Looks like Former U.S. Treasury Secretary Henry Paulson may be headed back up to Capitol Hill soon.

On Wednesday, the Chairman of Congress' Financial Crisis Inquiry Commission (Phil Angelides) stated that Paulson may be one of the witnesses called to testify in front of the panel. Right after emerging from the panel's first meeting, the chairman of the bipartisan group noted that it "must examine" the financial institutions that did or could have crumbled if not for the help of the government.

Luckily for American International Group Inc. (NYSE: AIG), the embattled insurer has agreed to sell its AIG Finance unit to China Construction Bank for $70 million in cash. This news is helping to offset some distinctly less bullish developments for AIG today.

Specifically, Patrick Fitzgerald of Dow Jones Bankruptcy Review reports that Lehman Brothers Holdings (LEHMQ) is asking a bankruptcy judge to force AIG to pony up millions of dollars it owes Lehman for credit default swaps.

Listen up! Listen up to what Fed Chairman Bernanke has to say about commercial real estate. He said that the market for securities backed by commercial mortgages had "completely shut down." This is a serious if not devastating statement. Can we infer that the market for credit default swaps (CDSs) has shut down? If so we are at the brink of a new financial situation.

Mr Bernanke also stated that continued deterioration in commercial property with defaults rising sharply would present a "difficult" challenge for the economy. Prices for commercial real estate have fallen 35% since the market's peak.

In the past sixth months, IntercontinentalExchange, Inc. (NYSE: ICE) has gone from high-risk play to a model whose electronic trading and centrally-cleared products have become marketplace leaders, particularly for energy products.

Further, while FY2009 revenue and earnings will not overwhelm, look for electronic trading, energy products trading, and clearing house function revenue streams to resume solid growth by mid FY2010.

In the film version of Tennessee Williams' 'Cat On A Hot Tin Roof' (1958), Maggie 'The Cat' (Elizabeth Taylor), knows her husband Brick (Paul Newman) is hiding something, but she can't figure out what it is.

Later, we learn that Brick is hiding the truth about his father, millionaire Big Daddy (Burl Ives), and he slowly gathers the courage to end the mendacity that has permeated their lives.

At some point the nation will, likewise, end the mendacity about American International Group (NYSE: AIG) and announce the full, probable cost of the orderly stabilization of AIG. For economic conservatives, market absolutists, most Republicans, and others who oppose government intervention, the above would be bad news, but at this juncture, it appears to be unavoidable.

Citigroup (NYSE: C) and American International Group (NYSE: AIG) have already taken about $496 billion in U.S. cash and guarantees to keep them from failing. This makes me wonder: Is there no way to allow them to simply fail without causing the entire global financial system to collapse? And if not, is there a limit to how much more taxpayer money we pour into them before we say "no more"? The answers: Maybe and Yes.

Citi looks to be a basket case after $345 billion in taxpayer bailouts. It has already gotten $45 billion in cash -- $25 billion of which was recently converted from preferred to common -- and $301 billion in guarantees of its toxic assets. The U.S. now owns 36% of the common stock of Citi -- which lost $27.7 billion in 2008 and has a market capitalization -- Citi common shares times price per share -- of $8.2 billion.

It looks like America has shut down until 2009. And that's probably a good idea because there were so many bad ones in 2008. Bad ideas are like vampires. They charm their way into the good graces of a host society and then they suck the blood right out of them.

Although they all didn't just pop into our lives in 2008, these eight ideas reached a peak of awfulness in 2008:

• Deregulation is good. The wave of deregulation that started in the early 1980s has created enormous problems for society. Sure there were some bad regulations on the books, but just one deregulated industry -- the $62 trillion credit default swaps (CDS) market -- has cost taxpayers hundreds of billions of dollars in the bailout of American International Group (NYSE: AIG).
• If you can lend against it, securitize it. Securitization -- the practice of buying, credit-rating, and bundling loans backed by assets like mortgages, credit card receivables, and leveraged buyout loans -- created the illusion that you could mix risky loans in with safer ones and you could earn above-average returns with no risk. Bad call -- securitization has spread toxic waste around the world from Iceland to Whitefish Bay, Wis.
• Home-ownership is good for everyone. The hungry maw of securitization created enormous demand for new mortgages. And that led mortgage originators to lend to people who couldn't afford to pay back the loans. The $1.3 trillion subprime mortgage market was born and it grew so big that its collapse refused to remain contained. In 2004 Bush bragged about home ownership reaching 69.2% -- three million foreclosures later it seems we should be careful what we wish for.
• Leverage up your balance sheet 30:1 or more. In 2004, the SEC gave financial institutions (FIs) discretion to borrow more money than they had ever borrowed before. Most banks and hedge funds borrowed as much as $35 for every $1 of equity. If they had used their $340 billion in equity to buy the $13 trillion worth of mortgage-backed securities (MBSs) and collateralized debt obligations (CDOs), a 3% decline in the MBSs and CDOs value would have wiped out the FI's capital.

