"AIG was teetering on the brink. The Federal Reserve stepped in. Was the right decision made?" "NO!"

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Transcript from PBS NewsHour Yesterday:

Government's Rescue of AIG Fails to Calm Nervous Investors
http://www.pbs.org/newshour/bb/business/july-dec08/aigbailout_09-17.html

The government's bailout of AIG failed to boost stock markets Wednesday, with the Dow dropping more than 400 points. Economic analysts examine the government's decision to aid the insurer and the state of financial woes.

AIG was teetering on the brink. The Federal Reserve stepped in.

Was the right decision made to move in, in this way?

GWEN IFILL: Now, the rationale behind the government's decision and possible fallout yet to come. Ray Suarez picks up on that part of the story.

RAY SUAREZ: And for that, we get two views. Allan Meltzer is a professor of political economy and public policy at Carnegie Mellon University. He's also a visiting scholar at the American Enterprise Institute.

And Michael Lewitt is president of Harch Capital Management, a money management firm.

And, Michael Lewitt, let's start with you. AIG was teetering on the brink. The Federal Reserve stepped in. Was the right decision made to move in, in this way?

MICHAEL LEWITT, Harch Capital Management: It was the right decision. I think that, if AIG had failed, it would have caused catastrophic losses throughout the global financial system.

AIG is a uniquely global company. It has relationships with virtually every other financial institution in the world. And its failure, its inability to meet its obligations would have caused a cascade of troubles for other financial institutions. It would have caused potentially other hedge funds and other companies to fail.

And I don't know if the losses could have been contained if the government had not stepped in.

RAY SUAREZ: Professor Meltzer, did the Fed do the right thing?

ALLAN MELTZER, Carnegie Mellon University: No. There were bids on the floor for AIG. AIG it didn't take the bids.
It thought it could get a better deal from the government. That's a bad way to run the system.

We can't afford to run a system and we won't be able to where the bankers make the profits and the public takes the losses. That just is not viable. Virtues and flaws of the bailout

RAY SUAREZ: But Michael Lewitt said there were very few choices because of the unique status of AIG in the world markets.

ALLAN MELTZER: AIG has four parts. One of them was in trouble. The other three make money. It could be sold.
It should have been sold. It should have gone as a private company to some other private company. And that was an option that was available.

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ALLAN MELTZER: "It's not a matter of getting rich. It's a question of whether we're protecting the public interest or the private interest.

The government is here to protect the public interest. What it's doing is protecting private interests.
And that's a big mistake and one that we shouldn't continue to tolerate.

We've gotten through now a whole range of these firms. The government has salvaged a number of them.
That just puts all those losses onto the taxpayers. That's not where they belong."

SNIP-->

ALLAN MELTZER: And it might have been better if we had allowed it to be sold. I've been following these problems for 40 or 50 years. You know, it always comes down at the end to this.

Someone goes to the secretary of the Treasury or, in this case, the chairman of the Fed and says, "If we don't do this, we're going to have a terrible depression. It'll be known as the Bernanke depression. And if you don't act, there's going to be a disaster."

Well, that's not always the case. And these disasters should be headed off early or should be left to the marketplace to settle. They made these mistakes, and they should pay for them.

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1. The context of AIG's rescue

The context of AIG's rescue

http://www.pbs.org/newshour/bb/business/july-dec08/aigbailout_09-17.html

RAY SUAREZ: Well, Professor, you said you've been following this for 40 or 50 years. Has the Fed ever come in, in this way, to buy an 80 percent stake of such a large company before?

ALLAN MELTZER: Not only that, but in 1921, way back in the midst of a terrible recession, depression, prices falling 20 percent a year, bigger than anything we've seen recently, the Congress came to the Fed and said, "You have to bail out the farmers."

The farmers were a big part of the economy at that time, and they had made bad purchases. The Fed said, "It's not our business," so Congress passed, created the Federal Land Banks.

A couple of years later, in the midst of the Depression, Congress came to the Fed and said, "We have problems with the housing industry." The housing industry often a place where there's problems. What did the Fed say? Said, "Not our problem." Congress created the Federal Home Loan Banks.

This is a problem -- if there is a government problem, it's a problem to be handled by the Congress, not by the Fed.

RAY SUAREZ: Michael Lewitt, was AIG a decent bet, given the fact that it had significant assets and many profitable operations?

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