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Incentives matter
As it turn out, the really risks in the system were being created not by hedge funds but by boring old investment banks and insurance companies. Sure there have been hedge fund failures but none on the scale and with the repercussions of the recent failures of Bear Stearns, Lehman Brothers, and the government sponsored mortgage companies. Hedge funds might not have had all that many rules governing their behavior but their incentive pay structure seems to have regulated their risk far better.
Here is more. On the other side of the governance fence:
The Wall Street Journal is reporting that the Federal Reserve has asked Goldman Sachs and J.P. Morgan Chase to help make $70-$75 billion in loans available to the AIG.
That's a lot of money to "ask" for.
Posted by Tyler Cowen on September 15, 2008 at 10:43 PM in Current Affairs | Permalink
Comments
No Kidding it is a lot of money, especially when AIG has a market cap of 13 billion. So both companies could come up with 3 times AIG's market cap in loans, but neither is willing to step up and purchase...
Seriously, they would rather loose 35 billion each then actually own the balance sheet...
Posted by: brian befano at Sep 15, 2008 10:53:46 PM
So, does this kind of situation (non-taxpayer money being loaned but the Fed asking for it) still create the same kind of moral hazard as a government bailout would?
"Hey guys, it's me, Ben. Why didn't you answer the first 14 times I called? Got some extra $$$? Pleasies?"
Posted by: pants at Sep 15, 2008 11:00:51 PM
Simple math: $75 billion / 110 million US households = $681 per household.
Curious that this is about the same order of magnitude as the economic stimulus package checks.
My guess is that AIG is dying. Warren Buffet probably has $13 billion sitting around and certainly knows insurance companies as well as anyone alive. If he saw cheap assets at an acceptable risk level, he'd be on this like lipstick on a pig. [sorry, just had to say that]
Posted by: ZBicyclist at Sep 15, 2008 11:22:06 PM
Presuming that B o A and Morgan can decline to provide the loan and the Fed isn't holding a gun to their heads then I would have to say that no moral hazard exists.
My concern for moral hazard at this point revolves around the fact that BoA is possibly getting close to monopoly status and that Congress, in order to save us, gives them anti-trust exemptions and effectively creates another GSE in the process.
Posted by: David J at Sep 15, 2008 11:24:02 PM
Maybe AIG must be kept intact because they have heaviy dealings in China?
Posted by: David at Sep 15, 2008 11:48:10 PM
Unregulated hedge funds came out OK but investment banks and insurance companies, subject to more regulation than nearly any sector of the economy-- state, exchange and federal (security and banking-- are tanking and disappearing? You must be wrong because the dominant narrative tells me that lax regulation caused the problems.
Posted by: guy in the veal calf office at Sep 16, 2008 12:15:18 AM
"Unregulated hedge funds came out OK but investment banks and insurance companies, subject to more regulation than nearly any sector of the economy-- state, exchange and federal (security and banking-- are tanking and disappearing? You must be wrong because the dominant narrative tells me that lax regulation caused the problems."
Seconded. Move to acknowledge hedge fund industry's clear lack of accountability to anyone.
Posted by: Jason Armstrong at Sep 16, 2008 12:38:38 AM
This narrative is naive bullshit. I thought everyone had friends working various trading floors in Manhattan. Koch I would guess could spring for that much.
Posted by: Russell L. Carter at Sep 16, 2008 1:09:51 AM
Simple math: $75 billion / 110 million US households = $681 per household.
Curious that this is about the same order of magnitude as the economic stimulus package checks.
So what? That was Congress and the President (all elected) being stupid together.
the dominant narrative tells me that lax regulation caused the problems.
Agreed. The dominant narrative is "More regulation, that's the ticket."
Posted by: fish on a bicycle at Sep 16, 2008 7:16:11 AM
Hmmm. The people who have the money are sovereign wealth funds, hedge funds and private equity consortia. The Fed did not ask them. Odd?
Posted by: Diversity at Sep 16, 2008 7:26:09 AM
It's got little to do with manageent incentives. Hedge funds typically are private and have raised money under SEC Rule 144a, which exempts them from various rules applicable to public companies, banks, insurers, etc. So they may not be required to apply FAS 157 (which requires mark-to-market) or may choose to apply FAS 157 Level 3, where one can mark-to-model instead of actual market price of similar securities.
With AIG (see the EDGAR filings) the auditor, PwC, seems to have forced AIG to use FAS 157's Level 1 to value certain securities it holds, even when there is currently effectively no market in those securities (credit default swaps in this case). So basically, this is not a credit crisis, it's an accounting error! Well, at least, a judgeement call by PwC on how to do the math...
FAS 157 came into effect last quarter. No coincidence that the crises hit just now...
Posted by: kp at Sep 16, 2008 8:14:36 AM
Well, I expect all that foreign money to come in and save us. You know, like the Chinese who we were so eager to appease with the bailouts of Freddie and Fannie. Any word on how much money is pouring in from all corners of the globe?
I think AIG is a better candidate for 'saving' than Freddie and his fat sister.
We're past moral hazard and into "let's pick favorites." BS can be saved, Fannie/Freddie can be saved, but Lehman and AIG can fail. What leadership.
Posted by: meter at Sep 16, 2008 10:01:41 AM
meter thinks we're playing favorites.
I think the feds have decided that odd names are an endangered species and need protection.
Bear Stearns: odd name ["Bear" for a Wall St firm?], save.
Fannie Mae: weird name, save.
Freddie Mac: weird name, save.
Indy Mac: weird name, save (FDIC, of course).
WaMu: weird name, probably to be saved (FDIC, of course)
Merrill Lynch: familiar name, on your own
AIG: standard corporate name, on your own
Lehman Brothers: standard corporate name, let go.
OK, I'm not serious with this, but ...
Posted by: ZBicyclist at Sep 16, 2008 11:10:16 AM
On the other other side, perhaps the hedge funds that are unwinding their position now that they are unpopular were keeping the big guys from blowing up before.
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