AIG and global jitters

The U.S. Federal Reserve and central banks in Europe and Asia lent financial markets more than 260 billion dollars to help them pay obligations that are due today. It didn’t help restore confidence in those banks though — stock markets led by bank shares continued to fall.

After the collapse of Lehman Brothers and the sale of Merrill Lynch, it doesn’t look as if any big financial institution is safe. The next domino could be the American International Group, and as "The World’s" Matthew Bell reports, an AIG bankruptcy could hit the world economy harder than any other.

The head of the Bank of America said yesterday that he doesn’t know of a single bank that doesn’t do business with AIG.

Matthew Bishop, the chief business correspondent in New York for the "Economist" says AIG’s tentacles reach into every conceivable corner of the global economy. So if the insurance giant fails, Bishop says, there’s a lot more at stake than people’s home, car and life insurance policies.

By one estimate, AIG insures more than 300 billion dollars worth of loans and mortgages held mostly by banks in Europe. Those insurance policies minimize risk for the banks by hedging against possible defaults. That allows banks to shovel out more loans and mortgages — essentially to do more business and make more money. But if the insurer, in this case AIG, fails those policies become worthless. This would be a shock to those European banks.

The insurance policies that companies such as AIG sells are themselves bought and sold as investment products on the open market — they’re called credit default swaps. The market for these newfangled investment instruments has exploded into the tens of trillions of collars in recent years, but no one knows what the credit default market is really worth, because it’s completely unregulated. Unregulated also means undercapitalized — which means that there’s not enough income to compensate if the market fails.

PRI’s "The World" is a one-hour, weekday radio news magazine offering a mix of news, features, interviews, and music from around the globe. "The World" is a co-production of the BBC World Service, PRI and WGBH Boston. More "The World."