Business and Economy: Fed bails out AIG, averting crisis

Story by Chris Graham
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The Federal Reserve is lending $85 billion – with a b – to rescue American International Group in a move that analysts are saying will forestall a global economic crisis that could have resulted from the collapse of the insurer.

“Insurance companies are not normally institutions that the federal government has anything to do with. The Treasury, the Federal Reserve, the FDIC, any of them. There’s no formal mechanism for supporting an insurance company. And usually we don’t think of insurance companies as being profoundly integral to the financial system. But AIG is very deeply interwoven into the world’s financial system,” said Barkley Rosser, an economics professor at James Madison University, who had tried to talk down the idea that doom was impending if AIG were to fail to avoid bankruptcy earlier in the day on Tuesday before the announcement from the Fed about its bailout.

Under the terms of the loan, the federal government will receive a 79.9 percent stake in AIG. An eventual liquidation of the company, a major player in the market for credit-default swaps, which are contracts that like insurance guarantee against a company defaulting on its debt, and in the more traditional life-, property- and casualty-insurance markets, and has $1.1 trillion – with a t – in an assets and 74 million clients in 130 countries, is likely

It is the global reach of AIG that made it incumbent upon the Fed to step in and do something to keep it from failing. “Part of why it’s in trouble is it had been ensuring these wildly complicated financial contracts that are the sort of thing that had gotten Lehman Brothers in trouble all over the world,” Rosser said. “A lot of these kinds of contracts have gone bad. In a sense, AIG has been acting as a sort of Federal Reserve for these financial contracts. Central banks operate as kind of lenders of last resort, entities that back up regular banks in their normal financial dealings. Nobody backs up these much more complicated derivatives markets operations,which operate on a much larger scale. We’re talking about hundred-trillion dollars markets. They’re huge,” Rosser said.

The failure of AIG would have meant that “you would have people all over the world left holding the bag. It’s very, very scary,” Rosser said.

The Fed acknowledged that in a statement released Tuesday evening to announce the news of the loan. A “disorderly failure of AIG could add to already significant levels of financial market fragility and lead to substantially higher borrowing costs, reduced household wealth and materially weaker economic performance,” the statement read.