The market's decline late last week was directly related to the bonus payments made by AIG to a few of its employees. Once the word got out our entire political system went ballistic. Our elected representatives quickly jumped to action and held a vote to place a 90% tax on any bonuses paid by companies who received bailout funds to employees whose household income exceeds $250,000. Senators did not want to be left out as they too said they would consider a similar measure.
This outpouring of anger emphasized by the media and supported by our representatives is not the proper way of addressing the problems within our financial system. Making decisions from this point of view will do nothing but add to the problems and hinder progress towards stability and growth. The markets recognized the real problem and it had nothing to do with the bonus payments, which by the way are less than 1% of the total funds invested by you, the taxpayer, into AIG. No, the real problem is that if our government can arbitrarily break contracts whenever or for whatever reason it chooses, who would ever enter into an agreement with it. The market gave us the answer quickly - no one in their right mind.
What is necessary to repair our banks is a working partnership between the public and the private sector. This requires an understanding of the rules and relationship between these two sectors. Both parties will need individuals who understand the toxic assets, or those financially engineered products that got us into this mess. Firms and individuals will require the incentive to expose their funds to risk by purchasing these toxic assets, and finally, the certainty that these agreements are enforceable must be clear and plain.
The uproar over AIG muted the most important activity of last week, the actions taken by the Federal Reserve. On Wednesday the Fed indicated they will be buying $300 Billion in long-term Treasury Securities. They will increase the Term Asset-Backed Securities Loan Facility (TALF) by $750 Billion, and will open up the range of eligible collateral to existing asset-backed loans. And finally the Fed will increase the amount available for purchase of agency issues by $100 Billion.
The fed will be injecting over 6,000 times as much as the amount spent on bonuses. This action will impact the course of interest rates, the funds available to buy a house, a car, or a college degree, and the funds required to start and expand businesses. These are the funds that will drive the future of the markets, not the anger over AIG.
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