> > There's an uproar about whether the government should let AIG fail, a > debate re-energized by the latest revelation of bonus payments going to > AIG's executives. In fact, there's a good case to be made that AIG should > fail, and it has nothing to do with bonuses. > > The rescue of AIG is warping the banking system and unnecessarily extending > the credit crisis. This misguided effort stems from a lack of transparency > and some basic misconceptions about AIG's business. > > Let's take a moment to review how AIG made money and why it's now losing so > much. Most of AIG's losses have been attributed to its failing positions in > credit default swaps (CDSs). Essentially, AIG is swapping cash flows with > other institutions: those banks pay AIG a small sum on a regular basis, and > then under certain conditions — like mass foreclosure or corporations' > defaulting on their loans — AIG pays out a large sum. In other words, AIG > sold insurance — its problem is that it is paying out too much. > > Of course, it's a bit more complicated than that due to the funky nature of > AIG's insurance. Other types of insurance do not carry the same risks > because when one claim pays out, it does not snowball. AIG's insurance on > foreclosures or other defaults is not like insurance for accidents or > disasters; while earthquakes in California are not correlated with > earthquakes in New York, foreclosures are spiraling out of control together, > fueled by a widespread recession. > > Moreover, investors or banks holding credit default swaps do not > necessarily own the tranches of mortgages or bonds that the CDSs insure. AIG > may have even written multiple swaps over the same mortgages or bonds. It > would be like an insurance company selling earthquake insurance on one > single house to multiple investors. When the house falls, so does AIG. > > But there's a true insight into this mess if you just step back and > consider the bigger picture, not just AIG. Regardless of the details of the > various swap contracts, they all represent potential transfers of wealth > between financial institutions. If we consolidated the entire financial > sector, all these debts would effectively vanish. > --http://www.time.com/time/business/article/0,8599,1885578,00.html
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