Reply #23: It was Widely Believed at the Time

[On the Road]

that an AIG failure would cause a chain reaction among world financial institutions (http://www.washingtonpost.com/wp-dyn/content/article/2009/03/09/AR2009030902806.html">WaPo article).

Here are some numbers on a very limited scenario in which only Bank of America failed as a result of the government not keeping AIG in business:

(1) The FDIC insures about $8Trillion of personal deposits. Here's a list of the largest FDIC-insured deposits:

Company                         #States #Off    Dom Dep($B) %ofTotDep

Wells Fargo & Company            40 6,586   750.4  9.8%
Bank of America Corporation      36 6,041   916.1  11.9%
U.S. Bancorp                     26 3,056   169.2  2.2%
JPMorgan Chase & Co.             24 5,227   652.7  8.5%
PNC Financial Services Group     16 2,572   177.3  2.3%
Regions Financial Corporation    16 1,774    95.8  1.2%
KeyCorp                          15 1,027    61.8  0.8%
Citigroup Inc.                   15 1,023   307.3  4.0

http://www.fdic.gov/bank/analytical/quarterly/2010_vol4_4/FDIC_Quarterly_v4n4_SOD_120610.pdf

If BoA had failed, the FDIC would have been on the hook for over $1 Trillion in deposit insurance, including business accounts (below). If other banks failed in the process, it could have been several times that. That risk alone is more than enough reason to institute a bailout of AIG.

(2) Maybe even more important are business deposits.

        Size                 #Establ          #Employees      Payroll($K)
Zero Employees	       19,523,741			
1-100 Employees		5,197,440	41,839,701	1,289,644,895
100+ Employees		1,386,929	73,235,223	2,924,307,288
Total		       26,108,110      115,074,924	4,213,952,183

http://www.census.gov/epcd/www/smallbus.html

The major expense of most businesses is payroll, which has to be kept in cash. The FDIC insures business accounts only up the same $250,000 as personal accounts. Any sizeable business is going to exceed that by a large amount. (GM, for example, keeps $27Billion in cash and equivalents on its balance sheet.) If Bank of America went under, 12% of sizeable US businesses would not be able to issue paychecks or pay their creditors. Now think about the effects on their suppliers, their employees' mortgages and other bills, and the ripple effect throughout the economy. That is a recipe for catastrophe.

(3) Think about the effect on income taxes, business taxes, and other government revenue on top of FDIC payments and any necessary bailouts. The deficit would swell and it is likely that government services would be substantially cut and taxes raised. Just raising taxes on the top 1% would come nowhere near solving the issue -- all of would feel the pain in various ways.

(4) Federal employees would continue to be paid, since the US government can create money. State and local governments, however, cannot. Cities like Baltimore or Detroit ravaged by a fleeing tax base and higher costs know what it's like to have tax revenues plummet.

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Many DUers complain about high unemployment, as they should. Multiply the current problems by at least 2-3 times to get an idea of the impact of letting these institutions fail. Same holds for concerns about the deficit.

As far as the perception that allowing widespread failure would result in a deeper but shorter recession, it is based on wishful thinking rather than economic analysis. The current recession is bad, but it's manageable and within the normal range recent recessions. The alternative is much, much worse for all of us.

It's unlikely that you are insulated from the effects of widespred bank failues and general economic conditions as you believe. Even if you were, wanting AIG to fail is wishing serious financial harm on hundreds of millions of people for your moment of schadenfreude.

As it is, AIG gave up 92% of its stock. The business owners lost their investment, the government took over, and the operation continued. This is the right type of solution. Now the government has to gradually sell the stock and return it to private hands with a minimal loss. I don't see how anyone can complain about that.