Weird Equations

This is a brilliant riff on the financial crisis and how it got to where it is today.

Some of the things you learn in an advanced maths degree, are that 1+1 is not always 2 (as in modulo 2 with addition), and big numbers can be small numbers (like the measure of a Cantor set). Irrelevant, but by way of introduction, small numbers like the size of executive bonuses at AIG relative to the scale of the company bailout, can be large numbers when it comes to their impact, as shown by the panicky half-baked legislation passing into US law.

Here are some selected paragraphs from the Rolling Stone article that really put the bat to the numbers.

Nor did anyone mention that when AIG finally got up from its seat at the Wall Street casino, broke and busted in the afterdawn light, it owed money all over town — and that a huge chunk of your taxpayer dollars in this particular bailout scam will be going to pay off the other high rollers at its table. Or that this was a casino unique among all casinos, one where middle-class taxpayers cover the bets of billionaires.

The mistake most people make in looking at the financial crisis is thinking of it in terms of money, a habit that might lead you to look at the unfolding mess as a huge bonus-killing downer for the Wall Street class. But if you look at it in purely Machiavellian terms, what you see is a colossal power grab that threatens to turn the federal government into a kind of giant Enron — a huge, impenetrable black box filled with self-dealing insiders whose scheme is the securing of individual profits at the expense of an ocean of unwitting involuntary shareholders, previously known as taxpayers.

The problem was, none of this was based on reality. “The banks knew they were selling crap,” says a London-based trader from one of the bailed-out companies. To get AAA ratings, the CDOs relied not on their actual underlying assets but on crazy mathematical formulas that the banks cooked up to make the investments look safer than they really were. “They had some back room somewhere where a bunch of Indian guys who’d been doing nothing but math for God knows how many years would come up with some kind of model saying that this or that combination of debtors would only default once every 10,000 years,” says one young trader who sold CDOs for a major investment bank. “It was nuts.”

The following February, when AIG posted $11.5 billion in annual losses, it announced the resignation of Cassano as head of AIGFP, saying an auditor had found a “material weakness” in the CDS portfolio. But amazingly, the company not only allowed Cassano to keep $34 million in bonuses, it kept him on as a consultant for $1 million a month. In fact, Cassano remained on the payroll and kept collecting his monthly million through the end of September 2008, even after taxpayers had been forced to hand AIG $85 billion to patch up his fuck-ups. When asked in October why the company still retained Cassano at his $1 million-a-month rate despite his role in the probable downfall of Western civilization, CEO Martin Sullivan told Congress with a straight face that AIG wanted to “retain the 20-year knowledge that Mr. Cassano had.” (Cassano, who is apparently hiding out in his lavish town house near Harrods in London, could not be reached for comment.)

Then, in January 2009, the company did it again. After all those years letting Cassano run wild, and after already getting caught paying out insane bonuses while on the public till, AIG decided to pay out another $450 million in bonuses. And to whom? To the 400 or so employees in Cassano’s old unit, AIGFP, which is due to go out of business shortly! Yes, that’s right, an average of $1.1 million in taxpayer-backed money apiece, to the very people who spent the past decade or so punching a hole in the fabric of the universe!

The bonuses are a nice comic touch highlighting one of the more outrageous tangents of the bailout age, namely the fact that, even with the planet in flames, some members of the Wall Street class can’t even get used to the tragedy of having to fly coach. “These people need their trips to Baja, their spa treatments, their hand jobs,” says an official involved in the AIG bailout, a serious look on his face, apparently not even half-kidding. “They don’t function well without them.”

While the rest of America, and most of Congress, have been bugging out about the $700 billion bailout program called TARP, all of these newly created organisms in the Federal Reserve zoo have quietly been pumping not billions but trillions of dollars into the hands of private companies (at least $3 trillion so far in loans, with as much as $5.7 trillion more in guarantees of private investments). Although this technically isn’t taxpayer money, it still affects taxpayers directly, because the activities of the Fed impact the economy as a whole. And this new, secretive activity by the Fed completely eclipses the TARP program in terms of its influence on the economy.

None other than disgraced senator Ted Stevens was the poor sap who made the unpleasant discovery that if Congress didn’t like the Fed handing trillions of dollars to banks without any oversight, Congress could apparently go fuck itself — or so said the law. When Stevens asked the GAO about what authority Congress has to monitor the Fed, he got back a letter citing an obscure statute that nobody had ever heard of before: the Accounting and Auditing Act of 1950. The relevant section, 31 USC 714(b), dictated that congressional audits of the Federal Reserve may not include “deliberations, decisions and actions on monetary policy matters.” The exemption, as Foss notes, “basically includes everything.” According to the law, in other words, the Fed simply cannot be audited by Congress. Or by anyone else, for that matter.

For the rest of 2008, the numbers (in the weekly H4 reports) remained similarly in the stratosphere, the Fed pumping as much as $125 billion of these short-term loans into the economy — until suddenly, at the start of this year, the number drops to nothing. Zero.

