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AIG saved, but with Government intervention

This is a time that no Economic Affairs Minister (or Secretary of Commerce), and Central Bank Governor would want to see. Imagine spending public money to shore up private companies ! Balance that with a risk to sentiment if such large companies, immensely integrated in the economy, suddenly collapse. The potential that overall sentiment becomes very negative is too huge. So, public officials, even if against intervention in the market economy, have to balance such intervention against the need to prevent economic sentiment from turning negative (and such a need is central to their jobs of shepherding the economy to growth and prevent malaise such as a depression or low growth).
All these sentiments came right to the fore when the question about what to do about the economic giant, AIG came to the fore. Suddenly, after the sale of Merrill Lynch and the collapse of Lehman Brothers, problems revolving AIG and its credit problems were a massive problems to the US Government. It could let Lehman Brothers go down the tubes, but not so AIG. The extent of AIG’s integration into the economy made a resurrection seem a very obvious, and given that it was unlikely another private party could intervene, it was finally the US Federal Reserve that intervened and provided AIG the life support (in the form of a massive loan) that it needed:

American International Group Inc. averted the worst financial collapse in history by accepting an $85 billion federal loan and giving the government a majority stake. The U.S. reversed its opposition to a bailout of AIG, the nation’s biggest insurer by assets, after private efforts failed and the Federal Reserve concluded that “a disorderly failure of AIG could add to already significant levels of financial market fragility,” according to a Fed statement late yesterday.
AIG gives up a 79.9 percent stake to the government and senior managers including Chief Executive Officer Robert Willumstad, 63, will give up their jobs. The two-year revolving loan gives AIG time to sell assets “on an orderly basis,” the New York-based insurer said late yesterday in a statement. The U.S. has the right to discontinue payment of dividends to AIG’s common and preferred stockholders, who are already reeling from a 94 percent drop in common shares this year.

The question that now remains is about which is the next major company that is on the danger list. The Government has already rescued the 2 housing giants, and seen many other major corporations in serious trouble. In many cases, these companies get into trouble since their investments have been massively damaged by the sub-prime credit issues, or since they were holding derivatives that were backed up by these assets. Now, these are worth as much, and downgrades by credit-rating agencies push them down a spiral; they are not able to raise money either through loans or by selling stocks (since stocks have declined in value). This is a downward spiral that takes them down very fast when they are near the end.

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