The Federal Reserve System's Nationalization of AIG Has Transferred Authority over Federal Government Spending to the Federal Reserve System.

Gary North

September 16, 2008

Two words: fait accompli. American translation: done deal.

The primary economic function of the Federal Reserve System, our nation's central bank, is to protect the largest commercial banks from bankruptcy. This has been true ever since 1914, when the FED went into operation. No major commercial bank has ever failed since 1914. The FED has always made arrangements to save every large commercial bank that ever got into financial trouble great enough to threaten its bankruptcy.

Note: Bear Stearns and Lehman Brothers Holdings were investment banks, not commercial banks. Merrill Lynch is now owned by America's largest commercial bank.

AIG's bankruptcy would have put several of them in very big trouble.

Fractional reserve commercial banking is a legalized cartel. The Federal Reserve System is the policeman of the cartel: establishing the terms of entry and operation, and protecting the largest banks from the follies of their officers.

This is not how the FED is described in the textbooks, of course, but from the point of view of economic theory, this is how it operates. If you read the textbook's chapter on the economics of cartels, you will see that the Federal Reserve System conforms to this analysis. But no college-level textbook ever places the chapter on the Federal Reserve anywhere near the chapter on cartels.

There is one exception to this rule: a textbook that is never assigned, written by Murray Rothbard in 1983, The Mystery of Banking. You can download it for free here.

Large banks were facing bankruptcy because of the bankruptcy of AIG, whose debt certificates and guarantees are on the books of every major bank and most Fortune 500 companies. So, the Board of Governors of the Federal Reserve System stepped in and nationalized AIG in the name of the United States government, authorizing the Federal Reserve Bank of New York, a private corporation, to issue newly created money to make the loan to AIG.

All of AIG's liabilities cannot be covered by the taxpayers' infusion of this "bridge loan." Bridge to what? More loans! If the justification was avoid defaults, AIG will need more loans. Meanwhile, the taxpayers have $85 billion of equity in a dying company.

This was announced at 10 p.m., eastern daylight time. The details are here.

The FED will create $85 billion of new money to lend to AIG. This will gain an 80% stake in the company for the Federal government. This was a debt for equity swap.

The United States government now owns AIG, just as it has owned Freddie Mac and Fannie Mae since September 7. The earlier transfer of ownership and liabilities was done by the Secretary of the Treasury, the former CEO of Goldman Sachs, Henry Paulson, who unilaterally made the transaction on behalf of the government.

Congress was not asked to approve the previous transaction. That fact established a legal precedent. The Board of Governors of the FED has now extended this precedent.

"Congress. What's Congress?"

Article 1, Section 8 of the United States Constitution reads:

The Congress shall have the power

1. To lay and collect taxes, duties, imposts and excises, to pay the debts and provide for the common defence and general welfare of the United States; but all duties, imposts and excises shall be uniform throughout the United States:

"Constitution? What Constitution?"

The Board of Governors has demonstrated that it possesses the legal authority to increase the debt of the United States government in order to buy stock in a dying firm. The New York Federal Reserve, a private corporation, has the authority to carry out the decisions of the Board of Governors. Anyone who says otherwise is obviously clinging to the outmoded past.

For years, I have argued that the FED will buy up whatever it wants -- equity -- on behalf of the government. Now we know. It can loan the money, as a good central bank does, yet get equity. It buys ownership with newly created money.

This has always been implicit in central banking. Now it has become a reality.

Don't kid yourself. This $85 billion is merely a down payment. There will be more injections of fiat money to de-leverage this monster.

It's a trillion-dollar behemoth with $447 billion in derivatives. (On the derivatives figure, see AIG's latest filing with the Securities and Exchange Commission. Click here and scroll to page 87.)

The FED's PR says the FED will liquidate the company later. How? To sell AIG's assets, it will have to sell them into the capital markets. For hundreds of billions of dollars of so-called assets, there is no market. At the time of the sale, these assets will have to be marked to market: written down. The FED will never get its money back -- meaning the public's money. This would expose the reality of what is now about to happen when Congress rolls over and plays dead by accepting this transaction on its behalf. No one at the Treasury or the Federal Reserve has any incentive to expose economic reality to taxpayers.

This is one more example of the end of free markets. The government now owns Fannie Mae, Freddie Mac, and AIG. This took nine days.

Fannie and Freddie have liabilities of $5 trillion. AIG has liabilities of a little over $1 trillion, plus $447 billion in derivative contracts. All three have offsetting assets on their books, of course. No one knows what they are worth, which is why the nationalizations took place in the first place -- to keep the markets from finding out in three gigantic bankruptcies. The taxpayers now own these assets, better known as toxic waste -- illiquid assets.

"Too big to fail" means the nationalization of the largest financial firms when such bankruptcy threatens the solvency of the largest commercial banks.

Unnamed FED staff said this was not a nationalization.

Fed staff denied that the deal represents a nationalization of the insurer. The government has provided liquidity to the company to allow it to fund its operations in an orderly fashion, they said.

This was reported by Reuters.

Similarly, the nationalization of Fannie Mae and Freddie Mac on September 7 was called "conservatorship."

George Orwell named this practice in his novel, Nineteen Eighty-Four: newspeak. For a complete dictionary of newspeak, click here

The public will accept it. It will pay for it. There is still faith in the Federal government and its Constitutionally unauthorized representatives.

Profits go to CEOs who bankrupt large firms. Then the FED and the Treasury bail out the companies at the expense of taxpayers.

I think the net Federal debt for the three agencies will easily exceed a trillion dollars. Far more important, we have lost Congressional sovereignty over spending. The taxpayers had no say. The Constitution was violated mercilessly. Nothing will be done by Congress. The entire process will be accepted.

The de-leveraging means that the government has taken on huge liabilities. These can be paid off only by fiat money.

The future of the dollar is certain: lower. The debt will never be reversed. It will be paid off with fiat money.

This set the legal precedent. Congress will accept it. The courts will accept it. It's over, folks. The republic, what little remained of it, has been auctioned off to the Federal Reserve System, which used newly created money to make the purchase.

This process will continue. Read Dr. Rozeff's prediction, made before the AIG bailout. http://www.lewrockwell.com/rozeff/rozeff220.html

We have all seen it coming, infringement after infringement. It will not be reversed. It will go forward. The mess the bureaucrats will make of all of this will call forth more crises. These will be paid for with more FED bailout money.

Mises was right in 1951: the middle of the road policy leads to socialism . . . until socialism collapses. Read it here: http://mises.org/midroad.asp

If you are as tired of all this as I am after 50 years in the trenches, you need to lighten up. This will help.