Wisdom from Michael Lewis

by Russ Roberts on March 20, 2009

in Financial Markets

At Bloomberg (HT: RealClearMarkets.com):

The complexity of the issues at the heart of the crisis
paralyzes the political processes’ ability to deal with them
intelligently. I have no doubt that, by the time this saga ends,
we will all know what happened to every penny of that $165
million in bonuses and each have our opinion of the morality of
it.

I doubt seriously we will ever understand the morality of
the $173 billion payment that is the far more serious issue. For
instance, Goldman Sachs, which received about 8 percent of the
pile, or $13 billion, has claimed publicly that the money was,
to them, a matter of indifference, as Goldman had hedged itself
against a possible collapse of AIG — by making bets against
AIG.

This suggests that it was clear to at least one market
player, before the collapse, that AAA-rated AIG was behaving in
ways that might lead to its demise — which is to say that there
was really no responsible place to lay off these bets. (So why
bail out those who made them?)

It also suggests that it is a matter of indifference to
Goldman Sachs whether AIG lived or died, as either way it was
protected. (So why bail it out?)

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{ 23 comments }

Chris in Austin March 20, 2009 at 10:20 am

Instead of taxing away their bonuses, which will involve administrative and overhead costs, why don't they just order the executives that they have to spend all the money to "stimulate" the economy? Wouldn't this satisfy the Keynesian multiplier effect?

tarran March 20, 2009 at 10:32 am

Because so many former Goldman Sach's employees work for the Federal Government?

The employees of the Federal Government come from somewhere. Many of the decision makers in the Treasury department worked for – and plan to work someday in the future for – the big companies getting bailed out.

The Federal Government is just a more thorough and well organized version of the mafia.

Hydra March 20, 2009 at 11:24 am

Where did they palce their bets against AIG?

Since AIG is so big it would have taken undreds of other insurors or hedge funds to cover the risk.

If AIG went down, Godman Sachs and others might be coverd, but you might take down AIG AND all of its insurors, they being much smaller.

You now have an even biiger problem, once removed. I'm not sure I see this as an answer.

Superheater March 20, 2009 at 12:16 pm

Funny, we've gone from Eisenhower's "military-industrial complex" to a "government-financial" complex.

Seth March 20, 2009 at 12:26 pm

"The complexity of the issues at the heart of the crisis paralyzes the political processes’ ability to deal with them intelligently."

If complexity was the only thing that paralyzed the political process from intelligent action we would be in good shape.

Steve March 20, 2009 at 12:47 pm

Goldman bet against AIG by shorting their stock. They were involved in complex trades that required insurance for them to work out. The problem was that at the first sign of trouble with the insurer the backstop strategy was to short the stock of the insurance provider. I'm guessing that Goldman was among the first to move to this strategy. It didn't work out for everybody. That is why these stocks fell so far and so fast when this all started. There was a small window and only a very few were able to execute their strategy.

geoih March 20, 2009 at 12:52 pm

Quote from Tarran: "The Federal Government is just a more thorough and well organized version of the mafia."

If I were in the mafia, I would be thoroughly insulted. At least the mafia has to generate a profit. The government may use mafia tactics, but it is far from well organized or thorough.

Methinks March 20, 2009 at 1:01 pm

LOL, geoih! You took the words right out of my mouth.

John March 20, 2009 at 1:16 pm

The mafia has to generate a profit for itself.
The government generates a profit for it's friends, and sticks us with the bill/debt.
It's even better than running a protection racket, because you not only force people to pay you, you force them to borrow money for you as well!

TrUmPiT March 20, 2009 at 2:24 pm

Do all the churchgoing, communist-fearing, salt of the earth, blue-state folks realize that capitalism is one big casino? "Everyone" knows that casinos are rigged in favor of the house, not the victimizable, willing players. Do the conservative, provincial folks that support blue laws and prohibition and condemn alcohol as an evil demon drink understand the evils of capitalism as it is rigged in the U.S. against them in favor of a tiny, "special" rich minority? No, they are just like the people who buy lottery tickets and play slots in Vegas – a bunch of ignorant losers. It's time for you to shift the blame on this blog to the People (the peasants) who are digging their own graves. Have fun blaming the politicians for everything. The problem is US.

Randy March 20, 2009 at 2:47 pm

Us, Trumpit? You got a mouse in your pocket?

Stephen March 20, 2009 at 3:26 pm

I suppose in that sense, Trumpit, that all of life is a casino. Every decision involves risk and reward.

