AIG and global jitters

The head of Bank of America said yesterday that he doesn’t know of a single bank that doesn’t do a lot of business with AIG, and this analyst says AIG reaches into every sector of the American economy. So if AIG fails there’s a lot more at stake than homes, cars, and life insurance policies. Here’s one example of the derivative contracts that that analyst mentioned: by one estimate AIG insures more than $300 billion dollars worth of loans and insurance policies held by banks in Europe. Those insurance policies minimize risk for the banks by hedging against possible defaults, which allows those banks to hand out more loans and do more business. But those loans will become worthless if AIG fails, and that’s a horror scenario for the European banks. But the problem is more complex than that: those insurance companies that AIG sells are bought and sold on the open market and the market for those instruments has exploded into the trillions of dollars in recent years, but no one really knows its worth because it’s uncapitalized, which means someone is not holding enough capital to compensate you if it fails. The U.S. government could decide that AIG is simply too important to allow to fail.