Confirming my intuition on AIG

on Jul 08 in Financial Market tagged by Trevor Hicks

I’ll reiterate that if you have any interest in what’s going on in our banking and financial industries than anything by Michael Lewis is mandatory reading. His latest article for Vanity Fair is an insider’s account of what happened at AIG the last few years.

You may recall the letter from AIG trader Jake DeSantis that was printed in the New York Times back in March defending the work that he and others had done to clean up the mess at AIG. At the time I thought that this confirmed my intuition that most, or really all the people there were genuinely doing their best to earn money for the firm. Some of them screwed up, it happens. This article from Michael Lewis I think cements that interpretation as the most likely. It also confirms for me that a huge source of the problem was simply that the executives didn’t understand what was on their books. And I think another contributing factor was the fact that the prudent decision to stay out of the securitized subprime market was to deliver lower earnings than your competition and with it lower compensation and maybe even a pink slip.

I’d also like to chip in that lack of government oversight was not a major contributing factor. Indeed, government created the securitized subprime market both by its sponsorship of Fannie Mae and Freddie Mac and in its overly detailed capital regulations that actually treated as less risky and permitted greater leverage against securitized subprime mortgages than loans a bank originated and serviced itself. My point here is not that the government regulators were obviously stupid, rather that attempting to even control these institutions at such a fine level of detail is always doomed to failure as it’s impossible to get the rules right or to create a system that cannot be gamed. Best to try to create a system that is fault tolerant and robust to such failures than to try to create a system that never has failures. Things will go wrong at some point, it’s inevitable, and the less hubris our government has about its ability to insulate everyone from every problem the better off we’ll be.