Don't Forget This Story

Remember when the press reported that mega-insurance giant American Internation Group (AIG) received an $85 billion bailout from the federal government? Well, the original plan, which was announced on September 16 and gave the government an 80% equity stake in the company, was quickly followed by another bailout of $38 billion on October 8. Three weeks after that, it got another $21 billion. Total $144 billion so far. This bailout is the poster child for all bailouts, because more than any other bailout so far, it has come to symbolize what many see as the socialization of private business.

Now comes word of an expanded bailout of $150 billion announced today. It is made up of a $25 billion write-down of the original $85 billion loan to $60 billion, a purchase of $40 billion in preferred shares, and purchase of $53 billion in mortgage-backed securities owned by AIG. "Preferred" shares in a company allow the purchaser to get their money out before shareholders of common stock.

I am so skeptical of this bailout at this point. I mean, what really happens if AIG fails? According to an interview with former AIG chief executive Maurice Greenberg, AIG is tied to many firms through its various complicated financial contracts. If AIG fails, then all these contracts will have to be unwound -- and the ripple effects of this unwinding are very far reaching, on a global basis. Investments purchased and resold and resold would come crashing down on the balance sheets of dozens of financial services companies, including Goldman Sachs and Morgan Stanley. It's not a surprise, then, why they decided to become federally chartered bank holding companies rather than just Wall Street investment banks. In the wake of Lehman's being allowed to fail, they'd be able feed from the federal trough if they are in similar circumstances. And AIG's problems are likely tied very tightly to Goldman and Morgan, so if AIG fails, then Goldman and Morgan get to apply at the Fed window for bailout money too, because now they're banks.

It's important not to forget this ongoing story -- one, because it has implications that are likely to reverberate all the way down the financial food chain (in political terms, "Main Street"); two, because Barack Obama's administration will inherit this problem and his handling of it will certainly provide grist for the mill in 2010 and 2012, on both sides of the aisle; and three, because now that the government has taken a $25 billion loss on this bailout, it's important to see how, or if, we will ever be paid back to the point where the government is no longer a shareholder.

My bet is that the government shoulders the whole bailout and loses everything.