The folly of breaking up AIG

AIG (AIG) costs the U.S. government more money with each passing month. AIG has survived on a $150 billion handout from the U.S. government. In exchange, tax payers own 80% of the company. But the company, which was once the largest insurance firm in the world, is projected to post a loss of $60 billion for the last quarter.

For reasons that are difficult to understand, the government and AIG are currently negotiating to further restructure the company. One of the plans being discussed is breaking the firm into several pieces with a portion of the company's assets being distributed to each of the newly created firms. According toThe Wall Street Journal, "The assets, expected to include some of AIG's Asian holdings, would likely be spun off and may be taken public with the government owning a major stake."

How the dismantling of AIG would aid the government's attempts to wash its hands of the problems at the company are a mystery. AIG has been shopping almost all of its operations for nearly a year. There have been very few buyers, to a large extent because the credit markets will not allow potential acquirers access to the capital they need to strike deals.

The Federal Reserve clearly thinks that it can do something AIG has not been able to, which is manage the disposition of its assets more quickly than the company can. Having the government control the process is not likely to speed it up unless the Fed plans to lend money to firms that want a piece of AIG. That kind of loan would only increase the tax payer's exposure. If a buyer went into default, the Fed would be stuck taking back the assets and writing off the loans.

The government is trapped. The firm will need tens of billions of additional dollars to keep the ratings it needs from credit agencies to remain viable. If the insurance company fails, it will cause the same sort of losses throughout the financial system that Lehman caused. The critical difference is that AIG is a much bigger company and the effects of its collapse could put significant weight on the global credit system -- weight it might not be able to bear.

Douglas A. McIntyre is an editor at 24/7 Wall St.

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