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Why Not Just Let AIG Go Under?

Last week’s outrage over big bonuses paid to executives at AIG has more than a few readers wondering: Why can’t we just let these big companies go out of business?

Roughly half of the $180 billion the government has given AIG has already flowed, indirectly, to the “counterparties” that bought what amounts to financial insurance policies. The list includes big banks, other financial institutions and governments.

The state of California, for example, collected $1 billion it invested in what’s called a Guaranteed Investment Agreement. That’s a kind of interest-bearing savings account where states and cities stash money they’ve raised from a bond offering until they need the money. More than $12 billion in federal bailout funds paid to AIG went to more than 20 states that invested money with the company.

Some $80 billion in AIG bailout money also went straight to banks and investment firms around the world that did business with AIG. It’s possible some of those banks might be able to absorb those losses. But given the current fragile state of the global banking system, it’s entirely possible that AIG’s failure could bring down one or more big banks.

Why not let those banks fail, too? The problem is that the world’s banks are interconnected in a kind of global river of money that we all rely on to keep the economy moving. If too many banks fail, that river starts to dry up. With the economy in a steep decline, we need money flowing through the system faster — not slower.

AIG’s Financial Products division wasn’t regulated. After Congress passed a law in 2000 deregulating the kind of paper bets AIG was making, the company was free to write as much of this “insurance” as it wanted without demonstrating it could cover any and all bets that went bad. By some estimates, the company made about $500 billion in paper bets with little or nothing to back them up.

Taking back bonuses paid to the people who made the mess does little to fix the underlying problem. Some of the members of Congress now expressing the loudest outrage were among those who approved the rules that let AIG get into the casino business in the first place.

Then again, maybe the failure of Congress to act sooner isn’t all that surprising. AIG was one of the biggest contributors to key members of Congress in charge of making the rules. The company, like the rest of the financial services industry, got some of the best laws money can buy.