AIG Is Toast

How dangerous is AIG? Michael Lewitt tells us, in today's NYT:

There is a substantial possibility that A.I.G. will be unable to meet its obligations and be forced into liquidation. A side effect: Its collapse would be as close to an extinction-level event as the financial markets have seen since the Great Depression...
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.

Paul Jackson is on the same page; he also notes that AIG, which is a huge player in the P&C business, will have a substantial amount of exposure to the damage caused by Hurricane Ike -- damage estimated at between $6 billion and $18 billion.

AIG stock is now trading on option value only, which means that we can no longer look to its share price as an indication of what the market thinks is going to happen. But we can certainly look to the bond market, and if you thought the share price was ugly, just wait until you see this:

AIG's $2.5 billion of 5.85 percent notes due in 2018 plunged 19.5 cents to 33 cents on the dollar as of 9:55 a.m. in New York, according to Trace, the bond-price reporting system of the Financial Industry Regulatory Authority.

33 cents on the dollar? The message is loud and clear: AIG is toast. This is the massive counterparty failure everybody's been scared of, and frankly I'm astonished that the broader stock market isn't plunging as a result. No one is prepared for the repercussions here: The failure of AIG is likely to be an order of magnitude more harmful than the failure of LTCM would have been. And it's not even happening on a Friday, where we could have yet another Emergency Weekend to try to work things out.

Here's my favorite comment on my stock-market round-up yesterday:

That's right, Felix. FEEL the fear, sweat openly, swallow hard, stammer, piss your pants. You pathetic weasel. Go back inside until you get a grip.

I'm not ashamed to admit it: I'm having a really hard time being sanguine right now. Of course I hope that the global financial system will be able to get through this somehow. But Hank Paulson's new hard-line no-bailouts policy isn't helping: It was justifiable with Lehman, but the unintended consequence is that no one now expects a bailout for AIG, and that's just making things worse.

My one hope is that someone will essentially find a way for AIG's bondholders to suffer all the losses, while AIG's counterparties suffer very little if at all. (That also seems to be the idea behind Barclays (BCS) buying Lehman's brokerage operations.) So long as counterparty risk is minimized, we should be able to get through this. But will that happen? I have no idea.

Comments

[mrtaxx:]

That's some title to the article.
How many shares are you, your family and friends short?

2008 Sep 16 12:50 PM

[venividivici:]

Oh you are so right Felix. This market should be in complete freefall. This goes further than blind denial. This is total madness. What is holding this idiot casino up. Look at the number of shares being traded in AIG. I notice the shares and the whole market went up an hour or so ago and I went looking for the reason, CNBC of course. They headlined a new rumour that the Government was relooking at a fix. God help me. This is beyong a sick joke. If AIG didn't have enough problems, IKE may have caused $15 billion dollars of damage. How will they pay the claims?
America's reputation is being irreparably damaged by all these goings on.
Today it was reported that Singaporeans were lined up outside AIG's office there desperately trying to retrieve money they had with them.

2008 Sep 16 12:52 PM

[razorfangius:]

You're terrified, but at least the WSJ has a lovely new website.

2008 Sep 16 01:01 PM

[Jackson Cash:]

Relax, here comes another short term Federal lending shinanigan by our predictable socialist masters of monetary policy.

Whatever is left "un-cobbled" in any arrangement will be covered by yours truely.

2008 Sep 16 01:39 PM

[Gary Millichip:]

Very true Felix. And I'm just waiting for Paulson to turn tale and save AIG because of the "systemic" risk involved. Well, you know what my friend Paulson - if you had saved Lehman, we would not be in this position today!

2008 Sep 16 02:05 PM

[Gary Millichip:]

turn tail that is!

2008 Sep 16 02:06 PM

[Smarty_Pants:]

"My one hope is that someone will essentially find a way for AIG's bondholders to suffer all the losses, while AIG's counterparties suffer very little if at all"

Sure....as long as the other financial sector high-rollers can survive unscathed who cares about Joe Sixpack's pension, disability insurance, or retirement funds?

