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Who Is All That Aig Money Really Helping?

Two quick AIG thoughts, both of them relating to who it is we're bailing out by propping up AIG.

First, as the Times points out in an editorial today, and Josh Marshall has repeatedly observed, one company that clearly had a lot to lose if AIG failed was Goldman Sachs, the former employer of Bush Treasury Secretary Hank Paulson. As the Times writes:

The serial A.I.G. bailouts are especially problematic for their connection to the Wall Street bank Goldman Sachs. At the time of the first A.I.G. rescue last fall, it was reported by Gretchen Morgenson in The Times that Goldman was A.I.G.’s largest trading partner, with some $20 billion of business tied into the insurer. Goldman has said that its exposure to risk from A.I.G. was offset, or hedged, by other investments.

What is certain is that Goldman has lots of friends in high places--yet one more reason why this bailout has to be as transparent as possible. Lloyd Blankfein, Goldman’s chief executive, was the only Wall Street executive at a September meeting at the New York Federal Reserve to discuss the initial A.I.G. bailout. Also involved in the discussion was the then head of the New York Fed, Timothy Geithner, who is now President Obama’s Treasury secretary.

It's worth adding, though I'm not entirely sure what the significance is or should be, that Paulson appointed AIG's current CEO, Edward Liddy, who'd been a member of the Goldman board. (Former AIG CEO Hank Greenberg reminded me of this in our interview yesterday.)

Second, as Tyler Cowen points out, riffing off another Times piece, the money we pour into AIG is actually propping up a lot of European institutions:

Here is some simple background:

If we let A.I.G. fail, said Seamus P. McMahon, a banking expert at Booz & Company, other institutions, including pension funds and American and European banks “will face their own capital and liquidity crisis, and we could have a domino effect.” A bailout of A.I.G. is really a bailout of its trading partners — which essentially constitutes the entire Western banking system.

No one wants to say it, but essentially the Fed has been bailing out European banks. 

The inflation-adjusted cost of the Marshall plan has been estimated at about $115 billion in current dollars.  If we end up spending $250 billion on AIG, how much of that sum will go to European financial institutions and might it someday exceed the scope of the Marshall plan?  (I do not, by the way, think that central banks ought to treat foreign creditors differently.)

Then again, given the lead-footedness of Europe's own policymakers, there maybe worse things than our involvement here.

Update: I should clarify that I don't see a nefarious conspiracy at work here. I think it's unfortunate that we have to spend hundreds of billions of dollars bailing out not just AIG but, indirectly, Goldman and a lot of European institutions, but I don't really see an alternative. (I think of the benefits to Goldman et al as a kind of collateral damage.) I really believe AIG is too big to fail--that it's failure would cause the kind of global financial meltdown that would make Lehman look like a tiny spark.

Having said that, do I think Paulson's Goldman ties helped focus his mind a bit on the AIG problem? Absolutely. And I'm certainly open to seeing if various AIG counterparties like Goldman can take a hit on the contracts they entered into, so they can share the burden with the U.S. taxpayer. (Admittedly, I have no idea how this would work in practice. Thoughts welcome.)

At the very least, I think Treasury would help itself by being a little more transparent about who the counterparties are. In the absence of more information, people are apt to see this as a pure backroom deal for Goldman, which strikes me as unlikely.  

Update II: Commenter roidubouloi, who's had a lot of smart thoughts on the financial crisis so far, weighs in with this:

A much smarter response to the potential "domino effect" would have been coordinated action with the Europeans to cordon off derivatives liabilities for the financial system and net them out to the gain or loss of the ultimate parties. This is an astonishingly inefficient way to protect the financial system because it involves paying billions to non-institutions who have no greater claim to be made whole than the millions of people who have just lost half their stake in the equity and real estate markets. It would have been far better to ID any critical losers from the quarantine of derivatives players and use the money to aid them directly. Billions are being poured into AIG so that some piece of it protects critical institutions.  

That makes a lot of sense to me, depending on how feasible it is.  

Update III: Please see my follow-up item pushing back a bit on the AIG-Goldman conspiracies...

--Noam Scheiber