Historical Summary of Events
The term “Too big to fail” is an underlying concession and a popular metaphor used in reference to almost all private company bailouts by the government. The label became famous in the 1980s following the financial crisis that involved the Continental Illinois National Bank. The idea behind government financial assistance to companies is that, should an organization fail, then society would suffer. The most recent use of this phrase happened in 2008 when AIG received assistance from the National Treasury to help ameliorate potential systematic risks to the economy. During the 2008-2009 period, both the United States and European governments initiated capital and liquidity support programs for banks and other large non-bank financial institutions. During these massive bailouts, the scale and prominence of federal efforts resulted in a significant political backlash from the public. It is against this backdrop that the book was written.
Main Characters, Companies, and Key Terms
A financial institution highlighted in the book includes Chrysler, which had been bailed out previously before the financial crisis. Others are General motors, Citibank, Savings and Loans, and Fannie Mae and Freddie Mac (Sorkin 11). The emergence of Wallstreet movement was marked by the collapse of what is considered the dot com bubble. The crowning example was the mortgage-market liquidity deferments whereby banks eagerly provided home loans to anyone without prior inspection of potential buyers’ financial statement (Sorkin 5). These actions led to an increasing housing problem primarily in the US. The securities that derived their income from a pool of residential loans were amalgamated, forming the basis for new investment products, which were advertised as collateralized debt obligations or CDOs (Sorkin 58). Purchasing and reselling CDOs were a lucrative business for Merrill Lynch, becoming the biggest issuer in Wall Street in a short period. However, when the company began expanding into mortgages, the housing sector began displaying signs of distress.
Laws and Regulations
The sudden withdrawal of the largest United States dealers from the housing industry resulted into liquidity issues that posed risks to financial institutions, including banks that had been federally insured. Following this occurrence, Charles Bowsher was tasked with the responsibility of studying a developing market trend known as derivatives, which provided various insurance options that protect an investor from potential default by a trading partner (Sorkin 40). Although there is a lack of federal regulations on insurance companies, state insurance superintendents and commissioners possess substantial authority to regulate an insurer’s sale of assets. The role of the state regulator was defined as offering protection to policy holders. Following this crisis, a new regulation known as the Emergency Economic Stabilization regulation was passed, creating a Troubled Assets Relief Program that was valued at several billion dollars.
Andre Sorkin’s book is a non-fictional chronological narration of events that happened during the 2008 financial crisis centered on the then Treasury Secretary and Lehman Brothers. In September of the following year, Paulson suggested that the Lehman Brothers should file for bankruptcy, which they did (Sorkin 78). As the stock market rose, this strategy worked; however, the Lehman Brothers collapsed shortly afterwards. Paulson later realized that Merrill Lynch was also on the verge of failing (Sorkin 90). The problem was not limited to the organization alone, as it also affected other corporations. This turmoil spread to Goldman Sachs and Morgan and the consideration to merge was proposed by their executives (Sorkin 113). However, with a lack of a fair valuation for some financial instruments in financial institutions, fewer deals were consummated.
Paulson was left to deal with Freddie Mac and Fannie Mae, which were government-sponsored enterprises on the brink of failure (Sorkin 117). He decided to place both companies under federal control as a means of stabilizing the financial markets. As the financial crisis continued, Henry Paulson realized the need for additional government intervention, developing a solution that would purchase assets from banks for a total of 700 billion dollars (Sorkin 324). The proposal, known as the Emergency Economic Stabilization Act, was passed into law on October 2008 under the Bush administration (Sorkin, 340). Andrew Sorkin concluded by stating that government regulations aided irresponsible risks undertaken by financial institutions.
Yes, I agree that the main themes in the book are the causes of economic downfall. As companies continued to fail, stakeholders raised concerns about the lack of rules or partners in the bailout process. Tim Geithner, in February 2009, admitted that the emergency actions that were instituted to provide reassurance to the public often contributed to anxiety and subsequent investor uncertainty (Sorkin 343). It is undeniable that public outcry was a factor in how Paulson and other executives approached the Lehman Brother’s dilemma. At first, the treasury claimed that allowing Lehman to fail was a strategy aimed at signaling reckless management of Wallstreet firms was not a guarantee for government bailouts (Sorkin 344). However, when chaos ensued, the treasury was forced to intervene.
In future, the occurrence of another financial crisis can be prevented by fixing previously instituted liquidity incentives. Before the 2008 financial crisis, excess liquidity was justified from the availability of low interest rate policies that were adopted (Sorkin 74). The disaster could have been prevented using a strong regulatory response; however, the belief that markets should self-regulate led to a lack of guidelines on shadow banking, which was a great contributor to the crisis. Hence, I suggest fixing these incentives by regulating this form of investment banking under the same guidelines as traditional systems.
During the 2008 presidential campaign, Barrack Obama vowed to fix the economic crisis and end the great recession by changing the policies that caused it. In July 2009, Obama ended recession via his economic stimulus package (Sorkin 116). The incentive provided a financial allocation to various sectors of the economy, including health, education, heating assistance, and housing. Obama’s administration provided tax relief by eliminating income deduction for seniors who were earning less than $50,000 per annum, while recipients of social security were entitled to $250 (Sorkin 94). He also removed taxes against capital gains for small business investors at the same time extended write-off for equipment purchases by small and medium-sized enterprises.
I believe that the fall of AIG during the 2008 financial crisis could happen again. This possibility can be explained using the events that occurred in 2016. The operating profit in the first quarter of that year fell by over 50 percent. In relation to per-share capital, AIG received 65 cents against the dollar. The pre-tax income for the company’s casualty insurance business and commercial property dropped by over a third, while its unit net investment income dropped by over 40 percent.
The government bailout was the best course of action in relation to AIG insurance. Its bankruptcy and potential collapse would have resulted in one of the worst financial mistakes in history. Without the bailout, the mortgage market would not have grown to its current status. The collapse of AIG would have affected all financial institutions, resulting in a worldwide recession, and high rates of unemployment. Other potential ripple effects include home repossessions by mortgage facilities, significant reduction in house prices, and declining stock markets and interest rates. While most people believe that AIG was bailed out because it was one of the largest insurance company with millions of clients globally, the real reason was the underlying implications of such a massive collapse.
Sorkin, Andrew Ross. Too Big to Fail: The Inside Story of How Wall Street and Washington Fought to Save the Financial System and Themselves. Penguin, 2010.