Fact, fiction and speculation run rampant in the wake of the Lehman Brothers Chapter 11 bankruptcy filing that shook the worldwide financial community September 15. The impact ranging from Wall Street to London to Hong Kong and beyond was as devastating as the events of 9/11. The end of the continuing saga remains to be unraveled during the next coming months and years. It is bound to be a chief issue in the American presidential campaign.
Seen by many as a potential move to avert further financial panic on the world’s financial exchanges, Treasury Secretary Henry Paulsen agreed to permit the Federal Reserve to issue an $85 billion loan for roughly 80% of the U.S. insurer, American International Group (AIG).
This unexpected decision came immediately on the heels of the government’s refusal to rescue Lehman Brothers, the once venerable 158-year old brokerage firm, this week. More to the point, Paulson said in July, and reiterated as late as this week, “Moral hazard I don’t take lightly.”
“Moral hazard” generally refers to an economic term where insurance coverage against a loss might affect the risk-taking behavior of an insured.
The AIG move is not the first time that the U.S. government has effectively rescued firms in the private sector at taxpayer expense. Recently, investment banker Bear Stearns was rescued by the government to permit its orderly acquisition by JP Morgan.
Similarly, the quasi-governmental companies of Fannie Mae and Freddie Mac were effectively “bailed out” by the federal government. It was felt that collapse of the two companies, which control nearly $5 trillion in mortgages, would be too devastating to the stock and bond markets and ultimately the U.S. and world economy.
But the practice is not new.
In December 1989, Time magazine warned “Further – and Maybe Bigger – Federal Bailouts Ahead.”
The article cautioned that speculator and entrepreneur Charles Keating’s Lincoln Savings & Loan Association’s bankruptcy could cost taxpayers $2.5 billion. It ultimately cost the American taxpayer over $3 billion.
At the time, Senator John McCain was one of the key five senators during the savings and loan scandal who shared more than a million dollars in political contributions and “favors.” The other key senators included Dennis DeConcini of Arizona, the late Alan Cranston of California, John Glenn of Ohio and Don Riegle of Michigan.
While Glenn and McCain were exonerated of wrongdoing in the Keating scandal, both were reprimanded by the Senate Ethics Committee in 1991 for exercising “poor judgment.”
DeConcini was appointed by President Bill Clinton in 1995 to the Board of Directors of the Federal Home Loan Mortgage Corporation. It is the very Freddie Mac now under government control at the taxpayers’ expense.
Will the bailout of AIG set a further precedent to General Motors, the subject of bankruptcy speculation for more than two years? The stock closed at $10.84 on September 16, down from $43.20 over the last 52 weeks.
Should the company be forced to seek Chapter 11 protection, a government bailout is virtually guaranteed. It has ample precedent with the Chrysler plan engineered by Lee Iacocca in 1979.
At the time, Chrysler had 360,000 workers. Lee Iacocca painted the picture of that worker base as potentially unemployed and helped convince Congress to grant him close to the billion dollars he requested. Equally as important, Iacocca, evoking patriotism, pointed to Chrysler as being the largest manufacturer of American tanks.
Ford Motor Company, although considerably more liquid than its rival, is not immune from the effects of the Lehman bankruptcy. Ford has an unfunded credit facility with Lehman Commercial Paper, Inc., of roughly $11 billion. It also enjoys relations with Lehman Brothers Bank, Inc., of $16 billion that support the retail securitization program of Ford Motor Credit Company, LLC. According to Reuters, the two subsidiaries are not included in the Lehman bankruptcy.
A careful review of each potential company large enough to warrant a federal bailout is indicated well ahead of potential bankruptcy proceeding. The state of a company’s liquidity is a good indicator of its potential solvency.
The key questions surely to be discussed and debated are what constitutes the “national interest,” how philosophical, consistent and legally transparent should the leadership of the government be and how willing are U.S. taxpayers to bear the risks of private enterprise?