The problem with AIG

As noted earlier, The AIG story is all about the unregulated overconcentration of global risk in a fashion which if not criminal, was massively irresponsible. But instead, the story has become the bonus payments. There will be a ghoulish bus tour this weekend to visit AIG exec homes (including a few in my hometown), Congress is looking to tax corporate bonuses at 90%, and folks all over the country are outraged. With very much good reason. But all this sturm und drang really risks missing the forest for the trees: the world's banking system and economy is still perilously close to collapse, and very little is being done about it. Instead, all the air in the room is sucked up by posturing and populism.

I like a good populist revolt as much as the next guy, but folks - this is deadly serious and we're fast running out of time.

You've heard me worry about the disfunction of the G-20 (G-3). Expect more of that. But this morning brings fresh worries, and new news, from three places:

1. The WaPo: Facing Dilemma, Banks Cite 2 Paths to Disaster
2. David Brooks: Perverse Cosmic Myopia
3. Simon Johnson and James Kwak: Off With the Bankers

The Post points out the following:

Execs say either option -- accepting restrictions on compensation or returning billions in federal aid -- could have a disastrous effect on economy. I Don't disagree with bank execs on this, frankly. As they point out, legislation enacted in a fit of populist rage is not likely to be any good: The possibility of a newly weakened banking industry also raised concerns among businesses in the wider economy that already are struggling to find financial firms willing to lend them needed money.
"We're all going to lose on this thing," said an executive at a large bank that took federal aid. He and other bankers expressed shock at the rapid progress of legislation that could impose large pay cuts on thousands of workers, and dismay that the industry is at the mercy of an angry Congress. And the Post correctly points this out: legislative action could trigger the unraveling of the broader federal bailout of troubled banks, which has grown increasingly unpopular on Capitol Hill and across the country. I find the prospect that bank rescues might fail due to (relatively) small bonuses chilling. As David Brooks put it: We’re in the middle of a multitrillion-dollar crisis, and our political masters — always willing to throw themselves into any issue that is understandable on cable television — have decided to risk destroying the entire bank-rescue plan because of bonuses that account for 0.001 percent of the annual G.D.P.

Next we have more from Mr Brooks, who's getting better on the economic meltdown all the time. Today he's worried about things global, and the absence of any political will to act boldly. A few gems:

The tiger, of course, is the collapsing world financial system. Americans actually have a falsely mild view of this crisis because the economy is worse abroad. The U.N.’s International Labor Organization projects between 30 million and 50 million job losses worldwide. Central European countries are teetering; Japan’s economy is horrifying; and the Chinese job creation machine is losing the race against its demographic pressures.
There have been riots in Greece and China as well as huge protest rallies in Dublin, Paris, London and beyond. So far, the protesters express anger without an agenda, but if the global economy continues to slide through 2010, they’ll discover one. A predictable result is a series of beggar-thy-neighbor exchange-rate policies, followed by rising trade barriers and the degradation of the entire global system.

This is a global crisis, and a core lesson of the Great Depression is that a global crisis calls for a global response. As such, Tim Geithner and Larry Summers are preparing for the upcoming G-20 summit with an agenda that has the merit of actually addressing the problem at hand: coordinate global stimulus, strengthen the International Monetary Fund, preserve open trade.

But the G-20 process is heading toward global impotence because the Europeans are dismissing this approach. Instead, they want to spend this moment of peril working on a long-term architecture to regulate global finance. The world is in flames and they want directorates and multilateral symposia and vague plans for a powerless “college of supervisors.” This is what Marie Antoinette would be for if she were an annual Davos attendee

Then we have Mr Johnson and Kwak, also in the Times today. They debunk the myth that only banking insiders have the chops to unravel the messes they've created, and point to the 1998 crisis in Asia as evidence that nationalization works at a time like this. Excerpts, emphases mine:

They begin rather bluntly:

A.I.G. can hardly claim that its generous bonuses attract the best and the brightest. So instead, it defends the payments by arguing they’re needed to retain employees who are crucial for winding down transactions that are “difficult to understand and manage.” In other words, only the people who stuck the knife into the American International Group can neatly extract it for a decent burial.

There is no reason to believe this.

Similar arguments made during the 1997 Asian financial crisis, when currencies and stock markets collapsed in much of Southeast Asia, turned out to be a smokescreen to protect the executives who were partly responsible for the mess. Recovery from that crisis required Indonesia, South Korea and Thailand to close or consolidate banks. In all three countries, bankers protested, claiming that their connections with borrowers were critical to recovery....

The lesson of all this is that when insiders have broken a financial institution, the most direct remedy is to kick them out. Traders are hardly in short supply...

Even if the conclusion is that a few experts need to be retained, offering guaranteed bonuses to virtually the entire operation is hardly the way to achieve the desired results. We should not let people think that the best way to guarantee job security is to lose lots of money in a really complicated way.

The argument that A.I.G.’s traders are the people that we must depend on to save the United States economy is as weak and self-serving as it was in Thailand, Korea or Indonesia. A.I.G. is essentially advocating survival of the weakest. Thankfully, the American people are not buying it.

My bottom line here? Sure, fix the worst of the Wall St bonus system, and for sure do not give $$$ to mediocrities who got us here. And for sure, do not guarantee bank bonuses, especially for short-term performance. But do not destroy all of Wall Street in one fell swoop, and for very sure do not lose sight of the growing real crisis and for the need to act ever more boldly. We dither while the world burns.

Here's the bold action needed:

1. Nationalize as many bank as needed ASAP in a few weeks when the stress tests are completed. Then quickly implement the RTC model (or the good bank/bad bank one). We know how to do this, even if the scale this time is staggering. If in doubt, nationalize all of the biggest ones, so as not to play winners off losers. That could end up being the top 150 banks in the nation
2. The G-20 needs to have coordinated joint stimulus programs equal to 3% of GDP per country, and needs to eschew protectionism. The US should lead here by example, and stop picking on Mexico, etc
3. The US needs another, bigger stimulus in the next 6 months, one focused more on longer-term infrastructure investment, and less on near-term spending
4. There needs to be a serious effort to boost the capabilities of the IMF, beginning with more money and staff ASAP, but more importantly changing the charter to allow more involvement by developing countries, and less by Europe

Absent this stuff the decline towards global depression steepens....