If AIG wasn't too big to fail, why did the government rescue it? And why do we need to turn the financial system upside down?
Since last September, the government's case for bailing out AIG has rested on the notion that the company was too big to fail. If AIG hadn't been rescued, the argument goes, its credit default swap (CDS) obligations would have caused huge losses to its counterparties—and thus provoked a financial collapse.
Last week's news that this was not in fact the motive for AIG's rescue has implications that go well beyond the Obama administration's efforts to regulate CDSs and other derivatives. It's one more example that the administration may be using the financial crisis as a pretext to extend Washington's control of the financial sector.
The truth about the credit default swaps came out last week in a report by TARP Special Inspector General Neil Barofsky. It says that Treasury Secretary Tim Geithner, then president of the New York Federal Reserve Bank, did not believe that the financial condition of AIG's credit default swap counterparties was "a relevant factor" in the decision to bail out the company. This contradicts the conventional assumption, never denied by the Federal Reserve or the Treasury, that AIG's failure would have had a devastating effect.
So why did the government rescue AIG? This has never been clear.
The lack of candor about credit default swaps, the effort to blame lack of regulation for the subprime crisis and the excessive reach of the proposed consumer protection agency are all of a piece. The administration seems to be using the specter of another financial crisis to bring more and more of the economy under Washington's control.
With the help of large Democratic majorities in Congress, this train has had considerable momentum. But perhaps—with the disclosure about credit default swaps and the AIG crisis—the wheels are finally coming off.