[ExI] AIG Bail out

[Lee Corbin]

Kevin writes

> [Lee wrote]
> 
>> From your point of view, what caused these managers
>> ---who normally are profit-oriented profit-hungry
>> capitalists with no heart---take such stupid chances?
>> WHY would they do it?
> 
> It wasn't just the managers. It was a complete underestimation
> of the risk these pools represented. They weren't going to keep
> and service these loans. They would package them into pools
> of similar loans and sell them to the next bigger bank who again
> would do the same all the way up to Lehman and Bear Stearns.
> Fannie and Freddie were even on the verge of rolling out
> subprime programs because they were so lucrative. 
> 
> But that was a problem. Everyone in this industry knew that it was
> cyclical. So they wanted to get as many as they could while they
> could.

So it resembles a classic bubble? In 1637 at its height, surely many
people knew that the tulip mania could not go on forever, but merely
kept hoping to find "the greater fool", who'd turn over even more
cash than they themselves had paid. Ultimately, I don't see any solution
to this aspect of the problem; there will always from time to time be
"irrational exuberance", to use Greenspan's memorable phrase
http://en.wikipedia.org/wiki/Irrational_exuberance

Waves of optimism or pessimism *are* going to sweep through
the traders now and then, and I doubt if anyone can suggest a
solution to this part of the "business cycle" which is entirely an
element of human psychology.

But what we need is to know how laws and policy should be
affected. You continue

>  Every type of loan imaginable was put together and it was
> always an easy sell. We were getting 112 basis points on
> 8% 100% self-employed stated with a 580 credit score!

So how many people "sort of" knew? Was it the case that 
practically everyone "knew" but just figured that it was part
of the long term unknowable future, or that it would happen
"sooner or later", but didn't think that it was imminent? (Oh,
I see that you've answered below.)

> In the end, it kept happening because some idiots at the
> top had a great interest in buying all of this debt.

But how "idiotic" can this really be if indeed the "day of reckoning"
is still years off? As you and John Clark are saying, it seems inevitable
that people will simply end up (for the most part) placing their trust
in those offering the greatest rewards, right? So are we just *supposed*
to individually be more cautious, and try to be aware of this, and try to
avoid the very best interest rates we can find, if there is even a bit of
uncertainty in it? Somehow, that doesn't sound right---yet one who has
read Taleb's books and essays is indeed wary of "balanced portfolio",
"portfolio theory" and so on.  (Clueless am I.)

> Their company worth was shifted towards assets and not cash.
> The way the process works - including a foreclosure process
> that sometimes drags on for a year or more - provided an
> atmosphere where the default rates were going up while
> they were continuing to expand these products even further. 
> 
> In the end, I would say it is a case of people at the top not
> understanding fully what they are buying, OR willfully ignoring it.
> I'm not sure which. Both are probably somewhat true.

Okay, great, Kevin. This fits in with the picture that is beginning
to emerge for me. What seems *absolutely* necessary is that
government policies first and foremost should have been designed
so that the government is *never* left holding the bag. This means
that we should even eventually (pace singularity) remove
the guarantees of small investor safety---because just as soon as
there is any *guarantee* of government money, sooner or later
the situation will evolve so that the public pays (and in a way that
is NOT wealth-creating). Buyer beware.

> After all, these execs made hundreds of millions of dollars each
> and it really doesn't matter to them whether or not the whole
> thing collapses. They can retire just fine.

All right. So as I admitted the other day, some of our freedom under
the current circumstances does have to be traded for security, and
the SEC must have tough rules, and we *must* return to the 1933
law that Phil Graham and Bill Clinton repealed in the 1990s.

We never should have got into this, but it's a bit late to complain.
We should instead strive to slowly extract ourselves from this
in the future. (No one should ask *me* for details!)

> One thing I am not sure of is the role that regulation played here.
> I am left to wonder if less regulation would have allowed the
> shareholders and the end buyers of the debts at the top to be
> aware of the situation at the bottom much sooner.

Very interesting. Now, on the one hand, it's pretty clear that whether
we are talking about the savings and load fiasco of the late eighties
or the mortgage meltdown now, regulation cannot simply be repealed---
you can't go "half-free market". You cannot simultaneous continue
government backing of this and that and then blindly deregulate. 

But of course, only complete enemies of the free-market (i.e. people
whose economic education is unbelievably inadequate) are for *all*
regulation. I wonder, do they want to regulate supermarkets? piano
lessons? who can buy electronic devices?  I think the answer even for
them is "no". So clearly, at present we must seek a middle ground.

But your idea is intriguing, and commands attention.

> 18 month foreclosures, short sales, multiple appraisals, RESPA,
> predatory lending, all work to muddy the waters making it less
> clear what is going on...an incomplete thought at the moment,
> but something else to ponder.

Yes, muddy waters indeed. Sometimes I wish I were a simpleton
and could just scream "away with *all* government", or "we must
institute total control of everything, and completely regulate the
so-called free market to oblivion!". But I still have a bit of self-respect
on these matters.

Lee