Once again, Dow 8,000 has come back into focus.

For those investors who may not follow indices closely, the 8,000 level has a psychological but not technical support, the latter of which measures such things as the number of investors who are buying / selling, whether investors are committing more money to the market etc.

Even so, right now, a battle is taking place between the bulls and the bears: the bears argue the worst economic news stemming from the financial crisis is yet to come; the bulls argue that the worst news is behind us, and that government stimulus, fiscal and monetary, will get the U.S. economy moving again.

The Dow Jones Industrial Average Wednesday closed below 8,000 at 7,997. If the bears can keep the Dow below 8,000 and then push it through 7,800, then 7,600, it will not be a pleasant time for investors.

Let's do a condensed, cross-methodology analysis to see if we can arrive at an informed investment decision / conclusion regarding where the Dow is headed, near-term.

With apologies to actor William Shatner, How big could the bailout of AIG get? Really big.

The U.S. government -- which is all of us, citizens and taxpayers -- may have to increase its investment in American International Group (NYSE: AIG) by still another $70-80 billion to keep the insurer solvent through the end of 2009.

Just call it USG-AIG

AIG, which reported $43 billion in losses tied to home mortgages in the past quarter, "will probably not function properly if it doesn't receive another cash infusion by September 2009," economist David H. Wang told BloggingStocks Tuesday. Wang based his forecast on his projection for cashed-in credit default swaps stemming from home mortgage defaults.

AIG is a major issuer of credit default swaps, actually a type of credit default insurance, which many holders of mortgage backed securities and bonds purchased to hedge against bond issuer defaults.

"If we project a rise in home mortgage defaults through Q2 2009, that will likely take credit default claims to levels that will require more money for AIG in late 2009," Wang said, although he qualified his projection by stating that it is contingent on negative U.S. GDP for Q1/Q2 2009. A U.S. economic recovery in Q2 2009 is possible, but not likely, Wang said.

AIG's shares fell 15 cents to $2.14 on Tuesday at mid-day, amid a broader market sell-off.

Every once in while during a crisis or history-altering event, you run across a quote or an observation that sort of summarizes events on the ground, in a nutshell. Former U.S. Federal Reserve Chairman Paul Volcker articulated one such observation during a recent chat he had with PBS's Charlie Rose.

"It seems to me what our nation needs is more civil engineers and electrical engineers and fewer financial engineers," Volcker said.

U.S.: a decade of descent

And there you have it -- the United States' decade of descent, in a nutshell. Volcker's observation speaks volumes about where the United States economy -- and the nation, at large, for that matter -- is today.

For reasons that historians will undoubtedly debate for decades (globalization, automation, flawed public policies, inadequate regulations, overconsumption, the availability of foreign capital, greed) the United States embarked on a financing boom -- creating an increasing array of creative and untenable mortgage types, accompanied by an equally problematic set of mortgage backed securities. It generated an unsustainable housing bubble, which ended as all bubbles do -- badly -- triggering the global financial crisis.

And yet, all the while, as Volcker observed, public investment in infrastructure -- the physical backbone of the economy, of the nation, really -- declined. That infrastructure is now in a state of disrepair. The nation's schools, hospitals, roads/bridges/mass transit systems/air travel system and even our electric grid are inadequate to meet the nation's current requirements, let alone the requirements of an expanding, vibrant, dynamic, twenty-first century economy.

What financial services/banking reforms and related measures should the new U.S. Congress consider when it convenes in January 2009?

How much time do you have?

Yes, without question, the Congress is going to have a full plate when its first 2009 session starts, and there is a sincere wish -- a really, really sincere wish -- that none of these items has to be addressed sooner. That's the hope, anyway. We'll see.

Task 1: Credit default swaps/derivatives regulation and reform

Simply, all credit default swaps/derivatives -- direct and those with counterparties based in the United States -- must be regulated by the U.S. government through the Securities and Exchange Commission, or by the creation of a new Derivatives Regulatory Commission.

Among other powers, this agency would establish capital requirements, list pricing data, and limit leverage ratios for all parties. Banks protected by the FDIC would be banned from owning or selling derivatives or swaps.

The global derivatives market was more then $530 trillion as of June 2008. Of this amount, credit default swaps -- it's really credit default insurance -- totaled more than $55 trillion, according to the International Swaps and Derivatives Association.

