Michael Lewis has a long article reporting the story of the rise and fall of AIG, the institution that over the course of a single day — Monday, September 15, 2008 — faced collateral calls on its derivatives portfolio in excess of $80 billion.
We're talking about the heart of the financial storm: the infamous AIG Financial Products unit — and Lewis is here to explain it, in his usual engaging style.
He spends a good portion of the article examining the character of Joe Cassano, the AIG executive who oversaw the Financial Products office during the crucial years. There are some fascinating conjectures in this discussion, but I think that for all the interest in Cassano's "cartoon despotism," the real story is this: What Lewis is describing is usury.
"Financial risk had been created, out of thin air, and it begged to be either honestly accounted for or disguised."
"There was a natural role for a blue-chip corporation with the highest credit rating to stand in the middle of swaps and long-term options and the other risk-spawning innovations. The traits required of this corporation were that it not be a bank — and thus subject to bank regulation and the need to reserve capital against the risky assets — and that it be willing and able to bury exotic risks on its balance sheet. There was no real reason that company had to be A.I.G.; it could have been any AAA-rated entity with a huge balance sheet. Berkshire Hathaway, for instance, or General Electric. A.I.G. just got there first."
"In a financial system that was rapidly generating complicated risks, A.I.G. F.P. became a huge swallower of those risks . . . Its success bred imitators: Zurich Re F.P., Swiss Re F.P., Credit Suisse F.P., Gen Re F.P. All of these places were central to what happened in the last two decades; without them the new risks being created would have had no place to hide, but would have remained in full view of bank regulators. All of these places have been washed away by the general nausea now felt in the presence of complicated financial risks, but there was a moment when their existence seemed cartographically necessary to the financial world. And A.I.G. F.P. was the model for them all."
Etc, etc, etc.
But this is the kicker:
"Here is an amazing fact: nearly a year after perhaps the most sensational corporate collapse in the history of finance, a collapse that, without the intervention of the government, would have led to the bankruptcy of every major American financial institution, plus a lot of foreign ones, too, A.I.G.’s losses and the trades that led to them still haven’t been properly explained. How did they happen? Unlike, say, Bernie Madoff’s pyramid scheme, they don’t seem to have been raw theft. They may have been an outrageous departure from financial norms, but, if so, why hasn’t anyone in the place been charged with a crime? How did an insurance company become so entangled in the sophisticated end of Wall Street and wind up the fool at the poker table? How could the U.S. government simply hand over $54 billion in taxpayer dollars to Goldman Sachs and Merrill Lynch and all the rest to make good on the subprime insurance A.I.G. F.P. had sold to them — especially after Goldman Sachs was coming out and saying that it had hedged itself by betting against A.I.G.?"
Lewis is saying that in this mess we have encountered a new sort of vice and malfeasance. It is probably not as simple as calling it fraud like any other, case closed. We may need new conceptual tools and tool terminology.
I would only record the codicil that what we have encountered is not new but rather very old. The raw material used in the operation of this malfeasance may have been, as they say, cutting edge, but like so much that appears to modern eyes newfangled and progressive, this was merely a renovation of ancient folly. The modern age verily excels at this sort of thing, reviving bad ideas that are very old under the seductive pretense that they are shiny and new.
So we have revived usury, adorned with all the sophistication of rocket science finance. But there is no sophistry by which financial risk can be neatly whisked from the scene. There is no mathematical formula by which it can be packaged tightly away and forgotten about.
To think that way is to enter into the utter folly of what F. A. Hayek famously called simply planning. This is the nostrum, often propounded by postwar Socialists, that it is possible for the minds of of experts to compass the whole of the economy, replacing their expertise for the welter of individual decision-making and thereby removing ruinous economic uncertainty.
We know now that Capitalists have indulged this insidious error systematically as well, in their case imagining that the expertise and math genius of the "quants" can similarly conquer the uncertainty of the world.
They did not set out to defraud people, but they committed a terrible mistake. The Usurers were utopians, and their planning, like that of the Socialists, threatens the prosperity of the Republic.
One of the advantages of the term usury, from my perspective, is that, rightly understood, it provides us with a word to describe this folly, this intellectual hubris and its concurrent malfeasance, that does not require us to accuse, well, basically everyone at AIGFP, and every other financial products unit, of deliberate fraud. But neither does it require us to let them off the hook.
It short, it provides us with a middle road between populist demonizing of the bankers and defending what they did.
Both of these extremes, it seems to me, are deeply imprudent political postures to take. For one thing the bankers were not alone in the wild optimism that drove this speculative boom. The whole Republic was part of the exuberance. Both parties, dozens of industries, quacks and thoughtful men alike; the common wisdom for years has been to encourage this notion of housing as forever destined to gain equity value. On Wall Street the reckless and morbid optimism spread to this peculiar form of Hayekian planning in shadow banking, but the underlying optimism was very widely shared.
We revived an ancient but very bad idea, thinking it something new and wonderful and invincible. Not just the i-bankers. Not just the sub-prime mortgage crew. Not just the ratings agencies. Not just the speculators. Not just the CRA pushers. The plutocracy was the main benefactor of this folly, but the fact is our usury has been a very democratic one indeed.
We have to face the fact that we built up a usurious economy and have now witnessed its precipitous collapse, leaving us in quite a predicament.
* With apologies to GKC.