UPDATE 2: The Fed appears to be caving and is said to be working on an AIG bailout plan. Market has recovered accordingly.
UPDATE: AIG’s former CEO Hank Greenberg went on CNBC this morning to beg the government for a bridge loan. He tried to differentiate the company from Lehman, Fannie, Freddie, et al, by arguing that failure would be catastrophic (and un-American). He also said the company’s subisdiaries are healthy, so the company is “not insolvent.” Here is the full transcript from CNBC.
EARLIER: We’e survived the collapse of Lehman Brothers (LEH) and the sale of Merrill Lynch (MER), but money manager Michael Lewitt argues that AIG (AIG) is a different story.
In an op-ed for the Times, Lewitt argues that a liquidity crisis at AIG will hammer everyone on Wall Street by interrupting the $60 trillion market for credit default swaps, in which AIG is a central player.
A.I.G. does business with virtually every financial institution in the world. Most important, it is a central player in the unregulated, Brobdingnagian credit default swap market that is reported to be at least $60 trillion in size.
Nobody knows this market’s real size, or who owes what to whom, because there is no central clearinghouse or regulator for it. Credit default swaps are a type of credit insurance contract in which one party pays another party to protect it from the risk of default on a particular debt instrument. If that debt instrument (a bond, a bank loan, a mortgage) defaults, the insurer compensates the insured for his loss. The insurer (which could be a bank, an investment bank or a hedge fund) is required to post collateral to support its payment obligation, but in the insane credit environment that preceded the credit crisis, this collateral deposit was generally too small.
Many of the Street’s largest financial institutions count on AIG to insure the risky assets they bought during the credit and mortgage boom. So, Lewitt’s theory is that, if AIG goes under, all of these institutions will have nowhere to turn. Additionally, the price of risky assets would plunge even further as AIG unwinds its positions on morgage-backed securities and derivatives:
If A.I.G. collapsed, its hundreds of billions of dollars of mortgage-related assets would be added to those being sold by other financial institutions. This would just depress values further. The counterparties around the world to A.I.G.’s credit default swaps may be unable to collect on their trades. As a large hedge-fund investor, A.I.G. would suddenly become a large redeemer from hedge funds, forcing fund managers to sell positions and probably driving down prices in the world’s financial markets. More failures, particularly of hedge funds, could follow.
Regulators knew that if Lehman went down, the world wouldn’t end. But Wall Street isn’t remotely prepared for the inestimable damage the financial system would suffer if A.I.G. collapsed.
After the ratings agencies downgraded AIG late yesterday, it will be forced to post an additional $20 billion in collateral. To keep itself afloat long-term, the firm will have to find even more. If AIG can’t secure a loan on its own from J.P. Morgan (JPM) and Goldman Sachs (GS), Lewitt argues that the government will simply have to step in.
See Also: AIG (AIG): We Lent Ourselves $20 Billion. Now Please Lend Us More!
AIG (AIG) To Investor: We Don’t Want Your Money. We’d Rather Have a Fed Bailout
AIG (AIG): Oops. We Just Made Same Mistake As Lehman Brothers (LEH)
Business Insider Emails & Alerts
Site highlights each day to your inbox.