AIG rescue fails to boost investor confidence

John W. Schoen Senior producer • Profile • E-mail

The government’s rescue of insurance giant AIG prevented a deeper financial catastrophe but failed to restore confidence Wednesday as investors continued to flee the stock market.

Part of the reason is that the unprecedented move late Tuesday is only a stopgap measure in the ongoing unwinding of a credit bubble that continues to weigh on the financial markets and the economy.

The Fed's decision to extend an $85 billion lifeline to AIG was intended to prevent the insurance giant's cash squeeze from spreading to the hundreds of institutions, investors and governments it does business with.

The immediate concern Wednesday was whether the Federal Reserve’s $85 billion loan to AIG would be enough to stop the company's bleeding. Continued uncertainty about the value of AIG’s holdings left some on Wall Street wondering if the capital infusion is big enough to turn the company around.

Investors began selling at the opening bell Wednesday, and losses accelerated in the final hour of trading, when the Dow, of which AIG is a component lost over 300 points. AIG lost another 45 percent Wednesday to close at $1.70 a share, compared with more than $20 last week and nearly $50 as recently as June.

The blue-chip index already is down 7 percent this week.

AIG’s problem stemmed from uncertainty about the value of a class of investment known as credit default swaps — a kind of insurance against a debt going bad.

The explosion of this paper — some $60 trillion of these swaps are held by banks, brokerages, hedge funds and other financial institutions — is clogging the credit markets and lies at the core of the crisis now engulfing the entire financial system.

“If the markets turn against them and those assets lose value, they’ll have to post additional collateral,” said Carlos Mendez, senior managing director with ICP Capital, referring to AIG. “The majority of that $85 billion will go out the door for collateral calls and other more immediate needs for cash.”

Officials involved in the the rescue said it’s unlikely AIG will need more cash.

“There could be a greater need for capital, but the valuations that were done assumed a lot of worst-case scenarios. Some of the holding companies and the noncore insurance companies were given very, very low valuations,” said Eric Dinallo, superintendent of the New York state Insurance Department.

“So I think that while it is possible and there may be continued degradation and it would require more capital, the federal government has put into place enough to handle those transactions,” he said.

Dinallo added that, with breathing room to sell parts of its business in a more orderly fashion, AIG can get a better price for those assets than if it had to sell under pressure. Other insurance companies already have expressed interest in buying pieces of AIG, he said.

While the clock has stopped ticking on AIG, it appeared to have little impact on the loss of confidence in the financial markets. Several major financial companies remained under pressure due to widespread uncertainty about the value of assets. Morgan Stanley was reportedly looking for a merger partner, and a buyer was being sought for Washington Mutual.

The growing uncertainty over the value of assets raised the cost of short-term borrowing, putting further pressure on companies that need to cover short-term debts.

“If your business is based upon having to walk in every morning and borrow billions of dollars to keep your business going, you got a real problem right now,” said Stephen Massocca, a partner at the investment firm Pacific Growth Equities. “So many of these (companies) — be it hedge  funds or investment banks or whatever — are dependent on the ability to borrow money on a day-to-day basis. That drives their business plan, and that's a big issue right now.”

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