Felonious Derivatives

by digby

These AIG bonuses certainly are causing a furor and for good reason. It is just such a clear demonstration of the indefatigable chutzpah of these Big Money Boyz. But the AIG story is very, very bad on many levels. For those of you who may not be as conversant with the dark arts of the world of derivatives , this article by James Lieber in the Village Voice may help explain it:

The basic story line so far is that we are all to blame, including homeowners who bit off more than they could chew, lenders who wrote absurd adjustable-rate mortgages, and greedy investment bankers. Credit derivatives also figure heavily in the plot. Apologists say that these became so complicated that even Wall Street couldn’t understand them and that they created “an unacceptable level of risk.” Then these blowhards tell us that the bailout will pump hundreds of billions of dollars into the credit arteries and save the patient, which is the world’s financial system. It will take time—maybe a year or so—but if everyone hangs in there, we’ll be all right. No structural damage has been done, and all’s well that ends well. Sorry, but that’s drivel. In fact, what we are living through is the worst financial scandal in history. It dwarfs 1929, Ponzi’s scheme, Teapot Dome, the South Sea Bubble, tulip bulbs, you name it. Bernie Madoff? He’s peanuts. Credit derivatives—those securities that few have ever seen—are one reason why this crisis is so different from 1929. read on …

The article was published at the end of January and some things have happened since then, most astonishingly today’s other bailout news:

Statement of SEIU Secretary-Treasurer Anna Burger on Secretary Geithner’s latest TALF proposal

Washington, DC –Treasury Secretary Geithner’s plan to invite private equity and hedge fund investors to a fire sale of bank assets is a return to the very same policies and practices that triggered the financial crisis in the first place.

Secretary Geithner’s proposal for the Term Asset-Backed Securities Loan Facility (TALF) would enable private equity firms and hedge funds to buy up higher quality loan securitizations, including auto, consumer, student and small business loans. The Federal government would provide low-cost financing for up to 95% of the purchase price, with private firms putting down as little as 5% and the securitizations as collateral. The hope is then to expand this proposal to include toxic mortgage-backed securities.

Each of these programs could cost taxpayers up to $1 trillion. If the private firms make a profit from the deal, they keep all of it. If they end up losing money, they are only on the hook for the nickel or two of equity they put in. The taxpayers would then assume the rest of the losses. Even worse, subsidizing the purchase up to 19-to-1 will drive up the price of the assets, which would be yet another gift to the same banks that caused this crisis while at the same time putting taxpayers at a much greater risk of bearing huge losses.

If you read the VV article and then this in the same sitting you will come to understand that we may be dealing with something far more nefarious than greedy executives insisting that taxpayers pay their bonuses. As Ian Welsh points out:

There is no reason to do this. If the government is providing 95% of the money, the government might as well provide 100% of the money and just take the profit as well as the risk. Under Geithner’s plan, the government accepts all the risk and none of the profits and puts up almost all of the money? This is ideology run rampant at the cost of common sense. What conceivable reason would Geithner have to pitch something like this? Could it be because he doesn’t believe government should make a profit, or that private investors should take losses? Or, worse than that. . .

Lieber calls it a criminal conspiracy and throws down the gauntlet at Eric Holder’s feet. From the administration’s actions, it appears that we are a long way from them seeing it in those terms. But maybe we need to start thinking about it that way. It tends to clarify things quite a bit.

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