Burden Of Saving AIG May Provide Future Lessons

American International Group (AIG) offices in New York City. i i

hide captionThe offices of American International Group in New York City. On Tuesday, Federal Reserve Chairman Ben Bernanke told the Senate Budget Committee that "AIG exploited a huge gap in the regulatory system."

Mario Tama/Getty Images
American International Group (AIG) offices in New York City.

The offices of American International Group in New York City. On Tuesday, Federal Reserve Chairman Ben Bernanke told the Senate Budget Committee that "AIG exploited a huge gap in the regulatory system."

Mario Tama/Getty Images

The element of the government's Wall Street rescue program that seems to have most upset Congress is the taxpayer bailout of American International Group. The bill so far: $180 billion and counting.

The government says it has to save AIG because, as much as it takes, it would cost even more to let the company collapse. AIG has become the prime example of a company "too big to fail." U.S. government officials and politicians say the challenge now is to draw lessons from the AIG experience.

Origins In China

The AIG story began 90 years ago in China, where the company got its start. In the years that followed, AIG became a venerable name in the business world. It was the largest insurance company in the world, operating in 130 countries with the highest ratings an insurance firm can get.

But no one these days has a kind word to say about AIG, even those who are working hardest to save the company.

"If there's a single episode in this entire 18 months that has made me more angry, I can't think of [it,]" Federal Reserve Chairman Ben Bernanke told the Senate Budget Committee on Tuesday. "AIG exploited a huge gap in the regulatory system. There was no oversight of the financial products division. This was a hedge fund, basically, that was attached to a large and stable insurance company, made huge numbers of irresponsible bets, [and] took huge losses."

Nevertheless, Bernanke said, the company's failure would be disastrous.

"We're not doing this to bail out AIG or their shareholders," Bernanke says. "We're doing this to protect our financial system and to avoid a much more severe crisis in our global economy."

Guarantor Of Investments

Millions of Americans depend on AIG to insure their retirement funds. Even more important for the global economy, many European banks turned to AIG to guarantee their investments against default, purchasing "credit default swaps" from the company. Many of those banks then figured those investments were so secure that they could take on even more debt.

The company's failure at this point would do serious damage to those banks and reverberate around the world.

"AIG will in the future be the business case study for allowing a firm to get too big to fail," says Robert Arvanitis, a former AIG executive who now runs his own risk advisory firm. "Right now, we have indices like the Herfindahl Index that says, 'Is a firm too big that it has monopoly power?' We must have a similar market impact measure so that a firm can't get so big it can put the gun to its own temple."

AIG did not intentionally hold itself hostage, Arvanitis says, "but when the trouble hit, we couldn't let it go down."

Too Big To Manage?

Along with banks like Citigroup, AIG may not only be too big to fail, but it may also be too big for the U.S. government to manage. During the Senate Budget Committee hearing, Republican Lindsey Graham suggested that a better alternative to pouring money into AIG would be for the government just to take it over, sell the healthy parts and dispose of the rest. But Bernanke suggested an act of Congress might be needed for that to happen.

"I'd like to challenge the Congress to give us a framework where we can resolve a multinational, complicated financial conglomerate like Citigroup, like AIG or others, if that became necessary," Bernanke said. "We do not have that framework, and therefore we have to work within the constraints of what we have. "

When pressed last week why he and the Treasury Department have been resisting outright nationalization of troubled banks, Bernanke said it would destroy what he called their "franchise value." But that argument does not seem to apply in the AIG case. Under the government's latest plan, AIG's most valuable insurance subsidiaries are likely to be separated from the company, leaving the part of the company that recklessly sold credit default protection.

"AIG as a holding company is dead," says Peter Morici, an international business professor at the University of Maryland. "AIG will be spinning off its insurance companies through the federal government now, and once the credit default swaps are unwound, that company will largely go away."

AIG's healthy insurance subsidiaries are actually known under their own names — American International Assurance (AIA), based in Asia, and American Life Insurance Co. (ALICO), which operates in more than 50 countries. Whoever is running those firms in the future in all likelihood won't want them associated with AIG, no matter what that brand used to mean.

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