Both TPM and Atrios recommended reading JOE NOCERA’s NYT piece on the AIG bailout. So I did, and now I’m tell you to read it. Nocera’s piece has by far the best explanation of how AIG gamed the system and caused the housing bubble.
There’s lots of important parts of the article, seriously read it, but this one jumped out:
When a company insures against, say, floods or earthquakes, it has to put money in reserve in case a flood happens. That’s why, as a rule, insurance companies are usually overcapitalized, with low debt ratios. But because credit-default swaps were not regulated, and were not even categorized as a traditional insurance product, A.I.G. didn’t have to put anything aside for losses. And it didn’t. Its leverage was more akin to an investment bank than an insurance company. So when housing prices started falling, and losses started piling up, it had no way to pay them off.
Keyword: Regulation. Or more importantly, a lack of regulation incentivizes bad behavior. Contrary to popular conservative belief, rules are important to maintaining a stable environment. Or should I say, oversight is critical to preventing systemic abuses.
I’m not sure why this is a controversial concept. We don’t rely on the honor system to prevent murder, so why would we rely on it to prevent fraudulent economic scams?