Back to AIG:

Back to AIG: As I said before, AIG is an insurance company that is worldwide in scope, operating in 130 countries. You have certainly heard that it is “too big to fail.” It may well be. According to Time Magazine, AIG insures 180,000 entities, which together employ 106 MILLION people worldwide. Those entities include banks, farms, hospitals, and nonprofits among other things. AIG is the country’s largest life and health insurer. If AIG goes down, the companies they insure could also fail, resulting in more unemployment and a stock market crash. Some believe our recession would become a depression.

A few critics are saying that if AIG had gone into bankruptcy, the economy could have withstood the repercussions. It’s just that no one has been willing to put it to the test. After all, would you want to make the decision that could potentially bankrupt the world? And that is a distinct possibility, should the company fail. Geithner may be wrong or right in what he is doing, but he must certainly have the most stressful job in America, and I wouldn’t have it for anything. Besides, he definitely knows far more about what is going on than any of us do!

The point is, we may be “mad as hell” about the bonuses paid to fat-cat executives, but we better be very careful that, in punishing AIG, we don’t bring the whole economy down around our ears! Right now, my major concern is that Congress may do just that. They know very little about high finance, but they do know what will cost them reelection, so they are probably more likely to listen to the ignorant masses than people who know something. (At least we hope they know something; at this point, I’m not sure anyone really knows what to do.)

It’s not just that AIG is a big company; it’s that they are so systemic. They are intertwined in financial institutions all over the world. Their failure could create a domino effect. No one knows where it would end, and no one particularly wants to find out!

AIG got in this situation for the same reason our whole economy got into such a mess. It all goes back to the housing market. Somehow, the idea that everyone deserves a home of their own whether they could afford it or not caught on among politicians in Washington. This really got pushed during the Clinton administration. The requirements for getting a home loan became less stringent, often requiring no down payment at all, and interest rates were kept low by the Federal Reserve. It finally got to the point that people did not even have to provide proof that they had a job! Not only that, but mortgage companies were pushing adjustable rate mortgages that started off at a low interest rate that could increase later on. People who didn’t know any better were sometimes misled into buying more home than they could afford, and other people who did know better figured they could always sell the house at a profit before their payments went up. They gambled – and lost.

You may wonder why mortgage companies would make such risky loans. Don’t they want to get paid back? The problem is, they did not keep the loans and so had nothing to lose. They made their money up front with fees charged to the buyer and then turned around and sold the loan on the secondary mortgage market. About 60% of that market is controlled by Fannie Mae and Freddie Mac.

Fanny Mae and Freddie Mac are government sponsored businesses. They are owned by stockholders like any other corporation. However, they get special protection and financial backing from the government. Fannie Mae was started by FDR during the Depression to increase home ownership. The company buys mortgages from lenders and then turns them into securities that can be bought and sold on Wall Street. Anyone can buy these. If you have a 401K or mutual fund, it’s possible that you own some and don’t even know it! If you own these securities, you will make money on them as long as people continue to pay for the houses they bought. If, however, people cannot afford to make their payments and their houses go into foreclosure, your bonds rapidly decline in value, and may even be worthless.

The party lasted for years. People were flipping houses and making a small fortune. With so many people buying houses, demand pushed the prices of homes much higher than they were actually worth. This is what is called a “bubble.” And like any bubble, it was bound to burst sooner or later. Eventually, interest rates rose on those adjustable rate mortgages, and many people could not afford the higher payments. When they tried to sell their homes, they found that many other people were also trying to sell. Builders had overbuilt as well, creating a housing glut. With too many homes for sale and not enough buyers, the only way to sell a house was to lower the price significantly. We personally experienced this, as we decided to move right before the bubble burst. Some people were really in trouble, however, because they owed more on their house than they could get for it! Many of these people just walked away and let the house go into foreclosure. This brought the prices of houses even lower. Loans were defaulting all over the place, and those mortgage-backed securities were rapidly losing value. Many banks owned these, and suddenly found themselves with huge deficits on their books. They couldn’t loan money. When they stopped loaning money, few people could get a loan to buy a house or car, and the housing and automobile industries suffered even more. As these industries and others suffered from an inability to get credit, they were forced to lay off workers. Unemployed workers have no money to buy goods and so retail stores were hit as well. It has just kept spiraling downward.

As for AIG, they had insured many of those mortgage-backed securities and were now having to pay out. They were bleeding billions. That’s when the government stepped in to the tune of 182 billion dollars, in an attempt to stop the bleeding. In helping AIG, they were also helping all the banks they had insured.

Somehow, someone has to figure out a way to get the banks in better financial shape so they can start lending money again. That is Geithner’s terrible job. Like I said, I don’t envy the guy.