The cause of the AIG bailout

Posted on 17. Sep, 2008 by in Featured

As usual the cause of an econimic melt down is being ignored while all the pundits and politicions flail at the symptoms. Mis-management, yes; corruption, no doubt; greed, a given: but why does the US Fed care enough to cough up 85 billion dollars for a “small” bridge loan?

Because the anti-trust laws of this country have been discarded. What does that have to do with the financial bail outs? The SEC/Justice Department have allowed companies through mergers and aquisitions to grow so large; so monolithic that their failure would bring down Wall Street.

In flight test we call that a single point of failure (bad) and it is avoided like the plague. How does this relate to aviation? Airlines are growing so large that they will not be allowed to fail. UAL went through a bankruptcy drill last week due to an errant “re-publish” of an old article. Let’s look at UAL: half of Chicago moves around the world by UAL’s network, most of Denver and Washington DC (Dulles), and a lot of San Fransisco. If UAL failed entire regions of the country would be stranded for a long time. Aircraft are virtually full the other carriers can not pick up the load. Even if they all picked up a share of UAL’s market share it would take months. And during those months the stranded citizens would be screaming at their Representatives. Even if one large Network Carrier was allowed to liquidate in the aftermath of the caos it would not be allowed again. AIG could not be allowed to fail; is that Capitolism or is it Communism?

2 Responses to “The cause of the AIG bailout”

  1. Edward Snyder 30 December 2008 at 21:45 #

    I found your site via a thread on the Continental runway excursion in Denver. While I haven’t seen much of it I’ve thoroughly enjoyed what I have read, particularly your dispassionate deconstruction of hype and headlines that play fast and lose with the ‘facts’; all the more reason for dismay upon reading your assessment of AIG rescue and its implication for Capitalism. It wasn’t corruption or mismanagement that brought AIG to its knees, it was the evaporation of credit induce by panic in the financial markets. Just like on September 12, 2001 when fear of flying spawned a recession and drove most U.S. airlines into the red, fear instilled by bank failures has caused panic in the credit markets. The Fed’s attempt to free up credit through billions in loans is no more a sign of corruption at AIG than the $15 billion in loans to the airlines in Nov ’01 was a sign that United was corrupt. An obsession with sound-bite explanations leads people to believe flight attendants can land airliners and bankers bring down economies. Your aviation experience suggests reality is far more complex than that; all the more so with the U.S. capital markets which are the cornerstone on which all other economies depend. If you don’t understand Vx, Vy, glide slopes or cross winds you’ll not understand why a flight attendant couldn’t land a jumbo jet. If you don’t understand swaps, LIBOR, MBS or converts, you probably won’t understand how the absence of credit could bring down the financial system. It isn’t a blameless debacle but if you deconstruct the system and pull back the curtain you will meet the culprit, and he is us. American’s massive addiction to credit, super-heated by government mandated cheap money has come full circle.
    First, the crisis in subprime mortgages — loans to those with poor credit — infected the credit markets. Then home prices started sinking. Then mortgage defaults rose, and the economy began to sputter. Now, the Federal Reserve is desperately trying to stabilize the credit market before a failure of confidence can poison the entire U.S. financial system.

  2. chip 1 January 2009 at 12:32 #

    Thank you for your response, I think you may have missed the main thrust of my post. It was not corruption, greed or mis-management that caused the Fed to make the loan. It was the size of AIG, too big to fail, as bernanke himself pointed out. I still stand by the thesis of “single point of failure”.

    The mortgage companies and congress were corrupt pushing loans they knew could not be paid; and then packaging these high risk loans with others. The rating agencies in my opinion either had to be corrupt or failed to do even basic due diligence taught in ECON-101. The bubble grew based on a corrupt premiss (that these loans would be re-paid). But again it is a side issue to my main point. AIG and other companies have been allowed to grow too big to fail.

    As for the airline loans? It was a huge mistake and caused the airline industry to wallow in red ink for years instead of reconciling the industry to demand. Most of the countries airlines did not take the loans.

    The industry finally, driven by high fuel prices, reconciled the size of the industry fleet to demand by pulling 500 aircraft out of the system. Had the weak airlines been allowed to fail post 911 the industry melt down would have been shorter and less painfull.

    4-5 years ago I was pitching an African Airline to a Wall Street firm, (it will remain nameless, however made the press). We finished, they liked it BUT: the PhD. analyst asked us. “Why should I invest in your airline when I can get a guaranteed 20% in mortgage funds?”

    We were dumbfounded; later while sipping an ice cold beverage we laughed. “Does this guy not see the melt down coming?”

    I suspect he would have rather invested in Yambuta Airlines than mortgage funds now. But that is hind sight.

    Thank you again for your well reasoned response.

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