The reason the number has dropped to nothing is that the Fed had simply stopped using relatively transparent devices like repurchase agreements to pump its money into the hands of private companies. By early 2009, a whole series of new government operations had been invented to inject cash into the economy, most all of them completely secretive and with names you’ve never heard of. There is the Term Auction Facility, the Term Securities Lending Facility, the Primary Dealer Credit Facility, the Commercial Paper Funding Facility and a monster called the Asset-Backed Commercial Paper Money Market Mutual Fund Liquidity Facility (boasting the chat-room horror-show acronym ABCPMMMFLF). For good measure, there’s also something called a Money Market Investor Funding Facility, plus three facilities called Maiden Lane I, II and III to aid bailout recipients like Bear Stearns and AIG.

When one considers the comparatively extensive system of congressional checks and balances that goes into the spending of every dollar in the budget via the normal appropriations process, what’s happening in the Fed amounts to something truly revolutionary — a kind of shadow government with a budget many times the size of the normal federal outlay, administered dictatorially by one man, Fed chairman Ben Bernanke. “We spend hours and hours and hours arguing over $10 million amendments on the floor of the Senate, but there has been no discussion about who has been receiving this $3 trillion,” says Sen. Bernie Sanders. “It is beyond comprehension.”

If you are interested in knowing more about Maiden I, II & III, here is a pdf complete with boxes and arrows.

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0 thoughts on “Weird Equations

  1. Don’t understand why he put so much emphasis on regulation or lack thereof. He himself admitted that the regulator COULD HAVE shut down AIG but ACCEPTED THEIR WORD for the validity of the derivatives!!!

    This is what happens when POLITICS is mixed with BUSINESS!!!

    NO regulation. If you F!#@ up, YOU PAY!!!

    Bring back debtors prison. Send them to GITMO!!!!

    “When one considers the comparatively extensive system of congressional checks and balances that goes into the spending of every dollar in the budget via the normal appropriations process, ”

    This man is delusional. A lot of excellent information though.

  2. Don’t understand why he put so much emphasis on regulation or lack thereof. He himself admitted that the regulator COULD HAVE shut down AIG but ACCEPTED THEIR WORD for the validity of the derivatives!!!

    This is what happens when POLITICS is mixed with BUSINESS!!!

    NO regulation. If you F!#@ up, YOU PAY!!!

    Bring back debtors prison. Send them to GITMO!!!!

    “When one considers the comparatively extensive system of congressional checks and balances that goes into the spending of every dollar in the budget via the normal appropriations process, ”

    This man is delusional. A lot of excellent information though.

  3. Mish made a reasonable argument for letting AIG fail, because they were largely backstop insurance for the instruments, the counterparties (mainly international banks) could have been compensated directly on AIGs default, rather than establishing Maiden Lane I II and III and who knows what else to keep them afloat. Winding up AIG is much simpler that entangling a complex intermediary, say. Question is, was the decision to put AIG on life support just a bad decision in the heat of the moment, or as the article argues, the good old boys calling in favors.

  4. Mish made a reasonable argument for letting AIG fail, because they were largely backstop insurance for the instruments, the counterparties (mainly international banks) could have been compensated directly on AIGs default, rather than establishing Maiden Lane I II and III and who knows what else to keep them afloat. Winding up AIG is much simpler that entangling a complex intermediary, say. Question is, was the decision to put AIG on life support just a bad decision in the heat of the moment, or as the article argues, the good old boys calling in favors.

  5. It seems to becoming recognized that repealing of key aspects of the Glass-Steagall Act was a major contributing factor. This act ensures that banks are banks, investment houses investments houses, and not mixtures. One would hope it gets put back the way it was.

  6. It seems to becoming recognized that repealing of key aspects of the Glass-Steagall Act was a major contributing factor. This act ensures that banks are banks, investment houses investments houses, and not mixtures. One would hope it gets put back the way it was.

  7. admin,

    my feeling is that as long as people are involved, and corruptible/influenced by less than perfect information and theories, regulation is more likely to make people feel more sure of themselves than they should be. You know, like statistics!!

    In other words, regulation actually has helped make these bubbles much larger than they could have been in a non-regulated environment where people would, for good reason, be less trusting of institutions!!

    Sadly, many people actually still trust gubmint to a greater extent than deserved.

    Of course, in either scenario, it still takes a legal system where crooks who take advantage of others are actually PUNISHED!! So far no one in in gubmint or business, except Madoff and other small time crooks, are in any danger of losing money or liberty over their abuses of the rest of us.

  8. admin,

    my feeling is that as long as people are involved, and corruptible/influenced by less than perfect information and theories, regulation is more likely to make people feel more sure of themselves than they should be. You know, like statistics!!

    In other words, regulation actually has helped make these bubbles much larger than they could have been in a non-regulated environment where people would, for good reason, be less trusting of institutions!!

    Sadly, many people actually still trust gubmint to a greater extent than deserved.

    Of course, in either scenario, it still takes a legal system where crooks who take advantage of others are actually PUNISHED!! So far no one in in gubmint or business, except Madoff and other small time crooks, are in any danger of losing money or liberty over their abuses of the rest of us.

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