s capitalism runs on the leverage that borrowed money can command, and
credit plays a far more important role in the conduct of big business than most of
us realize. Businesses improve themselves by borrowing money to expand, knowing that
their profit will be well over the cost of borrowing money. In a situation like
this, if their ability to borrow dries up, then the economic force that is
capitalism comes to a halt.

So I guess it’s damned if we do and damned if we don’t. It will be unfair to regular
Americans either way, but the hope is that by bailing out AIG that the economy will
recover sooner than if we do nothing and thereby avoid some of the associated social
costs and personal tragedies that would result from even more bankruptcies spreading
through our economy. This whole sordid scenario is one of “capitalizing the profit
and socializing the loss.” That means that profits stay within the ownership of the
business but losses are picked up by the general public. I am afraid it is too much
to expect that AIG and their cohorts will remember the millions of American
families who sacrificed so that our nation could survive the idiocy of Wall Street.

Montana Viewpoint© is carried by 20 Montana weekly newspapers, including those in Helena and Billings, with a combined circulation of over 60,000.

Jim Elliott is a former state senator from Trout Creek. He served in the Montana House 1989 to 1996 and the Montana Senate from 2001 to 2008. Elliott has distributed his opinion column statewide since 1992. There is no charge for publication.