Michael Lewis on AIG-FP

"I'm convinced that our input into the system led to a substantial portion of the increase in house prices in the US. We facilitated a trillion dollars in mortgages," says one trader. "Just us." Every firm on Wall Street was making fantastic sums of money from this machine, but for the machine to keep on running, the Wall Street firms needed someone to take the risk. When Gene Park informed them that AIG-FP would no longer do so - Hello, my name is Gene Park and I'm closing down your business - he became the most hated man on Wall Street. The big Wall Street firms solved the problem by taking the risk themselves. The hundreds of billions of dollars of sub-prime losses suffered by Morgan Stanley, Merrill Lynch, Lehman Brothers, Bear Stearns, and the others were hundreds of billions of dollars of losses that might otherwise have been suffered by AIG-FP.

What no-one realised is that Joe Cassano, in exchange for the privilege of selling credit default swaps to Goldman Sachs, Merrill Lynch and all the rest, had agreed to a change in the traditional terms of trading between AIG and Wall Street. In the beginning AIG had required its counter-parties simply to accept its AAA credit: it refused to post collateral. But in the case of the sub-prime mortgage credit default swaps, Cassano had agreed to several triggers, including AIG losing its AAA rating, that would require the firm to post collateral. The subsequent race by the big Wall Street banks to obtain billions in collateral from AIG was an upmarket version of a run on a bank. AIG couldn't afford to pay off Goldman Sachs in MArch 2008. But that was okay. The US Treasury, led by the former head of Goldman Sachs, Hank Paulson, agreed to make good on AIG's gambling debts. One hundred cents on the dollar.

Martin Wolf on Mervyn King versus the Government

"One of the results of this crisis is to imperil central bank independence, not just in the UK. This is so for three reasons: at close to zero official interest rates, the boundary between monetary and fiscal policy erodes; governments are running huge fiscal deficits, particularly in the UK and the US, which threaten monetary stability; and, finally, those in charge wish to divert blame for the disaster.

"Mr King has made four points, all critical of the government: first, contrary to the views of the Treasury, “if banks are thought too big to fail, then . . . they are too big”; second, the Bank of England has “a new statutory authority for financial stability ... [But] it is not entirely clear how the Bank will be able to discharge its new statutory responsibility if we can do no more than issue sermons or organise burials”; third, he has not been consulted on the forthcoming financial services white paper; and, last, as he told the Commons Treasury committee: “If the economy were to recover along the path assumed in the Budget projections of GDP then I think the time over which deficits need to be reduced is likely to have to be faster than was implied by [the Budget] projection.”

"Let us start with a simple question: is the governor correct on the substance? The answers are: yes, yes, yes and yes.

"True, the politicisation of the independent central bank is potentially very dangerous. The Bank’s still-limited independence may be compromised or even overturned. Moreover, at a time when co-operation among the authorities is essential, the appearance of disarray is itself damaging to confidence. Yet, against these powerful considerations, a responsible public official has to decide whether a particular issue has become so important that bringing his views into the open has become the only patriotic thing to do.

Guido Fawkes on Gordon Brown

After Labour was voted into fourth place in the European elections, a flock of ministers resigned, and 5 MPs called for him to resign at the PLP earlier this week....

Gordon has had a damascene conversion to democratic renewal since little over 5% of eligible voters supported him at the polls last week. The irony of a PM who avoided facing election to be leader of his own party and has no democratic public mandate wanting “democratic renewal” is striking. If he really wishes to reconnect with voters he could always call a general election.

1980s redux, part two

The trading gap shuffle, the trading gap shuffle,
We're in a heap of trouble,
Doin' the trading gap shuffle, yes sir!

1980s redux

The deficit rag, oh yeah, the deficit rag,
Those budget gaps can be a twelve-digit drag.
I'm telling, that's the deficit,
They really made a mess of it,
That's the deficit rag.

On a High Inflation Future

Just got back from Barcelona where Willem Buiter gave a characteristically insightful and witty presentation on the outlook for the US (relatively quick bounce-back) and the Eurozone (much longer recovery, maybe into 2011.) The one killer point was about social cohesion around the task of rebuilding the public balance sheet. Previously, whenever public debt has exceeded 100% GDP the cause has been an expensive war. The public, Buiter suggests, is willing to suffer fiscal austerity on the back of a unifying national shock. But the public will prove to be less willing to pay higher taxes and/or suffer public spending cuts to pay down the debt incurred, according to the caricature, by greedy bankers earning phat fees by speculating wildly. The result will be high electoral resistance to necessary fiscal prudence.

Worse still, Buiter suggests that politicians will not have the necessary gumption to impose fiscal restraint. In the US, "the Republicans will not impose higher taxes and the Democrats will not impose spending cuts." As to whether the Fed will, Volcker-style, do the job for them, Buiter is sceptical. The government will simply "install Larry Summers at the Fed". The result will be monetisation of the Federal debt, and inflation in the high single digits or low double digits.

I see no reason why the same argument wouldn't apply in the UK. The only difference is that Sterling is not a safe haven, reserve currency. Whether the combined threat from the bond market and the ratings agencies will be enough to scare UK politicians remains to be seen. And of course, it's much harder to co-opt the Bank of England, but not impossible.

So it's seems we're lining up for 1970s style stagflation. Below trend growth: above target inflation. And once again, Germany (and her post Euro hinterland) will be the only exception as the Buba-isation of the ECB continues....

On the Chinese buying Hummer

An historic moment, as the manufacture of an iconic US vehicle shifts to the Communist Super-power. How are the mighty fallen.