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A Long-Expected Takeover

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We cannot say we're shocked that the Federal Reserve and the Treasury swooped in to take over the American International Group US Department of Insurance. We began reporting that a takeover was under consideration shortly before two in the afternoon. But to say we expected this takeover is not to say we understand it.
We're told that this was necessary because the failure of AIG posed a systemic threat to the financial system. This gives rise to a riddle, however. If the financial system was threatened, why wouldn't the financial firms who were presumably staring into the abyss agree to build the bridge loan? Surely they would have had the most to lose from the collapse of AIG.
We know that the Federal Reserve and the Treasury Department worked hard to find a market based solution to AIG's problems. Morgan Stanley was hired as an adviser. JP Morgan and Goldman Sachs were asked to organize a lending syndicate. Government officials attempted to signal that they would allow AIG to go the way of Lehman Brothers unless private funding for AIG was found. None of this worked.
It looks as if the heads of our banks and Wall Street firms called the bluff of their comrades in the government's bank. Perhaps they never for a moment believed that the government would allow AIG to sink. Perhaps they knew that they could get New York's public officials and foreign governments frightened enough to pressure the government to act.
Or maybe, just maybe, they understood that the dynamics of government are very different from the dynamics of business. Executives in private-sector banks (to the extent such things continue to exist) stand to make or gain an enormous amount of money when the institutions under their care profit. Incentive pay, options grants, restricted stock have somewhat aligned their interests with those of their shareholders and the profitability of their firms, reducing what the economists like to call "agency costs."
No such incentive alignment has been undertaken with respect to taxpayers and government officials. If the money lent out to AIG is not paid back, Hank Paulson and Ben Bernanke will not suffer financially. If you ever wanted to see an agency cost roaring, the AIG takeover is your dream come true. What's more, the deal allows government officials the rare thrill of feeling that they are not only very, very relevant, they are now the masters of the universe, the warrior kings of Wall Street.
From the perspective of, say, Jamie Dimon, it must have been obvious that the government would bail out AIG. Everything he knows about human behavior would have told him this. The bailout was overdetermined. If he was surprised, it was no doubt by the brevity of the resolve of the Treasury and the Fed not to offer up money. Remember, we reported that a takeover was in the works before 2 in the afternoon. At that point, it had been under discussion for hours.
So maybe we do understand this thing after all. One one woman recently said to us: "The only difference between Wall Street and the Titanic is that the Titanic had a band." It's an old joke but still clever. The Titanic might have been billed as an unsinkable ship. But it turned out it could sink. Wall Street simply believes that, while it may lose a few compartments every couple decades, it is unsinkable.