There is a momentary sigh of relief among worried investors that the United States government has agreed to bail out American International Group Inc, the world’s largest insurer, to the tune of USD85 billion.
It has emerged that U.S. Federal Reserve will lend up to this amount to AIG for two years in exchange for a 79.9 percent equity stake. For the time being, AIG has staved off bankruptcy.
“In current circumstances, a disorderly failure of AIG could add to already significant levels of financial market fragility and lead to substantially higher borrowing costs, reduced household wealth and materially weaker economic performance,” the Fed said in a statement.
Nevertheless, investors are still keeping a nervous eye on AIG which does business with almost every financial institution in the world. The company insures US$88 billion worth of assets and plays an outsized role insuring mortgages and corporate loans.
However, what has Wall Street scared is that AIG is an integral player in the murky world of hedge funds and credit derivatives. Investors worry its failure would pose an even greater threat to the US financial system than the collapse of Lehman Brothers.
A collapse of AIG would force Wall Street to untangle the complex credit derivatives markets and send the market scrambling to figure out who owes what to whom – or even who owns what.
“Regulators knew that if Lehman went down, the world wouldn’t end,” money manager Michael Lewitt wrote in an op-ed column in The New York Times. “But Wall Street isn’t remotely prepared for the inestimable damage the financial system would suffer if AIG collapsed.”
But already, the rescue plan has come in for criticism. “What the U.S. government is doing is basically delaying the recovery of the economy by keeping AIG alive and going back to the printing press to issue more U.S. dollars, which in the long term should be negative to the U.S. dollar,” said Ronald Chan, chief investment offer for Asian equities with Fortis Investments in Hong Kong. “Recovery is going to be prolonged,” he added.
There is also argument that the Fed may have opened the door to countless other companies to come calling for help. “We’re essentially continuing a system where profits are privatized and … losses socialized,” said Nouriel Roubini, a professor at New York University’s Stern School of Business, adding that automakers, airlines and other struggling businesses will be lining up for a government bailout.