How is McCain connected to the almost bankrupt AIG?

Follow the trail between the ailing giant insurance company and McCain advisor Phil Gramm

Published September 16, 2008 10:17PM (EDT)

So why, after the Federal Reserve Bank declined to give investors the rate cut that they were slavering for, did the stock market, after an initial swoon, come back strong? Why, in the middle of a meltdown, did the Dow Jones Industrial Average close up 141 points?

One theory is that investors were heartened by rumors suggesting that the Fed was changing its tune about whether or not to come to the rescue of the huge insurance company, American International Group (AIG). At of the close of the business day in New York, there was no hard news confirming a bailout, but multiple media outlets were quoting unnamed sources as saying some sort of loan might be in the works.

This would be no ordinary loan, either, if reports that AIG needs $75 billion to remain a going concern are to believed.

But why, after snubbing Lehman, and initially denying AIG's request for help, would the Bush administration change its mind? There's a great story that isn't getting enough attention -- a clear a connect-the-dots drama that links AIG to the unregulated credit derivatives market to former Senate Banking Committe chairman Senator Phil Gramm all the way back to John McCain, the Republican presidential candidate currently fulminating all across the land about the recklessness and impropriety of using taxpayer money to bail out corporations such as.... AIG.

Here's how it works. The reason explaining why the possibility of an AIG bankruptcy is sending shudders of fear through financial markets is AIG's role as one of biggest sellers of credit default protection on the planet. So called "CDS" (credit default swaps) are a form of bankruptcy insurance for bond-holders. Worried that your subprime mortgage-backed CDO might default? No problem, AIG can help, happy to sell you an insurance policy protecting you against that default. For a nice premium, of course.

According to HousingWire, AIG is on the hook for "CDS protection on $441 billion of fixed-income assets, including $57.8 billion in subprime-mortgage related securities."

If AIG delcared bankruptcy, all the other financial players who bought insurance protecting the default of, for example, subprime-mortgage related securities, would be in an unpleasant position, stuck with having to bear the losses that are piling up in this most woeful sector of the bond market.

Too many other financial institutions would run the risk of swirling down the drain after AIG, if the big insurer declared bankruptcy. Thus Monday's stock turmoil, and Tuesday's wild swings.

Now, if you followed Barack Obama's speech on the state of the economy earlier today, you might have noticed him referring to the "complex financial instruments like some of the mortgage securities and other derivatives at the center of our current crisis." He brought up these financial products for a specific reason: he believes that the markets for new derivative products should be better regulated. Right now, for example, credit derivatives are almost completely unregulated. No one in a position of governmental responsibility is officially entrusted with ensuring that the hedge funds and investment banks and insurance companies buying and selling many trillions of dollars worth of credit derivatives own assets sufficient to handle their potential liabilities.

This is not an accident -- it is a direct result of political leadership -- on both sides of the aisle. Neither the Clinton administration nor the Bush administration was interested in regulating credit derivatives. As Salon reported more than six years ago, one Clinton appointee at the Commodity Futures Trading Commission (CFTC), Brooksley Born, did attempt to bring derivatives trading under the CFTC's regulatory ambit, but she was shot down by a powerhouse of government officials, including Fed Chair Alan Greenspan, SEC head Arthur Levitt, Treasury Secretary Robert Rubin and Senate Banking Committee chairman Phil Gramm.

A bipartisan effort, no doubt about it. But nobody made it more of a sacred mission to ensure that credit derivatives were kept unregulated than Senator Gramm, long recognized as the key force in the passage of the Commodities Future Modernization Act of 2000, which specifically exempted new derivative markets from government oversight. As Mother Jones' David Corn reported earlier this year:

The act, he declared, would ensure that neither the SEC nor the Commodity Futures Trading Commission got into the business of regulating newfangled financial products called swaps -- and would thus "protect financial institutions from overregulation" and "position our financial services industries to be world leaders into the new century."

History will judge whether Gramm was successful in his mission. But in the meantime, let's not forget who chaired John McCain's presidential run in 2000, and who, until he made his tactless comment about Americans being "a nation of whiners" was considered a top economic advisor to the Senator from Arizona.

Former Senator Phil Gramm.

So there you go. And if AIG has to be bailed out with taxpayer money, now you know who should get a significant part of the blame: John McCain's good buddy, and economic mentor, Phil Gramm.

By Andrew Leonard

Andrew Leonard is a staff writer at Salon. On Twitter, @koxinga21.

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