Policymakers and analysts use the term “moral hazard” with great
frequency these days, stressing the importance of allowing some
Wall Street firms to fail, lest businesses assume the government
will always guarantee the downside of risky behavior. However, the
real moral hazard that should concern Americans is not as much the
one in Wall Street boardrooms as the one that has infected
countries throughout the world. After all, whether the U.S.
military is disarming dangerous regimes and sending American men
and women into battle, funding one-quarter of the United Nations
budget, or using U.S. taxpayer dollars to stem a global financial
crisis, the rest of the world can take comfort in knowing the U.S.
will probably come to the rescue. In effect, we have become the
world’s insurance company.
Last week, the U.S. acted boldly once again with the Federal
Reserve Bank loaning $85 billion to AIG and putting the risk of
default on the U.S. taxpayer. As the Bush-Paulson-Bernanke team was
well aware, AIG is an enormous company with over 130,000 employees
in 136 countries. You might say it is “multilateral.” Because it is
an enormous seller of credit default swaps, which essentially
insure credit payments of institutions all throughout the world,
allowing the company to fall into bankruptcy could have triggered a
cataclysmic global scenario.
While almost every major bank has significant exposure to AIG,
its failure may have impacted Europe the greatest. It is estimated
that European banks own approximately three-quarters of the
financial instruments that AIG insures. AIG writes its credit
default swaps contracts through a French subsidiary; it employs
thousands of people throughout Europe; and, it writes over ten
million insurance policies a year in the United Kingdom. AIG also
has a presence in most Asian countries and owns almost 20% of
People’s Insurance Company of China, the country’s largest casualty
insurer.
American taxpayers are now guaranteeing AIG’s insurance
policies, thereby preserving much of the value for foreign
investors in their domestic financial institutions that rely on
such coverage. Foreign institutions and central banks also hold
over $1.5 trillion of mortgage-backed securities issued by Fannie
Mae and Freddie Mac. Bailing out these foreign investors and thus
preserving their faith in U.S. government credit was part of the
argument advanced in favor of the Fannie and Freddie takeover.
While the U.S. taxpayer assumes the entire bill, the benefits go
far beyond our shores.
Under the new bailout proposal, the Treasury would buy up to
$700 billion in mortgages and mortgage securities from the private
sector, including from certain foreign firms. Treasury Secretary
Henry Paulson said in defense of the proposal that “If a financial
institution has business operations in the United States, hires
people in the United States, if they are clogged with illiquid
assets, they have the same impact on the American people as any
other institution…The key here is about protecting the system.”
Why then is there not a greater contribution from foreign central
banks and taxpayers?
Thus far, however, the Group of Seven nations have resisted
calls from Secretary Paulson to take measures similar to the
Treasury’s. Unfortunately, this scenario isn’t novel. Time and
again, the U.S. contributes vast amounts of resources (both human
and financial) to world problems. And while the U.S. is certainly
not without blame in creating the current financial mess, it will
likely do more than its share to remedy the situation.
Nonetheless, even domestically, politicians would rather assign
blame to the other Party than defend America from foreign
criticism. Neither presidential candidate has proposed much of
substance for dealing with the financial situation, instead
exchanging empty partisan insults. Both should call on some of our
friends abroad to assume a larger portion of the U.S. taxpayer’s
bill.
And while they’re at it, Senators Obama and McCain might also
ask investors of the world to send a collective “thank you” to 1600
Pennsylvania Avenue. If the U.S. is going to act as the world’s
insurance company, is gratitude too high a demand? Then again, they
say no good deed goes unpunished. After eight years in the White
House, George W. Bush should know that better than anyone.