Better to let the chips fall where they may and let everyone re-learn the wisdom of the ages. "He that is surety for a stranger shall smart for it" Proverbs 11:15

Those who have violated this biblical tidbit of advice are now learning why risk control is not something you ignore. If you arrange your affairs in a manner that you can't survive the WORST POSSIBLE outcome then you are gambling with your financial future in the long run.

Using credit swaps and other derivitives to distribute risk isn't a bad thing. Pledging your resources to cover piles of these 'small' risks so that their total far exceeds your resources is the very definition of stupidity. Those who 'invested' in such schemes deserve to get burned, whether it was buying stock or bonds, or taking the opposite side of a trade.

The proper time to sidestep trouble is before you sign on the dotted line and money changes hands.

2008 Sep 16 02:24 PM

[jenrose:]

--immediately regulate short selling (prohibit it)
--regulate hedge funds
--regulate executive and board pay (based upon shareholder return only -- if the shareholders reap no rewards neither should officers)
--increase transparency across the board
--regulate 'exotic' instruments (before counterparties allowed to trade, the type of instrument first needs to be cleared by the SEC)
--convinct and send to jail those that created the CDS market and those that benefited from sub-prime
--Stop spending what you don't have and/or cannot pay back. The US as a whole needs to get real -- from the banks on down to the consumer. Cash is king.

2008 Sep 16 03:45 PM

[weiwentg:]

AIG offers policies in Asia through American International Assurance (AIA). My family has policies with them. The Monetary Authority of Singapore has assured the country that AIA is not in danger of bankruptcy and that they have sufficient assets to honor the policies. MAS generally knows what they're doing.

www.straitstimes.com/B...

Of course, people could start bailing anyway, and we all know what would happen then.

2008 Sep 16 04:03 PM

[Jackson Cash:]

Wipe out bond insurers, then this credit MONSTER can tear through bonds with no end in sight.

Total Notional Value Of Derivatives Outstanding Surpasses One Quadrillion - an interesting read:

www.jsmineset.com/ARho...

2008 Sep 16 04:13 PM

[1worldcurrency:]

Why bail out the counterparties? They're big boys. Individual policy holders, now that's another story. But someone made a commission selling the insurance, and profited on the float in the fat years. They should pay up big.

2008 Sep 16 04:51 PM

[JasonC:]

Squashnut - people unclear on the concept: bankrupts don't pay. The solvant pay. AIG either stays alive and realizes assets, then it pays. Or it dies, and it doesn't pay. You can't get more money out of a company by killing it.

2008 Sep 16 04:59 PM

[Jackson Cash:]

"Whatever is left "un-cobbled" in any arrangement will be covered by yours truely."

Update:
FED BAILS OUT AIG!!!!! * ARGH* Who's gonna bail me out!?

Here: www.bloomberg.com/apps...

2008 Sep 16 05:19 PM

[Reinko:]

I have some reading around this evening and most likely the AIG problems are derivate related. The credit default swap and the likes...

The last hurricane is not much of a problem: That simply belongs to the old ways insurance companies have worked and if it is ok they have the reserves to deal with stuff like that.

Also: They need 70 to 80 billion fast so CDS stuff is a far more likely culprit compared to evil hurricanes.

2008 Sep 16 06:06 PM

[herbert hoover:]

Wake me when the Dow hits 9000

2008 Sep 16 07:17 PM

[What A Farce:]

Hmmm..., hasn't the CDS freight train already been unleashed by the nationalization of FNM and FRE? LEH's demise just pushes that along a bit. Now AIG's demise would would really get it rolling! And really that's just what this market needs. Whether you like it or not, markets boom and they bust and they are directly related. We've had a big boom and now its time for the big bust. So deal with it.

2008 Sep 16 09:48 PM

[notsosmart:]

dont worry-socialism will solve all this.LOL & i think the world is laughing also.

2008 Sep 17 11:12 AM

[notsosmart:]

the us taxpayer is toast.

2008 Sep 17 02:30 PM