Saturday, September 20, 2008

A Useful Summary

I often disagree with the wiseasses at the Freaknomics blog, but after admitting that the current financial crisis is outside his area of expertise ("As an economist, I am supposed to have something intelligent to say about the current financial crisis. To be honest, however, I haven’t got the foggiest idea what this all means."), Steven Levitt called in a couple of experts to comment. They are Douglas Diamond and Anil Kashyap, and they are quite lucid. However, I note that the link is to a September 18 posting, which is before the Fed suggested the (urk) $700 billion bailout. They're commenting primarily about Lehman and AIG.

I've learned some things from their comments. For one thing, the Fed has an option to buy up to 80% of AIG. That's quite different from buying 80% of AIG outright. The bit about the difference between what Fannie and Freddie were supposed to and what they did supports claims of corruption; F & F were intended to use their government-backed status and funding to make mortgages less costly to homeowners, but instead they made huge profits. They were supposed to stick with smaller (conforming) loans with strong underwriting standards and did not.

2 comments:

calimac said...

I don't see why the option instead of the outright buy makes a difference. Isn't the bill to hand this gigantic sum over to Paulson to do whatever he considers necessary, with no oversight? Why should it matter that he's not being forced into the buy?

Lisa Hirsch said...

The $85 billion to AIG is a loan, I believe, and a done deal. The option to buy means we might get the money back when the liquidity crisis and rest of this mess clear up OR we might just take that 80% stake.

The $700 billion being proposed for the rest of the bailout is completely separate from the AIG loan. It will be used, theoretically, to buy up bad debt outright. As you say, there are no strings attached and it gives way too much money and power to Henry Paulson.