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Generational Dynamics Web Log for 17-Sep-2008
The Fed will loan American International Group (AIG) an $85 billion bridge loan

Web Log - September, 2008

The Fed will loan American International Group (AIG) an $85 billion bridge loan

In a stunning turn of events that is widely recognized as desperate, the US will become 80% owner of American International Group (AIG) Inc., the world's largest insurer, in return for an $85 billion loan.

The alternative was that AIG would declare bankruptcy. AIG stock lost 21% on Tuesday alone, ending at $3 per share, down from $70 a year ago.

Government officials felt that they had no choice, because of "systemic risk."

AIG and its subsidiaries don't just provide insurance for cars and homes. They also provide insurance for corporate defaults, in the form of credit default swaps (CDSs).

The nationalization of Fannie Mae and Freddie Mac 10 days ago caused a "CDS event," as I described last week. Last week's CDS event is causing interlocking CDSs to unwind. That process is still ongoing, and it's final result is still unknown.

(For a discussion of credit default swap (CDS) counterparty risk, see "Brilliant Nobel Prize winners in Economics blame credit bubble on 'the news.'")

An AIG bankruptcy would cause a much large CDS unwinding. AIG is insuring $441 billion of fixed-income investments, including $57.8 billion in mortgage-backed securities.

There have already been $25 billion in CDS asset writedowns for AIG in the last nine months, and there will be more. But if AIG were to go bankrupt, then it would have cost OTHER companies some $180 billion dollars.

(As the old saying goes, a billion here and a billion there, and pretty soon you're talking about real money.)

As regular readers of this web site know, we're less interested in the specifics of actual events than we are in changes of behavior and attitude. The Fed and the Treasury Dept. were widely praised a couple of days ago, when they didn't bail out Lehman Bros., but let the investment bank go bankrupt.

If you look at the hierarchy of financial organizations that are crucial to the operating of a healthy worldwide financial system, you have central banks (like the Fed or the European Central Bank or the People's Bank of China) at the top of the heap. The next layer is commercial banks, like Citibank and Bank of America; commercial banks are highly regulated, but have always had access to central bank funds in case of emergency. The next layer is investment banks, like Bear Stearns and Lehman Brothers; the Fed arranged an orderly collapse of Bear Stearns and received much criticism, in contrast to the praise for allowing Lehman Brothers to simply go bankrupt.

Normally, an insurance company would be so many layers down that no one would ever consider allowing the government to bail it out.

That's why Tuesday's actions are so stunning and breathtaking.

In order for Tuesday's actions to occur, the financial community, and the public in general, must believe that the situation is so entirely desperate that there's no choice.

Nonetheless, this decision will be widely debated.

From the point of view of Generational Dynamics, we see the acceleration of events. We first had Bear Stearns in March. The past ten days have been incredible!! We make history every day! First Fannie and Freddie, then Lehman, now AIG. Oh, and let's not forget that Merrill Lynch is going out of existence -- it is being acquired by Bank of America.

Compare this preceding paragraph with the following one, which I wrote last year in "The bubble that broke the world":

"On May 11, 1931, the Credit-Anstalt bank of Austria failed. This triggered mass panic and bank failures throughout Central Europe, and generated a worldwide banking crisis. On July 13, the German Danatbank failed. Foreign investors in Germany quickly withdrew their capital from Germany, heightening the crisis, leading to the complete collapse of the German economy. By the end of the year, there were over 6 million unemployed, and the resulting social tension gave rise to Communism and Naziism."

This is the kind of thing that we're headed for. As usual, precise dates cannot be predicted, but we seem to be accelerating in that direction. If you haven't read "The bubble that broke the world," you should do so now. (17-Sep-2008) Permanent Link
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Generational Dynamics Web Log for 17-Sep-2008 The Fed will loan American International Group (AIG) an $85 billion bridge loan

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Generational Dynamics Web Log for 17-Sep-2008
The Fed will loan American International Group (AIG) an $85 billion bridge loan