AIG bailout: Where does financial crisis lead next?
Other large firms may be close to the brink.
If one harrowing week can take the nation's largest insurance company from blue-chip stock to bailout recipient, how many other titans might fall? When do the financial implosions end?Skip to next paragraph
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After a Federal Reserve rescue of AIG Tuesday night, one big crisis was averted. But it's also clear that other companies may follow the insurance giant into a pickle that's increasingly familiar: Exposure to the troubled real estate market and an inability to raise quick cash to cover the resulting losses.
Unlike AIG, which was deemed to be too big to fail, most are unlikely to be rescued.
Already, some other large institutions may be close to the brink. According to news reports Wednesday, federal officials are working to line up a potential private-sector buyer for one of the largest home lenders, Washington Mutual.
In effect, what's going on is a new kind of bank run. It's a run not by depositors – whose money is federally insured in traditional bank accounts – but by investors. And the targets of distrust, while sometimes banks, can be insurance firms, mortgage lenders, or investment broker-dealers.
How many firms will be drawn into the vortex? The answer hinges on how two big forces unwind: falling real estate prices and pressure on financial firms to "deleverage," or make their balance sheets safer.
"There are a lot of credit risks," says George Feiger, chief executive officer of Contango Capital Advisers, an investment advisory firm in Berkeley, Calif. As a nation "we have borrowed more and more broadly than ever before."
It's possible that other big lenders – Wachovia and Washington Mutual are two with stunning share-price drops – "could be material for future weekends," Mr. Feiger says.
If future failures or rescues come, they'd be hard-pressed to outdo AIG in scale, originality, and impact on markets.
Think of it this way: The Federal Reserve and Treasury are in the insurance business. Not just their longstanding business of trying to insure market stability. The actual insurance business.
By extending $85 billion in credit, the Fed wanted something in return, as would any private investor taking such a risk. The government will now have an 80 percent ownership stake in AIG.
AIG writes millions of home, auto, and other insurance policies. Those are considered profitable and safe. And eventually the Fed may be able to sell its stake at a profit.
In the near term, AIG needed an infusion of money to work through problems in its investments in mortgage securities and in credit default swaps (CDS) – contracts that insure others against bond defaults.
AIG was an unusual case in its size and global reach – in the market chaos that would have ensued, analysts say, had it entered bankruptcy.
Even staid money-market mutual funds would have faced losses. This point hit home this week, as the venerable Reserve Primary money fund was unable to maintain its $1 per share price because of exposure to Lehman's bankruptcy.
Since the US taxpayer is its ultimate backstop, the Fed rescue of AIG came with support and involvement of the Treasury. And along with the loan came a new CEO for the company and news that dividend payments could cease to conserve cash.
AIG may have to sell many of its good assets to clean up its balance sheet.
It's a problem that numerous financial firms face, but not all to the same degree.