AIG too big to fall

The US Federal Reserve has announced an $85 billion rescue package for AIG, the country's largest insurance company, to save it from bankruptcy and avoid plunging the financial markets into deeper crisis.  ┬á The rescue follows the collapse of Lehman Brothers, the fourth-largest investment bank in the US, in which the Fed did not intervene, causing share prices to plummet all over the world. ┬á┬á The Fed's move is viewed by some as the most radical intervention in private business in its history, and has helped fuel a tentative rally on global stock markets. ┬á┬á US Treasury Secretary Henry Paulson declined to bail out America's fourth-largest investment bank Lehman Brothers after it filed for bankruptcy protection Monday. But he supported the rescue of AIG and said the move would protect taxpayers. "These are challenging times for our financial markets," he said.  The decision to save AIG and not Lehman Brothers is by no means arbitrary, however, nor is it contradictory. If the government steps in to save every financial institution in trouble, it would send a message of immunity that might make the industry more reckless in the long run than it has recently been seen to be.┬áIn AIGÔÇÖs case, however, because it holds the insurance policies for a substantial proportion of the financial commitments of the worldÔÇÖs banks, its demise would have catastrophic consequences for the whole sector. Ken Lewis, the chief executive of Bank of America, said this week that "I don't know of a major bank that doesn't have some significant exposure to AIG."┬áIn order to protect themselves against default on the part of their borrowers, banks take out insurance on their loans. This reassures regulators that risks are manageable, which encourages banks to lend more.┬áIf AIG were to fail, and be unable to honor these commitments to the banks (called super senior credit default swaps) the stability of the global financial system would be in jeopardy.┬áItÔÇÖs rather ironic that the banner on AIGÔÇÖs website boldly proclaims ÔÇ£the strength to be there.ÔÇØ ItÔÇÖs still there, of course, but its strength seems to lie more with its influence than its balance sheet.┬á┬á *┬á┬á┬á┬á┬á┬á┬á┬á┬á *┬á┬á┬á┬á┬á┬á┬á┬á┬á *┬á┬á