Tuesday, December 30, 2008

The dark side of the U.S. financial bailout: AIG

The Federal Reserve balance sheet is quite organic, growing in size with each week that passes (unusual before 2008). A significant amount of balance sheet space is now dedicated to the direct lending to and purchase of securities from American International Group (AIG) and its subsidiaries.

The chart illustrates the Fed’s balance sheet (Table 1 Factors Affecting Reserve Balances of Depository Institutions) spanning 2008, including the various lending measures instituted since the beginning of the year (to see these measures, click on policy tools here). Notable changes in the most recent release (December 29, 2008) include:

  • Bank reserve balances are now $785 billion, which is a $779 billion increase since this time last year.
  • The Fed continues to prop up the commercial paper market with its massive $326 billion net holdings under the Commercial Paper Funding Facility (CPFF), up by $10.5 billion since just last week.
  • The Fed has dedicated no resources to the money market investor funding facility – I guess that they are holding this facility in place “just in case”?
  • Other federal reserve assets – essentially the currency swap lines opened up with various global central banks – fell $28 billion to $614 billion. I suppose this is a good sign: the $US is now more accessible to foreigners.
  • The Fed purchased a new $2.5 billion for a total of $20 billion in residential mortgage-backed securities from AIG and its subsidiaries (Maiden Lane II in the chart above, the Fed first announced the purchase here).
  • The Fed purchased a new $8.5 billion in collateral debt obligations on which the Financial Products Group of AIG wrote credit default swaps (see this Washington Post article about Financial Products Group).

The Fed has extended direct credit to AIG and is now shoring up assets related to AIG and its subsidiaries; this is obscene. The bottomless pit that is AIG (currently, the government has invested $152 billion) goes deeper.

Have you seen Parenthood? Steve Martin is Gil Buckman, a dedicated father, who struggles with the tradeoff between career and family. Tom Hulce plays Gil’s younger brother, Larry, who fathers a son Cool that he cannot support in his plight to get rich quick. Larry promises Frank that he will change his life after he gets a loan, but he does not. Larry leaves Cool in Frank’s care and takes the money from Frank for his scheming, and is assumed to never never pay back the loan. AIG is Larry - Larry is AIG.

I am seriously disgusted by this facet of the government’s handling of the financial crisis; it goes against everything that is good about free markets. Bad business models should fail, certainly including AGI, Citigroup, GM, and GMAC (of course they got their $6 billion). The government is barricading the healthy process of consolidation.

Rebecca Wilder


  1. I hate to be flippant but the FED balance sheet looks like the whale it is. The whole AIG mess IS disgusting especially in light of all the partying they do with our $$ (a black hole)>??

  2. Rebecca,

    Growth in Fed assets has stalled since November. This started just around the time they began to talk up MBS purchases and persisted through the ZIRP adoption.

    What gives? Did they declare victory (the broader aggregates are rising briskly) and decide to take a break? Why did MBS spreads and Treasury yields collapse when the Fed DID NOT support those markets in size; and if it was front running, does that mean the spreads will back up again given the lack of Fed support?

    There is rampart confusion surrounding the Fed right now. No doubt Bernanke's communication strategy is to "keep 'em guessing", but IMO the market will test him until it gets what it wants: clarity.

  3. Hi David,


    Bernanke's secrecy + Paulson's mistakes = A very unhappy market,

    Thanks for commenting!


  4. "currency swap lines opened up with various global central banks –fell $28 billion to $614 billion.

    Yes, this is why currencies move. As bank credit contraction stops, the U.S. dollar will resume it's fall.

  5. Dr. William Poole"
    "No one has been able to come up with a forecasting methodology that will make you a lot of money"

    Poole is a fool.

  6. Dr. William Poole:
    "We cannot explain the fluctuations of currencies after they have occurred even with all the data that we can dig out"

    Poole's quote above concerned currencies as well.

    He is, of course, very ignorant.

  7. "bank reserves increased $779b" Yes, the fed drained reserves.