AIG - What is happening, and how it affects you.

Posted on Sep 24, 2008 by Sergio Ulloa (G+)

AIG: The letters on Manchester United's football shirts, on buildings dominating skylines in major cities worldwide, and in the past week, on the front covers of the business pages, if not the entire paper. A company with a long and storied history, AIG had posted total losses of $18.5 billion over the last three quarters, before being bailed out last Tuesday (Sep. 17^th) with a loan of up to $85 billion dollars from the Federal Reserve. This was designed to effectively secure the company's important economic position worldwide, and in exchange the Fed would get around an 80% stake in the company as a kind of security, and 12% interest on the loan. What happened? Why did AIG suddenly need so much cash to avoid going under? Should they have been lent it? This was not the start of the story, and it is far from being the end of it. It began, like so many of today's economic worries, with the sub-prime mortgage crisis. To enable them to continue making yet more bad loans, banks in the US and Europe insured some of the loans with insurers such as AIG. As the largest insurance company in the US, AIG also insured many other deals made by banks or large companies, so as the economy went into recession, it lost a great deal of money, resulting in a situation where the company was very illiquid and could therefore fail. This would have had a huge knock-on effect on banks and companies not just in the US but worldwide, meaning that the Fed felt justified in bailing out AIG (whereas it left Lehman Brothers Holdings Inc., who announced last week that they would file for chapter 11 bankruptcy protection, to their own devices). The government was fresh from shoring up Freddie Mac and Fannie Mae, (the Federal Home Loan Mortgage Corporation and the Federal National Mortgage Association) with guarantees and the prospect of a 'conservatorship', and back in March, the Fed backed the purchase of the stricken Bear Stearns by JP Morgan. The Federal Reserve has as a result been rather seriously depleted. The US is not the only country that is having to take action of this kind. The UK government 'nationalized' the Northern Rock bank, another victim of the sub-prime crisis in the US, back in February. Some slack is taken up by companies taking over other companies, e.g. Bank of America buying Merrill Lynch, Lloyds TSB merging with HBOS, or Barclays buying up some of Lehman Brothers' core assets- which many would argue is how the market should work. At present, however, the US looks likely to spend yet more money to try and solve a problem that, although originating in the country, affects the world's economy as a whole. It is unlikely that other countries will be able to continue to sit back and watch the US deal with the problem alone for very long. The AIG bail-out looks to be only the start of an almost unprecedented level of government spending to assist private business. Lawmakers are still hashing out the details of a plan to use taxpayers' money to buy the bad debts of financial institutions with significant operations in the US. The plan would put about $700 billion dollars spending money into the hands of Treasury Secretary Henry M. Paulson Jr. who would theoretically decide how to spend it in a way that balances the interests of the taxpayer - minimizing immediate costs but ensuring liquidity in the financial markets in the long term. This is a very controversial plan, and has even been called a kind of undemocratic socialism. Paulson in fact used to be head of Goldman Sachs, which along with Morgan Stanley just announced a change of legal status to enable it to take advantage of the proposal. Many politicians, including McCain and Obama, have expressed concern and are demanding greater oversight, but as it is hard even for financial experts to put a value on bad loans of the type that caused the crisis, it is unclear how this would work. How does this affect my insurance? Essentially, it shouldn't. AIG has been more or less guaranteed by the US government. In any case, most private policies are with subsidiaries of AIG that are separately regulated and financially sound. Also, in the US, policies are usually guaranteed to some extent by state run associations should an insurer fail. However, as anyone who has seen Mary Poppins should know, customers are not necessarily rational beings, as has been demonstrated in the past week, particularly in Asia. The offices of AIG subsidiaries in Singapore, Taiwan and Hong Kong have been mobbed by people wanting to either enquire about the safety of their policies or cancel them altogether. In Hong Kong some 1,700 people surrendered their policies with AIA on Tuesday. This was despite assurances, including from the monetary authority of Singapore, that the subsidiaries of AIG are still sound. AIA in Singapore has announced a policy conservation program to enable those who surrendered their policies in panic last week to reinstate them. While some unscrupous agents might be tempted to advise people to switch insurers to get a new commission, the best course of action is probably to wait and see. Effects on the presidential election race, and the candidates' healthcare proposals: Both candidates are going to have to make significant changes to their policy proposals in the face of the economic realities which will likely face the next administration. They also both have to come up with a stance on this new proposal. So far their responses have been fairly similar, with both calling for more oversight. Both McCain and Joe Biden were supporters of the deregulation in the late 90s that arguably made the sub-prime crisis possible, which may mean Obama has the edge in not having to backtrack too much. What is certain is that there is going to be a lot less money available for expensive programs such as Medicare or Medicaid, and any candidate promising tax-cuts will have serious credibility issues. The future of health insurance and healthcare financing in America is now very unclear.