AIG

AIG needs more tax payer money. While this seems a little like throwing good money after bad, what happens if we don’t? Here’s my lay-person’s take.

If AIG goes under, presumably it will not make good on its credit default swaps (CDS), the insurance-like products it sold to the banks. These CDSs were bought by the banks to protect the mortgage-backed securities they had written; in the event that the collateral (the properties against which the mortgages were written) turned out to be worth less than the mortgages themselves, their mortgage-backed securities (or collateralized debt obligations, CDOs) still had something behind them. If AIG doesn’t make good on its CDSs commitments, the banks’ CDOs are worth less than they currently and those banks will likely fail their ’stress tests’. Consequently, they will be forced into bankruptcy as well.

Some think this is a good idea (and perhaps in some ways they’re right), yet the cost to many could be horrendous. Without the banks to lend to business and consumers the economy will contract further, more people will loose their jobs, their houses, their 401k savings. Property prices will fall further, personal credit will be more difficult to obtain, consumption will decline, and the recession will deepen.

Of course, though keeping the banks alive may lessen the severity of the recession, we will have preserved the very system that was in no small measure to blame for getting us into the mess in the first place…