A new hit: AIG rescued by the Fed

On Tuesday Fed announced an $85 billion Federal Reserve loan to insurance giant AIG. The explanation: AIG was deemed too huge (its assets top $1 trillion), too global and too interconnected to fail. (Times, 16th. Sept. 2008)

Especially AIG Financial Services Division is concerned is deeply involved in the derivatives market related to housing and credit, having an astonishing $441 billion exposure only on the credit default swap market. The reason for the bailout seems to be that nobody has the faintest idea what the consequences of AIG's failure for financial markets would be, but the fear was that it could lead to total chaos. As a consequence, Fed paid a loan to AIG in order to counteract this so-called "systemic risk".

However, the terms of the loan are unclear and thus difficult to understand. According to the deal, "AIG agrees to repay the loan with asset sales and give the government (and thus taxpayers) a 79.9% equity stake in the company" ????

Furthermore, AIG would have apparently survived only one or two days more without Fed's help as they not only had lots of write-downs ($25 billion in the first half of the year), but the recent rating downgrade by Moody's and S&P forced AIG to owe an additional of $13 billion collateral to the buyers of the swaps.

So, what do you believe will happen to AIG? It might be broken up in businesses and sold in pieces. Those aware of the "conglomerate discount" notion know that this would be a valid option for a multi-business company, especially when confronted to liquidity problems.

In conclusion, what else can be said? The financial world is so unpredictable and interconnected that nobody (including the Fed) does not want to take the risk of testing the consequences of a "domino effect".