Wednesday, September 17, 2008
As we all know by now, a great deal of the current mess in our financial markets has been caused by the financing, insuring and sale of subprime “paper.” We’re talking about loans made to consumers whose credit histories and incomes did not, in and of themselves, justify the credit they received. Not surprisingly, these loans have failed at a high rate for which the banks which financed them, the companies which insured them – companies like Fannie Mae, Freddie Mac and AIG – and the Wall Street firms which purchased them – like Merrill Lynch and Lehman Brothers – were unprepared to handle.
Precisely because subprime loans are so risky, they would be made at unusually high rates of interest unless they’re insured or sold. Insured loans and loans which lenders sell are less risky, which encourages them to make loans they wouldn’t otherwise approve, bringing home ownership within the reach of Americans at the lower end of the credit spectrum. The risk of failure is still the same. It’s just that a portion of that risk has been passed through to the insurers like AIG and to Wall Street firms who purchase packages of these subprime loans through what are called “securitizations.” By securitizing the loans they originate, the lender (a bank or mortgage company) sells its loans, transferring the risk to the hedge fund or investment banker that bought them.
Yesterday evening, at 8 PM, AIG accepted a proposal – as if it had any choice — whereby the Federal Reserve agreed to lend AIG $85 billion, at a high rate of interest, collateralized by a zillion dollars of assets which AIG needs to sell over the next two years to pay the government back.
Here’s the irony… In order to bail out a giant insurance company which is in trouble for insuring subprime mortgages (and making other questionable investments), our government has made its own subprime loan to a debtor whose ability to repay those $85 billion is questionable. And who stands behind the Fed? Who is to the Fed what AIG was to the banks that originated all those subprime loans, and to the Wall Street firms that bought them? We are.
So who’s left to bail us out?