This article was last updated on July 13
Well, the next big company on the chopping block this week was insurance company AIG. Unlike Merrill and Lehman, it was able to secure government assistance through a $85 billion emergency cash injection. The government and fed officials justified the loan by saying AIG was another “too big too fail” institution that had to be saved in order to prevent further financial and economic turmoil.
“It might not just bring down other financial institutions in the U.S. It could bring down overseas financial institutions,” said Timothy Canova, a professor of international economic law at Chapman University School of Law. “If Lehman Brother’s failure could help trigger AIG’s going down, who knows who AIG’s failure could trigger next.” (Yahoo Finance)
It’s the interconnectedness and the fear of the unknown, meaning the impact of a failure,” said Roger Altman, a former Treasury official under President Bill Clinton. “But size is a factor, you can’t ignore that. The prospect of world’s largest insurer failing, together with the interconnectedness and the uncertainty about the collateral damage — that’s why it’s scaring people so much.” (NY Times)
It was interesting to see how the deal was similar to the recent bailout/conservatorship of publicly listed GSE’s Fannie Mae and Freddie Mac, with the government receiving a 79.9 percent equity stake in AIG for making the cash injection (loan). This was exactly the same equity stake taken in Fannie and Freddie, and basically gives the government full control of the companies with existing shareholders to face a near wipe out. To me it is questionable if the government and its regulators will be able to run these companies any better than current management given market conditions and climate of fear. I just hope they get in, fix things and get out as soon as possible with some kind of return for taxpayers who are ultimately funding these bailouts.
How did AIG get into this mess: AIG’s problems stemmed from its insurance of mortgage-backed securities and other risky debt against default. If AIG couldn’t make good on its promise to pay back soured debt, investors feared the consequences would pose a greater threat to the U.S. financial system than this week’s collapse of the investment bank Lehman Brothers. The worries were triggered after Moody’s Investor Service and Standard and Poor’s lowered AIG’s credit ratings, forcing AIG to seek more money for collateral against its insurance contracts. Without that money, AIG would have defaulted on its obligations and the buyers of its insurance — such as banks and other financial companies — would have found themselves without protection against losses on the debt they hold. (Yahoo Finance)
Investors will cheer this move because it stabilizes markets in the short term. Overall, I do understand (but not a fan of) the need for this action by the Fed because the failure of AIG would have cost much more to the economy in terms of tighter credit markets, higher borrowing costs and further exacerbation of the housing crisis. However as a taxpayer it does mean that you and I will have to potentially bear the costs of this bailout down the line through higher taxes. I also suspect that this will not be the last government bailout and a number of more companies are going to be at risk as the financial contignation and crisis of confidence spreads. For a free market, capitalistic society, we sure are nationalizing a lot of institutions – remind you of other countries we once looked down for doing exactly the same thing?
Picture courtesy : wallyg