That "rich minority" has their own set of risks, as we've seen with the AIG derivative desk staffers.

I just wish politicians didn't have such a favorable asymetric risk/reward alignment.

TrUmPiT March 20, 2009 at 4:01 pm

I meant red-state folks. My mistake. Sorry.

civilized minority March 20, 2009 at 4:07 pm

Steve, its highly unlikely Goldman could properly hedge itself against an AIG bankruptcy, by just shorting the stock. Also, since its already a penny stock, they would have covered that position already, and any further decline in stock price due to a bankruptcy would have been immaterial. They probably bought AIG debt default swaps or some other derivative method.

TrUmPiT March 20, 2009 at 4:14 pm

"… has claimed publicly that the money was, to them, a matter of indifference, as Goldman had hedged itself against a possible collapse of AIG — by making BETS against AIG."

"which is to say that there was really no responsible place to lay off these BETS."

Be sure to tell your students that the economy is really one big hedge fund. Which is a euphemism for casino. You said so yourself.

Sam Grove March 20, 2009 at 4:24 pm

Trumpit, when you figure out exactly how the games is rigged, then you'll have something.

Hint: house makes the rules.

Jon Olmsted March 20, 2009 at 4:29 pm

Michael Lewis provides an interesting perspective, though he misses the bigger argument. Don't get me wrong, I'm a fan of Austrian theory, but we need better arguments on our side if anyone is to listen.

I would not assume that Goldman protected itself from an AIG collapse a long time ago. They might have done it more recently.

and simply because Goldman was allegedly "ok", doesn't make his point.
Goldman would be exposed to JPM, Bank of America, Barclays, etc. etc. etc. etc. And there would be a domino effect. The question is how much, how big, etc?

Meaning, libertarians (much smarter than myself) should be arguing reality, not roses and puppy dogs. In other words, the argument should be that banks would have failed and should have failed. Because surely they would have.

Matěj Šuster March 20, 2009 at 5:06 pm

Jon Olmsted

Michael Lewis, of course, is neither an "Austrian", nor libertarian (at least to my knowledge).

vidyohs March 20, 2009 at 5:36 pm

We know, you've shown it over and over.

"Sorry.
Posted by: TrUmPiT | Mar 20, 2009 4:01:53 PM"

vidyohs March 20, 2009 at 5:41 pm

Jon,

"Michael Lewis provides an interesting perspective, though he misses the bigger argument. Don't get me wrong, I'm a fan of Austrian theory, but we need better arguments on our side if anyone is to listen.
Posted by: Jon Olmsted | Mar 20, 2009 4:29:08 PM"

Consider this, can anyone make a better argument for free markets and capitalism than Hayek or Freidman? I doubt it. So the excellent arguements are there and I doubt could be improved on, yet the only way anyone has been able to get an understanding of what those two gentlemen said is to make an individual effort to find their words in book, magazines, or now on youtube. The MSM quit giving them free airspace or facetime long ago, about the time that Freidman and his disciples showed the world what freeing up an economy, as they did in Chile, could do.

Socialist know better than to give opponents equal time.

Methinks March 20, 2009 at 6:26 pm

Goldman's AIG hedge, from
Goldman's AIG hedge from "Zero Hedge" for those who are interest.

"Purchasing $10 billion in CDS (roughly in line with what Viniar claims happened) at a hypothetical average price of 25 bps (and realistically much less than that) and rolling that would imply that at today's AIG 5 yr CDS price of 1,942 bps, the company made roughly $4.7 billion in profit from shorting AIG alone! This would more than make up for the $2.5 billion collateral shortfall (out of $4.4 billion total) GS claims AIG had with Goldman Sachs… If AIG had filed for bankruptcy, and assuming Lehman is any indication, the P&L would have likely hit $6+ billion."

Paulson and Bernanke have a lot of explaining to do.

LowcountryJoe March 20, 2009 at 10:28 pm

Felt compelled to share this:

http://www.youtube.com/watch?v=rWbKKydgj_o

Mr. Econotarian March 21, 2009 at 12:12 pm

As experts in regulatory arbitrage, it won't take long for the financial industry to "side step" the 90% bonus tax:

http://news.hereisthecity.com/news/business_news/8866.cntns

"The Wall Street Journal reports that, according to unnamed 'people familiar with the situation', executives at Citi and Morgan Stanley are now discussing increasing the pay of certain senior empoyees and top revenue earners, as a way of sidestepping the US government's bonus restrictions on firms which have taken TARP funding."

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