The media is telling us that Paulson and Bernanke deemed AIG "too big to fail." But apparently that was a very real option as late as Sunday night. Indeed, negotiations with various private lenders - Goldman, JPMorgan and others - collapsed over the weekend because Paulson and Bernanke were refusing to extend bridge loans much smaller than the $85 billion deal.
For anyone who has ever been involved in these kinds of negotiations, this was an extraordinary development. If Paulson, while Goldman CEO, had rejected much more advantageous deals only to accept a much worse deal, he would have lost his job. It’s important to understand that Paulson is not an idiot; he could not possibly have so badly estimated his leverage in this negotiation, driving a hard bargain with JPMorgan, Goldman, and others only to end up holding the whole fucking bag at the end. This confirms that from a purely economic and financial viewpoint it was Paulson’s belief that AIG could be allowed to fail.
Paulson’s error was misjudging the political implications. While AIG’s failure may have had severe longer term consequences, it was certain to have profound short-term consequences. Quite simply, it meant the end of ‘pub rule. The short-term economic impact of AIGs failure would have dominated the rest of the campaign, and it would have finished off mccain. This could not be allowed to happen.
The witless mainstream media take – that Paulson and Bernanke decided AIG was "too big to fail" – is patently untrue. It was mccain’s campaign that was judged "too big to fail." Despite mccain's recent surge in the polls, he remained far behind Obama on the issue of the economy. McCain's bumbling reactions on Monday to the looming economic crisis was certain to reinforce that voters' perception that mccain is not up to the job of handling the economy.
To be clear, I am not arguing that the AIG bailout was the wrong thing to do, or that AIG's failure would not have had profound consequences on the financial markets. But the story we're being told today - that Pualson and Bernanke believed AIG was "too big to fail" - cannot be true. The factors that drove Paulson's flip-flop were political.
In a fair world, this $85 billion bridge loan to AIG would be debited to McCain's campaign spending limits.