Busted: Bankers and The Global Economy

September 17, 2008

Bailout Fever Strikes U.S. Again

The world of insurance will never be the same. AIG, a major insurance corporation and the world’s largest insurer has averted the worst financial collapse in history by accepting an $85 billion Federal Reserve loan and giving the government a majority stake in the company. The U.S. Treasury was fearful of a “disorderly failure” that would lead to larger national failures.

American International Group was a wild card with failure creating an enormous and unknown measure of system risk to the entire economy. The federal government gets 79.9 percent take of the firm and senior managers give up their jobs.

panic on the street

panic on the street

Meanwhile, the Federal Reserve loan with a 2-year term will allow AIG (in theory) to divest itself of assets in a timely manner without creating an immediate crisis. Stockholders have been effectively squeezed out and are subject to losing any dividends.

AIG was huge in the credit default market, insuring contract guarantees that companies would not fail in large financial deals. A default contract buys protection against the threat of default by a company, municipality or a package of debt backed by mortgages. A buyer pays the seller a premium over a set term. The seller pays out if the default occurs. Defaults on mortgages and securitized bonds brought AIG to the verge of oblivion.

The complexity and global reach is huge, likely affecting every fund on the market in one fell swoop. Even with the loan in place to protect AIG for the short-term, Wall Street is reeling from the effects. A future bankruptcy would also play havoc on business contracts. There are reports that people are hording cash. Derivatives have been a highly profitable on Wall Street until now. The financial world is changing quickly as repercussions from the subprime mortgage crisis ripple across the globe.

~ E. Manning

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