‘Take yourself and your blowhard talk back home on the next flight’, Mr Paulson

The 2008/09 American financial crisis, when the rich got richer and the poor got the bills: That was the former US treasury secretary’s proudest achievement

PUBLISHED : Wednesday, 19 October, 2016, 4:56pm
UPDATED : Wednesday, 19 October, 2016, 11:35pm

China needs to get more “economic reformers” into key jobs as part of its upcoming leadership reshuffle, in order to break up state-run monopolies and allow the private economy to boom, former US treasury secretary Henry Paulson says.

- SCMP, October 18

Let me tell you the story of AIG, a big American insurance company also known as “The house that Hank built” until big boss Hank Greenberg lost his job in a bogus accounting scandal concocted by an ambitious politician who then lost his own job because of his overly ardent attentions to a prostitute.

Oh my, how convoluted these New York tales do get.

We shall make it simple. The new crew at AIG did what Hank Greenberg would never have done, which was to believe the gospel according to Saint Moody’s, to wit that whatever Moody’s and other ratings agencies said was sound debt was indeed sound and would always be repaid to the creditor.

Specifically, the new crew at AIG believed the good ratings that these agencies conferred on collateralised debt obligations (CDO), securitised bundles of 100,000 or so mortgages packaged together. Invest in one unit of a CDO and your risk of losing big because of a default is much less than if you hold a single mortgage.

It was, and still is, a grand idea, but its weakness is that it has no policeman to hold up his hand against inclusion of bad mortgages.

This was the job of the ratings agencies but they failed. They were paid by the issuers, not the holders of the CDOs, and it was not in their interests to say that the CDOs were going rotten.

AIG did not come to grief on CDOs, however, but on something called CDS, credit default swaps, essentially market bets that the CDOs would stay sound.

If everything goes well, a CDS pays a small annual fee of a few per cent. If the underlying CDO goes wrong the holder of the CDS is responsible for paying back the loss.

AIG in 2008 had something like US$400 billion worth of these things and when the CDO market then collapsed it was in deep trouble.

It went screaming for help to treasury secretary Henry Paulson, who then gave it US$180 billion, saying he had to because the whole financial system would otherwise collapse.

Now let’s understand a few things. Mr Paulson never checked out the truth of his story. He just jumped in blind panic. AIG’s insurance subsidiaries were never in danger of going bust. Their insurance assets were all ring-fenced by insurance regulators in the separate markets in which they operated and all were sound.

This in fact is why top management at AIG took to playing with derivatives. They couldn’t touch the money lower down the chain.

Where the danger lay was in the big New York investment banks that had advanced AIG vast sums and also dabbled heavily in CDO and CDS instruments on their own account.

Specifically, Goldman Sachs, the bank of which Mr Paulson had previously been boss, was in distinct danger of going bust. His bail-out campaign actually proved a campaign to save it and several other big Wall Street names. The eventual result was a doubling of US federal debt to US$20 trillion.

In other words, the treasury secretary of the United States, a public servant, protected the jobs and wealth of his former private associates by needlessly foisting an enormous debt burden on US taxpayers.

That’s the history of the 2008/09 American financial crisis, an opportunity lost to make irresponsible speculators incur the penalty of their ways and to reform financial markets. The rich got richer and the poor got the bills. That was Mr Paulson’s proud achievement as treasury secretary.

And now, rather than hide or apologise to US taxpayers for having wasted their money in a massive foul-up, this presumptuous fellow wants to lecture China on how to improve its economic standing.

He furthermore comes with a message recommending privatisation of state owned assets just days after President Xi Jinping proclaimed that state owned assets must remain the assets of the state.

Open your ears, Henry.

And take yourself and your blowhard talk back home on the next flight.