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It's beginning to look like American International Group (NYSE: AIG), the largest U.S. insurer, will file for bankruptcy possibly today or tomorrow. What could keep it from filing is a $75 billion raise in capital from the remaining investment banks. But thanks to a $14 billion margin call on its Credit Default Swaps (CDSs) resulting from S&P's downgrade of its credit rating, this capital raise is unlikely to happen.
I know that Ben Bernanke, Federal Reserve Chairman, has been reported to be an expert on the Great Depression. He is certainly going to pull the trigger on an interest rate cut this afternoon -- probably 1% -- which would bring the U.S. interest rate down to 1%. This cut will probably have no effect on stock prices, but it will telegraph to investors the level of panic within the U.S. government. After all, most Asian markets fell 4% to 5% in sympathy with the Dow's 4% decline -- the perpetrators of the 9/11 attacks must be celebrating in their caves over this bracket to Bush's eight year reign.
So what seems to be AIG's problem? Despite the New York Department of Insurance freeing up $20 billion of subsidiary capital to the parent, the U.S. decided not to give AIG a $40 billion loan, instead hoping to get a private solution. Barron's reports that "The Federal Reserve was working with JPMorgan Chase (NYSE: JPM) and Goldman Sachs (NYSE: GS) to arrange a massive loan package of up to $75 billion to stave off a severe liquidity crisis at AIG."
It will come again to the Credit Default Swap (CDS) market -- popularized by John McCain's chief economic advisor, Phil "Americans are Whiners" Gramm -- to wipe out AIG. The price of AIG's CDS have skyrocketed due to the risk of a bankruptcy and this requires AIG to pay a huge upfront premium to insure its debt.
How big of an increase? "The all-in cost virtually doubled, to a 1722 basis points, an increase of 820 basis points, according to Tim Backshall, chief strategist at Credit Derivatives Research. That would normally translate to a cost of $1.722 million annually to insure $10 million of AIG debt for five years. But, because the market fears an accident sooner, AIG CDS require an upfront payment -- some $3.05 million -- plus $500,000 annually," writes Barron's.
This is why AIG's CDS counterparties could demand that AIG come up with $14.5 billion in collateral. If JPMorgan and Goldman can somehow take money from the Fed through its Primary Dealer Credit Facility and lend it to AIG, then it will avert a bankruptcy filing. This would create the illusion that taxpayer money is not on the line in a bailout. I cannot imagine why these two banks would want to put their money on the line here.
If that doesn't work out, there's always bankruptcy for AIG. That $1 trillion bankruptcy would make it the largest in history -- surpassing Monday's previous record $639 billion bankruptcy from Lehman. But AIG is stuck in a no-win spiral where it needs to raise capital to avert a ratings downgrade. And that makes it harder to raise the capital.
The lessons of the Great Depression probably do not pertain to the current situation. This is the Greatest Depression -- about which I posted in March -- and the lessons of this one are likely to expose five fundamental flaws in our financial architecture.
An AIG bankruptcy would be the biggest sneeze ever and it would unleash a Category V storm in financial markets. I doubt that a 100 basis point interest rate cut will stop this.
Peter Cohan is President of Peter S. Cohan & Associates. He also teaches management at Babson College and edits The Cohan Letter. He owns AIG securities and has no financial interest in the other securities mentioned.
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Reader Comments (Page 1 of 1)
9-16-2008 @ 9:18AM
Sam said...
Getting sufficient funds is difficult for AIG in view of the very tight credit situation at present. The fund shortage of AIG is just too big for the market to afford. No one is willing to risk their money further in this kind of mine stock.
9-16-2008 @ 9:39AM
Gerald said...
Sell AIG it's a turd. This is the second worst Bad Faith Insurer i've ever seen next to Allstate. Cancel your AIG and Allstate policies and get a new policy with someone who will pay your claim with out the hassle.
9-16-2008 @ 10:39AM
TX CHL Instructor said...
"and the lessons of this one are likely to expose five fundamental flaws in our financial architecture."
...which are? (the term "five fundamental flaws" is highlighted, but there is no link)
9-16-2008 @ 11:20AM
ultra23 said...
Put your cursor over the letter I in I posted in March and you will get to the link.
9-16-2008 @ 12:22PM
G. Tucker said...
If businesses engage in unsound practices(eg sub prime lending) who, then, should be surprised at the 'market' disciplinary action?
9-16-2008 @ 1:12PM
Art Hill said...
How sad! The Masters of the Universe will now need to find real jobs.
9-16-2008 @ 1:49PM
Richard said...
AIG has no one to blame except themselves for this matter. The Board of Directors and the Executive Officers should be held accountable for their mistakes in this company. The American taxpayers should not have to foot any bill regarding this company, nor should banks take a risk to lend them money to keep them solvent. Remember the old saying
"The Bigger They Are The Harder They Fall"
9-16-2008 @ 5:20PM
Bill said...
Simple. I had to file bankruptcy due to the economy, health, loss of job, now let the fine idiots at AIG do the same thing.
It's all relative in the scope of things and it's time to call in the chits from all those greedy investment bankers.
Now with Uncle Ben at the Fed, he definetly needs to be on the front lines in Iraq along with that incompetent treasury secretary.
Hell, lets bring in "Chain Saw AL". Bet he could turn some cash.
9-16-2008 @ 6:38PM
Rob said...
Any CEO that puts a business in that kind of debt not only needs to be fired but put in jail. The idea of paying a criminal ceo millions of dollars for destroying a business revolts me. They should have to pay back every cent they earned and the money should go into the pension plans for the employees they screwed.
9-16-2008 @ 7:28PM
Commander Z, Patriot Militia said...
Jews did 911 and all world wars and depressions.
The solution is obvious.
http://www.Jews-Did-911.com
9-16-2008 @ 8:17PM
slinky said...
This is all crap. AIG.. SCREW AIG... let them feel the pain they deserve. Full Stop. For the Feds to bail them out is pathetic and unforgivable period. Greed is what got the financial institutions in this mess and let them suffer. Be more concerned about all the american jobs that we are loosing due to going overseas. HP is laying off 25000 pple. NOW that is a concern, as unemployment keeps rising and there is NO end in sight. Wall Street and the like need to suffer and make 7.95 a hour. Period.
9-16-2008 @ 8:48PM
Mike Landfair said...
I just posted at Mover Mike:
Aren’t the Government officials prudent with our money. According to the NT Times the FED agreed to buy an 80% stake in AIG for $85 Billion. At $3.75 the market was valuing the whole company at $10 Bullion and Yahoo’s proprietary enterprise value had AIG valued at $46 Billion. But, we didn’t get the whole company, we only got 80%, which means the value the FED is placing on AIG for the whole company is $105 Billion! Book value according to Yahoo is $29 Billion. That means we are buyiing AIG for 3X book! Bank of America bought Merrill Lynch for less than 1 1/2X book and they weren’t threatening bankruptcy!
Thanks! Can I have another?
9-17-2008 @ 2:17PM
Keith said...
This is a heist of biblical proportions. These companies have been robbed by the people at the top. Wake up people!
The bailout is the American people getting stuck with the tab. This was deliberate mismanagement no bad business deliberate criminal policy to steal all the assets of huge viable companies and have the Federal Reserve perform the obligatory criminal bailout. And take all the employees, investors for a ride.....When are you people going to wake up and cleave heads! These people are criminals! Enron on frigging steroids!