My blog of March 1, 2009, “Uncertain Asset Values and the Stock Market” (http://maseportfolio.blogspot.com/), was written before the most recent news surfaced about the continuing bailout of A. I. G. I believe that the example of A. I. G. represents a perfect ‘test case’ for what was presented in that post.
The March 1 blog contended that the major uncertainty facing the investment community…and the Federal Government…is the value of assets on the books of many of the nations businesses…especially many large and important firms that are “too big to fail.” The argument is that this uncertainty has to be cleared up as much as possible before the economy is really going to have a chance to regain its health.
The problem now is that not only are companies withholding information from the investing public…but the government is also withholding information from the investing public. Specifically, companies…and the government…are afraid to release information on who they are dealing with…the “web of counterparties”…because of their concern that the release of these names would cause a panic leading to deposit withdrawals or the cashing in of insurance policies and so forth.
This is the old “after-the-fact” problem. I used to be a part of “information sessions” for journalists to help them understand banking and the issues that surrounded the banking industry. One of the concerns that always came up at these sessions was about what responsibilities “the press” had in reporting on troubled banks. That is, if a journalist “knew” that a bank was in trouble…what responsibility did that person have to report that the bank was having problems…and thus, perhaps, cause a “run” on the bank.
This is an “after-the-fact” problem. The bank is already a troubled bank…now what do I do?
One of the arguments I made was that journalists should keep up closely enough with banks to report when banks were starting to experience difficulties. By making this information public, the press could help prevent the bank getting too far into a mess because it would want to avoid the bad publicity and work to rectify the difficulties before they got “out-of-hand.”
This, of course, was very difficult because of the insufficient reporting requirements applied to banks and the secrecy surrounding the regulatory examinations. And, if banks knew that they were being scrutinized that closely by “the press” they would certainty make it just that much more difficult for the “outsiders” to obtain information.
So, investors and communities had little information on financial institutions that were important to them and had to “trust” the regulatory agencies to apply the appropriate oversight to the banking system. Of course, the regulatory agencies did not always have “full information”, especially as the financial conglomerates began transacting in very sophisticated derivative securities and taking many assets “off balance sheet.”
I believe that the company A. I. G. is a striking picture of how this scenario played out. A. I. G. is a holding company that began as an insurance company and then diversified itself into a financial conglomerate that included a hedge fund and other “black box” investment vehicles. Their primary regulators were the state insurance regulators (and some international regulatory requirements) and the state laws caused the subsidiaries to be highly segregated so as to ensure the safety of those the insurance subsidiary had insured.
The rest of the company was not regulated to any degree. As a consequence, A. I. G. was able to build up a huge financial conglomerate that could engage in untold transactions that were both un-regulated…and un-disclosed! The accounting and reporting rules were such that investors…and the public…and the government…and even other areas within the company did not have any idea about the risk exposure of the holding company or the “spider-web” of relationships that made it a potential “carrier of contagion.”
And, we…and the government…still don’t know what the potential damage could be from this dismal situation!
As a consequence, the probability of a fifth (this last bailout was the fourth return to A. I. G.) is a lot higher than we would like it to be. And a sixth? And a seventh?
With the government owning almost 80% of the company it would seem like any additional funds would be relatively small.
But, that is the problem…we don’t know! No one seems to have a handle on the value of the A. I. G. assets!
And, as I argued in “Uncertain Asset Values and the Stock Market”, this problem exists throughout the economy. What about the assets of Citigroup? What about the assets of Bank of America? Again, to quote the earlier blog, “It is not altogether clear that even the people running a large part of this economy have any idea about the value of their own assets.” Again, I take A. I. G. as the example.
And, then we have General Electric…and the problems of GE Capital. Again…we have another conglomerate with few pieces that go together. For years, GE Capital carried the rest of General Electric. And, what happens if you have one subsidiary making up for the “not-so-good” performance of other subsidiaries? You put more and more pressure on the performing subsidiary to produce exceptional results. And, how do you do that? You take riskier assets into your portfolio and you increase leverage. Simple!
Now, GE Capital is suffering along with other financial companies that attempted to extend “exceptional” returns. And, with GE Capital failing to perform…the spotlight is being focused on all the other subsidiaries that were only mediocre performers. Consequently, General Electric must face the value of ALL of its companies and determine what are the asset values under its umbrella.
This, to me, is the picture that is unfolding…and the problems we face are not going to be resolved until we get a better grasp on asset values. But, we need to do this quickly because…and this is the problem of bad assets…the value keeps dropping if the difficulties are not resolved. This is true of bad assets in an individual institution…I saw this over and over again in the banks I helped turnaround…and it is true with the financial and economic system. In fact, that is the problem with a contagion…bad assets tend to play off of bad assets…and the difficulties cumulate. This is all the more reason for attempting to get a handle on asset values as soon as possible.
A $787 billion economic recovery plan is insufficient to overcome the possibilities of a multi-trillion dollar write-down of assets!