Understand something about AIG

I was listening to something on the radio yesterday, one of those talking heads rabbit on about how the situation with the Fed rescuing AIG was so bizarre.

I'm thinking - not so bizarre... big financial firm, lots of assets, domino effect, too big to fail-

-blah, blah blah.

The guy went on to point out that AIG does insurance, but they do a kind of insurance you and I can't get. They insure securities against loss - for big clients, like China.

Somebody like China goes to AIG and says "Hey, I'm buying a metric @ssload of mortgage-backed securities. On the off chance that the companies who issued these mortgages weren't following their stated practices, AND that the rating agencies were using three year old data to evaluate their appreciation potential - will you insure me against loss?"

AIG says "No problem. I mean, we all know that's not gonna happen, right?"

And AIG insures China against loss by undisclosed risk.

With me?

[Late Edit: This kind of insurance is called a Credit Default Swap. It was 1am, my brain wasn't functioning. Sue me.]

Okay. People like you and me don't get this insurance - and there's a reason (I'm not really starting a little guy/big guy kind of thing here) - big money cannot afford to take Wall Street at its word. You and I lose everything in the market, we're ruined - but life around us goes on. If China rolled the dice with 10% of their GDP and came up a loser, well.. life would change for a sixth of the world's population - for starters.

Scale that scenario down a bit. Let's say you're a Government Sponsored Entity that recently took 50% of their total losses on 10% of their mortgages (in subprime, naturally). You're big enough to merit insurance from AIG.

Happy dance, right? Except two things have to work out. You gotta live long enough to put in the claim - and your insurer has to pay it.

Well, the Fed taking over Freddie Mac and Fannie Mae spared those GSEs any chance of a quick death, but AIG going in the tank endangered any claim their securities had to being good investments for buyers like China.

No AIG, no securities insurance, no security for big money buyers.

Talking head man explained that the Fed, now the proud administrators of Freddie/Fannie's assets to save them from ruin - is now loaning money to the insurer who will write checks to big investors in case of big losses.

Pretend you're big money for a second. Does this fill you with confidence?

Yeah. CJR's Ryan Chittum agrees with you. What's more, he's not alone:

Forget about AIG. This [WSJ article] is the most important story of the day. Banks have essentially stopped lending to each other, threatening to bring the financial system, and thus the economy, to a standstill. This despite the Fed shoveling money into markets.

 That.... is downright creepy.

Don't look at the AIG bailout, look at what it was trying to prevent - and whether or not it is working.