Nationalize This

The Fed's embrace is suffocating AIG.

Thirty years ago, Nobel prize-winning economist Milton Friedman and wife Rose wrote that "the combination of economic and political power in the same hands is a sure recipe for tyranny." As we're learning, it's also really, really expensive.

Washington regulators tempted to nationalize banks don't need to study decades of history to understand the point. Merely consider the last five months, and the nationalization experiment the New York Federal Reserve Bank has conducted at AIG.

In September, the government took control of almost 80% of the giant insurer and to date has provided AIG with more than $150 billion in taxpayer financing. The initial terms of the government assistance were so poorly crafted that some AIG shareholders said the firm would be better off in bankruptcy. After several rewrites to the deal and a lot more taxpayer money at risk, an AIG spokesman now says that executives "hope" that they won't need more federal help.

Still, the firm is reviewing its options. One of them seems to be to seek government guarantees on new categories of assets. So far, taxpayer cash has largely relieved AIG of the burden of bad bets on residential mortgages. The firm is now at a "preliminary" stage in considering whether taxpayers can also help insure AIG's $22 billion in commercial mortgage-backed securities. Meanwhile, the company's stock price hovers near $1 per share, and AIG watchers are beginning to think the feds may never get the taxpayer's investment back. In short, the federal "rescue" appears to be squeezing the life out of AIG.

At the time of the September intervention, AIG had very healthy insurance businesses trapped under a holding company that had bet wrong on housing. Outsiders familiar with the firm say that now even those once-healthy AIG businesses are losing talent and having to cut prices to keep customers. Any price discounting will lead to further losses down the road. The company denies that it is writing unprofitable insurance policies and says that executive defections are within the range of normal turnover.

A clearer picture of AIG will emerge in a few weeks when the company files its annual 10-K report with the SEC. What's clear already is that the company has had difficulty fulfilling its stated plan to sell assets to repay government loans. With institutional buyers and even foreign capital scarce, AIG management is considering selling business units to the public. Buyers aren't very plentiful in that market either, however, as the U.S. suffers through the worst environment for initial public offerings since the 1970s.

We wish AIG well and we should note that the current management -- unlike many of the current directors -- did not create this mess. Still, we're waiting for someone to make the argument that this nationalization of a major financial firm has been a success. AIG has become the intervention that nobody in Washington wants to discuss, least of all the New York Fed or its former President and now Treasury Secretary Timothy Geithner. However, since some of the same people who gave us the AIG debacle are now contemplating plans to nationalize a good chunk of the banking system, it's vital that someone encourages them to learn from their mistakes.