What's AIG and What's Its Role in This?

American International Group Inc.
AIG: NYSE; Financials/Insurance - Multiline

American International Group was the largest insurance company in the United States before it suddenly collapsed in September 2008 under the weight of bad bets it made insuring mortgage-backed securities. The company was bailed out by the Federal Reserve, but even after that $85 billion infusion, losses continued to mount and in November the Treasury announced a new rescue package that brought the total cost to $150 billion. Read More

From Propping Up a House of Cards in the NY Times:

When you start asking around about how A.I.G. made money during the housing bubble, you hear the same two phrases again and again: “regulatory arbitrage” and “ratings arbitrage.” The word “arbitrage” usually means taking advantage of a price differential between two securities — a bond and stock of the same company, for instance — that are related in some way. When the word is used to describe A.I.G.’s actions, however, it means something entirely different. It means taking advantage of a loophole in the rules. A less polite but perhaps more accurate term would be “scam.”

The article goes on to explain how AIG used its AAA rating to package, sell and insure credit-default swaps to financial institutions all over the Western economy.

Later on in the article:

Here’s what is most infuriating: Here we are now, fully aware of how these scams worked. Yet for all practical purposes, the government has to keep them going. Indeed, that may be the single most important reason it can’t let A.I.G. fail. If the company defaulted, hundreds of billions of dollars’ worth of credit-default swaps would “blow up,” and all those European banks whose toxic assets are supposedly insured by A.I.G. would suddenly be sitting on immense losses. Their already shaky capital structures would be destroyed. A.I.G. helped create the illusion of regulatory capital with its swaps, and now the government has to actually back up those contracts with taxpayer money to keep the banks from collapsing. It would be funny if it weren’t so awful.

Why US keeps backstopping a flattened AIG

From an article in the Christian Science Monitor:

After Lehman Brothers failed in September, the financial markets froze up, causing interest rates to jump despite vigorous efforts by central bankers worldwide to keep credit flowing. Would the same thing happen – or perhaps something worse – if the US let troubled insurance giant AIG (American International Group) fail?

Yes, is the reply from the US Treasury and the Federal Reserve, which added another $30 billion commitment to AIG on Monday. This increases taxpayers’ pledges to the company to $180 billion – about the same amount to be spent this year under the just-passed economic stimulus package. It is the fourth time Uncle Sam has had to backstop the company.

“AIG by itself is not important, but it is intertwined in so many other aspects of our financial life and so many people rely on it in one form or another,” says Stan Collender, a partner at Qorvis Communications in Washington. “If AIG were allowed to go down, it could lead to possibly a global depression."