The financial crisis is not over. If things were back to normal, banks would be lending to each other and to businesses and individuals. But measures of bank lending risk suggest fear is 12 times as high as it would be in normal times. The reason? Banks know more than you do about what's wrong. And they're not talking about it because they don't want you to withdraw your deposits and sell your stock. What they know is that on October 21st, some of the biggest players on Wall Street could be required to come up with $400 billion that some may not be able to pay.

Last month, the White House decided that we could afford to let Lehman Brothers file for bankruptcy. That proved to be an enormous mistake. It triggered a run on money market funds because one of the oldest such funds, Reserve Primary, broke the buck since it held Lehman Brothers paper. The U.S. responded with a $50 billion guarantee of money market funds. But the biggest consequence of that mistake is in the $54.6 trillion market for Credit Default Swaps (CDSs).

A CDS is like selling insurance on your car to hundreds of people who don't own it -- yet if your car goes up in flames each of those people collects the full value of your car. More specifically, CDSs are insurance against a bond or loan default. Why are CDSs so dangerous? Three reasons: a CDS seller does not need to put any capital aside to cover losses if the security defaults, the buyer doesn't need to own the asset it wants to protect, and there is no central place where information about all these CDS deals is collected and updated.

This morning markets in Asia fell about 4% -- a relatively muted response to the 7% drop in the Dow Monday. Should we trust our increasingly fragile global financial system to the 73-year old gambler who claimed a victory in yesterday's failed vote on the bailout bill? One poll suggests that the answer is no.

A September 29th Gallup poll found that Americans have the least trust in the Administration's ability to handle this financial crisis and the most in Senator Barack Obama (D-IL), 47. Here is the percentage of Americans who approved of how various people were handling the economic crisis:

• Barack Obama (46%)
• Democratic congressional leaders (39%)
• John McCain (37%)
• Republican congressional leaders (31%)
• Hank Paulson and George Bush (28% each)

Senator McCain, a former POW, gambled on taking money from corporate interests, on appointing Sarah Palin as vice president, and on choosing Phil "Americans are Whiners" Gramm as his chief economic advisor -- the same guy whose bill to deregulate the Credit Default Swap (CDS) market helped get us into this financial catastrophe.

Our national decision is less than six weeks away.

Peter Cohan is President of Peter S. Cohan & Associates. He also teaches management at Babson College and edits The Cohan Letter.

Some investors/readers -- and certainly casual observers of the stock market in towns small and large -- have been perplexed by the turn of events that has led to the current state of affairs in these United States: namely how and why does the U.S. government need to pass a $700 billion bailout/intervention bill to end a financial crisis in the U.S., possibly globally?

While numerous economic, regulatory, and behavioral factors created the conditions that formed the basis for the crisis, economist Richard Felson told BloggingStocks that the imminent failure of insurance giant American International Group (NYSE: AIG), in his view, "was the flashpoint at which both [U.S. Treasury Secretary Henry] Paulson and [U.S. Federal Reserve Chairman Ben] Bernanke realized that a case-by-case, reactive policy would not be adequate to check the building financial storm."

No AIG, massive exposure

Felson pointed out that at least a portion of hedge fund trades -- and the trades of other financial institutions -- are predicated on the assumption that mortgage-backed securities are good/have value, or, if not, that the insurance behind these securities is in force as a result of policies written by AIG. When it became clear that AIG did not have the assets/resources to pay claims, it was necessary for the U.S. government to take over AIG via a $85 billion loan from the U.S. Federal Reserve for warrants for a 79.9% stake in the company.

The State of New York has proposed to start regulating credit default swaps owned by investors trying to protect bonds they own, Bloomberg News reported.

The plan won't apply to credit default swaps purchased by speculators, i.e. swap owners who are trying to profit from an increase/decrease in a borrower's creditworthiness, New York Governor David Paterson told Bloomberg News. Paterson also urged the federal government to follow New York's lead and regulate the rest of the credit default swap market.

Credit default swaps are contracts designed to protect against or speculate on default. CDSs pay the buyer face value if a company fails to adhere to its debt. Hedgers typically use them to guard against bond losses. However, speculators use them as an active investing/trading tool in an attempt to profit from a company's / issuer's credit worthiness.

Economist David H. Wang told BloggingStocks there's an upside and a downside to increased regulation of the $62 trillion CDS market.

"On the one hand, we do need a central regulator in the United States to verify that those selling credit default swaps can in fact pay the swap holder if there is a default claim," Wang said. "The system for swaps was jeopardized when AIG could not pay all claims, and could have resulted in contagion, which prompted the federal government's loan."