AIG bailout example of moral hazard

AIG bailout example of moral hazard
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First Published: Thu, Sep 18 2008. 12 09 AM IST

Updated: Thu, Sep 18 2008. 12 09 AM IST
Insurer American International Group Inc. (AIG) was at death’s door. Without the US Federal Reserve’s $85 billion (Rs3.9 trillion) bailout of the giant insurer, financial markets — and more tangible victims — would have taken another big blow. But now every other struggling US company will line up for help. And taxpayers’ cash will probably never be recouped.
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AIG’s traditional insurance business, which it said late on Tuesday was adequately capitalized, is weighed down by credit derivatives exposures that have led to billions in write-downs and crippling cash calls.
Letting at least this part of the business go under would have hit Wall Street firms yet again to the tune of tens of billions of dollars, because some of them hold assets that rely for part of their value on debt insurance from AIG. Some non-financial companies could also have been affected.
On top of that, the US treasury, the Federal Reserve and other regulators won’t have forgotten the turmoil when markets opened after they let the arguably less significant Lehman Brothers Holdings Inc. go under over the weekend.
But the bailout undoes any benefit from its refusal to help Lehman. In the wake of the Bear Stearns Companies Inc. rescue in March and the recent quasi-nationalization of Fannie Mae and Freddie Mac, that gave pause to those who thought the federal government was a soft touch. Another bailout makes it hard to resist calls for financial support from Detroit car makers—and any other struggling companies for that matter.
There’s a chance with Bear that the Fed’s holdings of dodgy debt will end up at least breaking even. Fannie and Freddie might just turn into earners for the government, too, although they should gradually be wound down.
With AIG, exposure to ultra-toxic collateralized debt obligations account for much of a hole that might be as big as $70-80 billion or even more. It’s hard to see how the government can plug the whole gap with any hope of getting all the money back, even though it is essentially taking over AIG. That makes the bailout a gigantic example of moral hazard.
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First Published: Thu, Sep 18 2008. 12 09 AM IST