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.
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