Will in Insolvency
In this week’s New Yorker, Nick Paumgarten, in the Talk of the Town, kindly draws on my work about the cultural contingency of financial reporting; he quotes me on the need to update the idea of insolvency. Usually defined as the ability to pay debts as they come due, or assets exceeding liabilities, there has always been a strong objective thrust to the notion. The emphasis is on measured financial activity reduced to a verifiable expression of ability.
But as Nick notes, equally important is a debtor’s will to pay. The differences appear in the contrast between the United States and Greece.When Standard & Poor’s recently lowered its credit rating of the U.S. Treasury by one notch, it registered doubt not so much about the country’s ability to pay its debt, but the will of its incumbant political class to do so. In contrast, Greece’s political elite seem committed to finding ways to meet that country’s debts; alas, its resources compared to its obligations raise real doubt about their ability to do so.
Another example of the difference between the ability and the will to pay debts arose in the September 2008 tussle over what to do about American International Group. It was then the world’s largest insurance company and shortly before the crisis boasted a market capitalization of $180 billion. Much of its trillion-dollar balance sheet was securely housed in walled-off insurance subsidiaries.
The roiling financial crisis infected two dozen banks with which AIG had financial contracts. The U.S. Treasury, reeling from a series of bank failures and criticism of its responses to them, feared that those banks could disintegrate one-by-one. It had run out of good ideas to boost their solvency.
So Henry Paulson, then Treasury Secretary, and his successor Tim Geithner, then head of the New York consortium of private banks misleadingly called the New York Fed, opted to wrest control of AIG in order to rescue those banks. The government loaned the company $85 billion and the government siezed 80% of its equity. The government then used that money, along with additional loans about twice that, to pay the two dozen banks off, dollar for dollar, under the financial contracts.
AIG may have been facing a liquidity squeeze while at the center of the financial crisis. But it had ample capital. And it was engaged in heavy negotiations with its counterparties about settling payments under the financial contracts–whose value was highly uncertain given the frozen capital markets. AIG, in short, had the ability to pay its debts.
AIG’s shareholders, of course, including Hank Greenberg, who built the company from the 1960s to 2005 when he retired as CEO, objected vigorously to the Paulson-Geithner move. Not only did AIG command ample capital internally, at its super-solvent insurance companies, many investors around the world were lining up to invest more.
What divided the government and the shareholders was less the question of whether AIG had the ability to pay its debts, but whose will mattered. The government’s will won out. It was an ironic result, considering that U.S. culture is generally against governmental nationalization of private business, and that AIG had stood for the principle in fighting nationalization of its property and that of its customers around the world for decades.