TW: Today we announced another eleven figure bailout for AIG. As Nocera frames, the situation is very frustrating but ultimately unavoidable. AIG is many ways is the poster child for the financial irresponsibility and incompetence that has led us into this morass. AIG is a complex business (with many that are still profitable) but the easiest way to think about it's problematical piece is to think of an out of control insurance company.
Except in this AIG unit's case, it issued massive insurance (multi-trillion $) policies covering financial instruments. AIG collected the premiums which was a great business as long as few attempted to collect on the insurance. But when the financial system imploded, all of those holding those insurance policies tried to collect but AIG not surprisingly in retrospect did not have the trillion $ or so it would have needed to pay off on those policies.
The U.S. government is faced with a dilemma, help AIG unwind those policies or create a whole new wave of falling dominoes. As the folks who bought those insurance policies include international governments, our already troubled banks and other financial institutions. Everyone kept the party going by buying these insurance policies and issuing even more debt ("we can always collect insurance if they default") but the punch bowl in empty now. Or rather U.S. taxpayers are re-filling it as fast as they can lest the world's financial system truly implode (i.e. remember I think u still want your ATM to work, we are not bailing out the "financial" system, we are bailing ourselves out).
From Nocera at NYT:
"...Donn Vickrey, who runs the independent research firm Gradient Analytics, predicts that A.I.G. is going to cost taxpayers at least $100 billion more before it finally stabilizes, by which time the company will almost surely have been broken into pieces, with the government owning large chunks of it. A quarter of a trillion dollars, if it comes to that, is an astounding amount of money to hand over to one company to prevent it from going bust. Yet the government feels it has no choice: because of A.I.G.’s dubious business practices during the housing bubble it pretty much has the world’s financial system by the throat.
If we let A.I.G. fail, said Seamus P. McMahon, a banking expert at Booz & Company, other institutions, including pension funds and American and European banks “will face their own capital and liquidity crisis, and we could have a domino effect.” A bailout of A.I.G. is really a bailout of its trading partners — which essentially constitutes the entire Western banking system.
I don’t doubt this bit of conventional wisdom; after the calamity that followed the fall of Lehman Brothers, which was far less enmeshed in the global financial system than A.I.G., who would dare allow the world’s biggest insurer to fail? Who would want to take that risk? But that doesn’t mean we should feel resigned about what is happening at A.I.G. In fact, we should be furious. More than even Citi or Merrill, A.I.G. is ground zero for the practices that led the financial system to ruin.
“They were the worst of them all,” said Frank Partnoy, a law professor at the University of San Diego and a derivatives expert. Mr. Vickrey of Gradient Analytics said, “It was extreme hubris, fueled by greed.” Other firms used many of the same shady techniques as A.I.G., but none did them on such a broad scale and with such utter recklessness. And yet — and this is the part that should make your blood boil — the company is being kept alive precisely because it behaved so badly."
http://www.nytimes.com/2009/02/28/business/28nocera.html?_r=1&pagewanted=all
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