All U.S. pensions are managed to balance short-term riskier investing and long-term “safe” investments. These safe investments come in the form of bonds which are a type of debt. Virtually all managed pensions need to have up to 40% of their asset allocation in these perceived “safer” instruments. However, since 2001, the asset that underpins debt – collateral – has been largely out of the sight or mind of regulators due to what was called a financial innovation – credit insurance.
Tomorrow, the Obama Administration faces an untenable decision thrust upon it by the opaque management of AIG which has led to the largest (and incomplete) charge-off in U.S. history. If it saves AIG in some federally-owned shell, it will delay disclosing to the U.S. citizens that their pensions are technically insolvent due to the erasure of credit insurance and the future failure of the insured bonds. You see, AIG has both primary and reinsurance risk on an estimated 4 trillion dollars of credit risk insurance and in their current default and bankrupt position, they will, with their announcement tomorrow, technically default on the credit insurance obligations meaning that tomorrow, EVERY pension fund will no longer be compliant under ERISA laws and management practices.
If the government allows AIG to fail, the exact same reality will be evident however, it will not have appeared to cover up the problem. Rather, as with the Nixon administration’s decision in departing from the gold standard on August 15, 1971, President Obama can declare an immediate federal adoption of the ERISA obligations under to 2006 pension fund laws and simply use the federal money to create an immediate bond insurance liquidity pool. By doing this he would save his credibility and allow the “intervention” to directly benefit the public rather than trying to bail out an entirely failed financial institution.
Once stabilized, President Obama can then establish a management function (modeled after the FDIC but NOT the illiquid FDIC) which can take the appropriate time and process to assess the true collateral inadequacies in municipal and corporate debt and then adjust the insurance demands commensurate with measured risk rather than impulsive guesses.
To hear the way another President managed this crisis: