With the Almost Insolvent Group setting the record for the worst quarterly loss in the history of corporations ($62 billion) and the resulting fourth bailout of the struggling company, many are asking “Why did we keep bailing out AIG?” Why keep throwing good money after bad?  Let them go under so we can move on with our lives!

Of course the response you get from media pundits and government is that they are too big to fail.  I think we’re tired of hearing that so it’s high time they explain what exactly they mean by it being too good to fail.  Perhaps then they could elaborate on why we keep throwing away taxpayer dollars.

As of today, AIG has access to $180 billion from the American government.  The most recent bailout was an increase of $30 billion to that figure.  This is in the form of a line of credit, so they might not need it all. Ha.

Please keep in mind this is a LOAN, and they are expected to pay this back.  We aren’t just writing blank checks.

The short answer for why we’re helping AIG is that it’s too big to fail.  But why?  Because allowing AIG to go bankrupt would set off a chain reaction in the financial markets. The reason why hearkens back to the beginning of this mess, mortgages.  When a bank owns a mortgage, they had two options to protect themselves: either stash or buy insurance.  This protects the bank from loss if you default.  AIG was a big player in the insurance side of this.  This insurance was known as a credit default swap (CDS).

When you default on a mortgage, the bank contacts AIG and receives a lump sum payout.  Naturally this has been occurring a lot.  Because the CDS industry is unregulated (still is), AIG failed to have enough cash in reserve to payout all of these CDS claims.  Once investors stopped buying shares of AIG, the company was forced to either declare bankruptcy or get money from the last great bank (the government).

Now this isn’t the only reason AIG is in trouble, but it’s been a big contributor.  The inject of capital into AIG has been a roundabout way of giving banks more money.  Now don’t think they’re greedy.  If you were rear-ended and needed insurance money to fix you car but the insurance company had no money for you then you’d want the government to give them the money too.

If we didn’t give AIG this money, the belief is that the banks (and other mortgage) investors would be forced to take even larger losses.  These losses would then force the banks to save more cash, further tightening up credit markets beyond what they already are.

The government has already pumped billions into the company.  Letting them fail at this point would be more expensive than just giving them money. Think of it as spending another $300 to fix your busted car because you’ve already put $1500 into it and you can’t afford to buy a new car.

So since Obama keeps Geithner on a tight leash in front of the media and economic pundits dumb down everything for the masses, there is your explanation for why the government continues to bail out AIG.

Whether or not you agree with the decision is another story.  Whether or not I agree with it keeps me up at night.

Photo: Mike Licht, NotionsCapital.com

[Updated 3/9/09]

I found a blog that lists some of the banks that have benefited from this bailout (receiving their premiums from the insurance they bought).  Here are a few:

  • Goldman Sachs
  • Deutsche Bank
  • Merrill Lynch
  • Calyon
  • Barclays
  • Rabobank
  • HSBC
  • Royal Bank of Scotland
  • Morgan Stanley
  • Wachovia
  • Bank of America
categories: business, government