Tuesday, July 28, 2009

Regulatory arbitrage and the fool at the poker table

Eliot Spitzer, the former governor and Attorney-General of New York, came crashing down in flames after a scandal over prostitutes. Yet that doesn't invalidate what he has to say. Now take a look at this video of him on MSNBC, and what he had to say about it (scroll down to see it; his comments start at about 5:30).

"The Federal Reserve has benefited for decades from the notion that it is quasi-autonomous, it’s supposed to be independent. Let me tell you a dirty secret: The Fed has done an absolutely disastrous job since [former Fed Chairman] Paul Volcker left.


“The reality is the Fed has blown it. Time and time again, they blew it. Bubble after bubble, they failed to understand what they were doing to the economy."


“You look at the governing structure of the New York [Federal Reserve], it was run by the very banks that got the money. This is a Ponzi scheme, an inside job. It is outrageous, it is time for Congress to say enough of this. And to give them more power now is crazy."


“The most poignant example for me is the AIG bailout, where they gave tens of billions of dollars that went right through — conduit payments — to the investment banks that are now solvent. We [taxpayers] didn’t get stock in those banks, they didn’t ask what was going on — this begs and cries out for hard, tough examination."

(hat tip: Raw Story)

AIG is an interesting case. As this 2008 report notes, AIG's previous annual report had noted cheerfully that all the credit default swaps AIG was involved in were:

"for the purpose of providing them with regulatory capital relief rather than risk mitigation in exchange for a minimum guaranteed fee”.

As everyone now knows, it was regulatory arbitrage that AIG was really selling - on a gigantic scale.

As Vanity Fair asked in a long and readable article about AIG:

"How did an insurance company become so entangled in the sophisticated end of Wall Street and wind up the fool at the poker table?"

So where was the focus of all this regulatory arbitrage? AIG F.P. And where is that based? The City of London, the world's biggest regulatory wasteland.

"Ground zero for AIG's spectacular implosion, which has soaked up more federal bailout money than any other entity, appears to have been a small London branch office that may have put as much as half a trillion dollars at risk." (link)

More on this in due course.


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