In the WSJ, Harvard Law professor Lucien Bebchuk wonders why the government is paying back AIG’s creditors through AIG, instead of pushing AIG into Chapter 11 bankruptcy, giving its assets to the counterparties, and then making up the difference directly as needed to keep those banks afloat.
The alternative would be to put AIG into Chapter 11. In this case, AIG’s creditors, including its derivative counterparties, would obtain the company’s assets. They would end up with a 50% recovery on their claims, bearing those $160 billion of losses themselves…
Still, what about the concern that losses to derivative counterparties — which are now known to include major U.S. and foreign banks — would substantially deplete the capital of some of them? That concern would be best addressed by the U.S. government (or foreign governments in the case of their banks) infusing capital directly — in return for shares — into the banks that need it. There is no reason to back AIG’s obligations as an instrument for infusing capital (with taxpayers getting nothing in return) into, say, Goldman Sachs or Spain’s Banco Santander….
A policy that doesn’t fully back AIG’s obligations should be seriously considered.
That does sound pretty appetizing. The US government should be doing all it can to end this mess as soon as possible, and propping AIG up with more and more moolah doesn’t seem like an efficient exit plan. That’s not to say that Bebchuk’s policy allows the US to wash its hands of this mess: in some ways it would just mean exchanging our interest in AIG for interests in other banks. But honestly, I’d probably rather the US own a small share of Goldman Sachs and other banks than a majority stake of the failing AIG. Our ownership of AIG exposes it to all sorts of populist anger (and now, Congressional intervention) with regard to management practices, bonuses, etc., that are not making it any more efficient or effective. Small shares in other banks would limit our unhelpful intervention into everyday affairs of those companies, with the added bonus that we also would no longer be saddled with a crumbling, unpopular institution staffed by a bunch of people who really screwed the pooch.
That said, Bebchuk does acknowledge the need for so-called “stress tests”, or concentrated research and multiple hypotheses of what might happen if we don’t back all of AIG’s contracts, and this is a necessary first step.