ReformerRay: From my perspective, the Congress should lhave refused to give Paulson the money he wanted. AIG would have failed. Their exposure to Credit Default Swaps would have been settled just like the exposure of Lehman’s was settled.
This misses the basic problem. Lehman fails. After we settle everything we find that A owes B $1 billion, B owes C $1 billion, C owes A $ billion. Everyone pays everyone else and we find out that no one really owes anyone in the end.
B is AIG. Suppose AIG was bankrupt. Now A owes B $1 billion, but it’s not about to pay. B owes C $1 billion, but can’t pay, and C owes A $1 billion.
You have a mess in which everyone suddenly finds that they need massive amounts of cash, even though the net payments are zero. C has to pay A $1 billion right then and there or else file for bankruptcy protection, and if C files for protection, then the dominos just keep falling.

All I know is that the Depository Swaps Clearning Coriporation reported, on Oct. 21, that all the swaps related to Lehman brothers were settled by the transfer of 5.1 billion dollars to the parties whose purchased insurnce. The site also reported that Lehman had a “nominal” exposure of $400 billion to CDS and DSCC reported that 72 billion of that amount were registered with them before the settlement.

If Lehman’s could be settled so easily and quickly, why not AIG?

I know some funds where some of my money is held would be hurt, but what the heck, they have multiplied my money in the past.

Twofish – sure, that money comes back to the U.S. (in the form of dollars) and it is exchanged for some other financial asset that the Chinese government or the Japanese government values more than the dollar. This last reality is ignored by those who try to maintain that the trade deficit is somehnow beneficial to the U.S.

After all the transfers in both directions are concluded, the U.S. has $800 billion dollars worth of goods in its possession to use as it see fit and China or Japan or Germany has part of the $800 billion in financial assets such as U.S. Treasury certificates or ownership of a U.S. firm – all of which pay interest or dividends to the owner – and all of which the new owner can use as they see fit.

Most of the goods received are used rather quickly. The financial assets transferred overseas retain value, so long as the interest and dividends are paid.

Lots of things were tried but everyone that looked at AIG ran away screaming once they saw the books.

“President Roosevelt sought to encourage trade with the Soviet Union. To promote this trade, the EXPORT-IMPORT BANK was established in 1934. The RFC provided capital, and later loans to the Ex-Im Bank. Interest in loans to support trade was so strong that a SECOND Ex-Im bank was created to fund trade with other foreign nations a month after the first bank was created”

“These two banks were merged in 1936, with the authority to make loans to encourage exports in general. The Reconstruction Finance Corporation provided $201 million of capital and loans to the Ex-Im Banks”

However, the U.S. severely restricted imports through sky-high tariffs (Hawley-Smoot, 1931, for example), customs red tape, commodity classifications and other devices. The volume of Federal Reserve Bank credit was determined more by domestic considerations than by gold flows.

In April, 1933 we nationalized gold, made the dollar inconvertible and by administrative fiat capriciously raised the dollar price of gold in a series of steps from $20.67 to $35 per ounce. This action precipitated a 57% devaluation in the U.S. dollar.

All of this was done even though were a creditor nation and had a chronic surplus in our balance of payments (like our Pacific Rim trading partners). In January, 1934 the Congress codified these administrative actions into law. Under this modified gold bullion standard, the dollar was convertible on foreign, but not domestic account at $35 per ounce. Thus, in contradistinction, the U.S. exacerbated world trade flow.

This misses the basic problem. Lehman fails. After we settle everything we find that A owes B $1 billion, B owes C $1 billion, C owes A $ billion. Everyone pays everyone else and we find out that no one really owes anyone in the end.

B is AIG. Suppose AIG was bankrupt. Now A owes B $1 billion, but it’s not about to pay. B owes C $1 billion, but can’t pay, and C owes A $1 billion.

You have a mess in which everyone suddenly finds that they need massive amounts of cash, even though the net payments are zero. C has to pay A $1 billion right then and there or else file for bankruptcy protection, and if C files for protection, then the dominos just keep falling.

The thing about depressions is that you end up with stupid things happening. Companies go broke even though no one really ends up owing anyone anything, you have idle factories and out of work people.

And people find that easy to say until the find out that they have a pension fund that is indirectly invested in AIG, which they lose if AIG goes under. The problem with AIG is that it is so interconnected, that lots of people that don’t think that they have anything to do with AIG and will lose nothing if AIG goes under, are wrong.

Just to give on example. If AIG goes under, most of the employees of the State University of New York will lose the money in their 403(b) plans. AIG has a huge business administrating the equivalent of 401(k) for a lot of hospitals, schools, and universities. If AIG goes under, all of that is at risk.

Why oppose it as long as the ruling system lets you make money making pencils?

ReformerRay: No matter how you wiggle, the large trade deficit is the elephant in the room. It requires the U.S. to transfer overseas 700 billion dollars of U.S. wealth every year.

And that money comes back in the form of purchases of Treasuries and also generates internal wealth within the United States that is worth far more than $700 billion. If you are exporting $700 billion but creating $2 trillion industries, that is good deal.

ReformerRay: it eliminates U.S. firms every year that cannot sell in the U.S. because better bargins are provided by imports.

And those firms should be eliminated and replaced by firms that can generate jobs and wealth. Which is what has happened. If you look at the value added by an IPod or a pair of shoes, most of that wealth stays in the United States and creates a lot of high skilled and low skilled jobs.

One point that I’ve been trying to make is that most of the US firms that trade has eliminated *are already dead*. That changes the political equation since most of the firms in 1985 that wanted trade protection, are no longer in existence.

ReformerRay: Securitization of loans is a dying business, is it not?

No. Securitization is quite alive and well. Subprime is dead. CDO’s are dead. Securitization is quite alive and well. People want low risk which means that money is being moved into money market funds which are a prime example of securitization in action. Also someone has to fund the a mortgage.

ReformerRay: Who wants to buy a complex instrument that they do not understand, in this environment?

People are quite willing to buy complex instruments that they don’t completely understand if they have credible insurance behind them. Witness the number of people that buy FDIC-insured CD’s and money market funds.

CD’s and money market funds are incredibly complex instruments (or for that matter so are checking accounts). It’s just that this complexity is hidden from most people, but *someone* has to understand it, and there is a high paying job there for people that do.

What I hear a lot of people saying is “who needs power companies, I can get electricity just by pluging my computer into the wall socket.” That sounds silly, but people say exactly the same thing when they say “who needs investment banks, I can get money just by buying a money market fund.”

The financial sector must be downsized. The best and quickest way to do it is to let businesses fail.