Chris Thomas

Back in the 1980s as the US ramped up military spending to counter the old Soviet Union, original thinkers like Ted Galen Carpenter of the Cato Institute pointed out that US defense expenditures were proportionately higher than the average expenditures of most European nations.

This was troubling, as the US defense budget's primary objective was to defend, well, Europeans.

Carpenter basically asked why the US should be spending so lavishly on Europe when Europe had the means to contribute more to its own security. Europe's answer to the free riding accusation was basically, thanks for the help, we're taking August off while the 82nd Airborne minds the store.

Call us if there's a problem.

Which brings us to AIG.

While ostensibly an American company, AIG was a global enterprise with a presence in multiple countries.

Its AAA rating allowed its swaps subsidiary, AIG Financial Products, based in London, to underwrite Credit Default Swaps on a variety of different securities. The swaps were designed to insure the value of assets held by AIG's counterparites.

Many of these swaps, because of AIG's rating and dodgy accounting, never had capital reserves standing behind them. Now that the value of those insured assets is in free fall, collateral calls are mounting. As AIG apparently never modeled in the possibility of asset prices actually declining (a fairly reasonable assumption for anyone who has actually looked at a Bloomberg screen in the last 20 years) it is now a ward of the US Treasury.

What has been underreported by the media during the financial crisis is the extent to which the London operation, which employed nearly 400 people, aided and abetted European banks in evading EU and global capital requirements, thereby allowing them to add tequila shots to the late and unlamented global credit party.

Indeed, the Wall Street Journal recently reported that of 15 banks it could identify as receiving major Treasury aid, 9 were European, and 1, HSBC, has substantial European exposure.

Names on the list included such stalwarts as Deutsche Bank, Barclays, Rabobank, Societe Generale and Lloyds, which is now state owned. While there is no way of knowing exactly how much Europe has received until the Fed stops acting like the National Security Agency, the WSJ estimated that Deutsche alone got $6b of the total $173b in AIG bailout money.

No wonder Fed Vice Chairman Kohn refused to release to Congress the names of all of AIG's counterparties in his recent testimony. Distressed taxpayers in places like Montana and Virginia ... people who are already extremely concerned about US firms like Citigroup receiving Federal aid ... may be less than thrilled to learn that financial institution bailout capital is America's hottest new export.

Our hapless European allies have much to answer for here as well.

Politicians on the Continent, who spent the early part of the credit crisis extolling their regulatory regimes and bashing American cowboy capitalism, have to reconcile the fact that while their supposedly brilliant regulators were defending the world from the American hordes, those self same hordes were providing the financial technology to allow European banks to thwart capital requirements and inflate their balance sheets to Citigroup like levels of risk.

The risk to the financial system is that if AIG defaulted on its CDS, those European banks would need massive amounts of cash to maintain appropriate capital levels. While Europe has indeed spent massive numbers of Euros to support its banking system, in an eerie parallel of the dysfuncitonal security relationship that exists between us and them, we are subsidizing the EU's bailout by not asking them to pony up to cover AIG's obligations to their banks.

Why is this? What is it in the DNA of Washington policy makers that makes them want to ship billions of dollars to Europe without asking anything in return?

NATO, designed to fight an enemy that no longer exists and a disgraceful failure in Afghanistan, has become a black hole, sucking down billions of dollars for fairly unfathomable reasons. Now, under the infinite wisdom of our policymakers in Washington, we are have created a second black hole, giving Europe an additional subsidy by putting Deutsche, Rabobank and Soc Gen on the same handout queue as our own Citigroup (NYSE: C) and Bank of America (NYSE: BAC).

We have already allowed Europe to ride our coattails on defense: we are now allowing them the same luxury on repairing the international financial system.

We have become the Bizarro Hegemon, or, the first dominant global power in history that doesn't exact tribute from its subsidiaries, but instead, pays it out.

How long can this last? How can we responsibly be concerned with the survival of Deutsche Bank when we are about to run mind-boggling deficits to support the Left's steroidal Keynesian stimulus plan? Our European friends have (of course!) rejected Obama's calls for additional stimulus spending, so technically they should have money that we don't to bail out their banks from AIG's exposures. Lets not also forget that Britain prospered disproportionately vs its EU compatriots: London has matched New York as a global financial center over the past few years, and the UK as a whole has prospered greatly because of London's success. Gordon Brown's checkbook should be wide open, especially as Lloyd's is now a ward of the state.

At the end of the day, the administration has some explaining to do, as does the Fed, which has guarded the AIG counterparty list more closely than the State Department guards secret letters from Obama to Medvedev. We are in difficult, though not insurmountable times. We can debate the merits of stimulus spending and bailouts when it comes to our own economy. We can also debate the wisdom of AIG handing out millions in bonuses while receiving billions in Federal aid.

But to export capital to feckless allies who drop the world's problems on our lap while simultaneously criticizing our every move is irresponsible and, more importantly, absolutely incomprehensible.

About Chris Thomas

Chris Thomas is a Managing Director at Hyman Beck and Co, a global macro hedge fund based in northern New Jersey.

His views are entirely his own, and do not necessarily reflect the views of the principals of Hyman Beck or iHaveNet.com.