Implications of an AIG Failure

Lehman brothers was allowed to fail today without a government bailout, and without a buy out (although there was opportunity for the latter by the Korean Bank KDB as I discussed in a previous post.) It could be assumed that the failure of this bank was a risk the government was willing to take in its strategy of picking and choosing companies in order avoid a complete collapse of the U.S. banking system. AIG, however, with its balance sheet worth over a trillion dollars, does not appear on the list of companies that will be allowed to fail and shouldn't. The implications of AIG failing are much greater than Lehman Brothers. AIG faces the threat of a credit downgrade from the rating agencies if the company is not able to sell its assets and raise capital. Personal insurance under the insurer would not be affected but commercial insurance would. If AIG was to receive a downgrade commercial interests across the world would not meet its obligations of having high grade insurance and would be forced to find insurance elsewhere. This would create opportunity for companies such as Metlife, Allstate, Prudential, Chubb, and The Travelers as AIG would lose a substantial portion of this market share. This is needless being that a substantial portion of AIG's woes come from its risky backing of complex derivative securities. AIG spans 130 countries with assets so large in number it would be impossible to quantify. It's failure would be incredible.

My contention on action must be weighed against it's ultimate benefit to society. You can say that all of these delicate actions to keep the country's economy afloat is ultimately beneficial in that it is preventing another great depression. You can also say that we are merely propping up the dead in the name of preventing a collapse - this having great social risks in itself through moral hazard. AIG was given a 20 Billion loan from the state of New York to create a bridge to sell more of its assets. Another 20 Billion is still needed which will presumably come from the federal government. If AIG can overlook its pride, the best course of action would be to sell all of its assets as cheap as they can and divide up what has become too large to quantify and too risky to manage. Merrill did this very intelligently. Bank of America bought the company cheap which at least keeps the company alive. I am personally impressed with the CEO of that company, John Thaine, for his diligent, selfless actions to save that company from collapse. AIG needs to do the same, as do all other companies in danger of collapsing in order to prevent a financial calamity with far reaching social consequences.