Why the AIG bailout was critical

The news has been full of reports about the recovery of insurance giant AIG, the once-mighty largest insurer in the world that crashed and burned when a tiny subsidiary gambled wildly and lost very, very big.
After the crash, the Obama Administration made the controversial, and much-debated, decision to bail out AIG and keep the company afloat. In a sound bite, AIG was judged ‘too big to fail’; a view many disagreed with, some vehemently. I opined then, and reiterate now, that AIG was far too big to fail, as failure would have had effects far more devastating than those resulting from a taxpayer bailout that was never repaid.
I just re-read my post of a year and a half ago; here’s the heart of the matter.
“AIG is not too big to fail; it is too ‘connected’ to be allowed to fail. AIG provides the underpinning for many pension funds and retirement plans; its financial instruments guarantee the returns for pensioners. It backs up the investment of many banks. It owns many of the airlines’ airplanes, planes that might be repossessed if AIG goes under. AIG insures many Fortune 500 companies, and is among the largest writers of workers comp in the nation. It is a large individual auto insurer as well.”
While free-market purists will argue that no business is too big to fail, I have to disagree. The economic impact of AIG’s demise would have crushed every sector of the US economy, and slammed the world’s as well. Everything from teachers’ pensions to airplane manufacturing would have been hit, with some seriously hurt and others facing an uncertain future.
At the time (early 2009), that may well have been enough to turn a severe recession into a depression.
Instead, we now face the very real possibility that we taxpayers will get all of our money back, a fortunate event indeed, but one that should not blind us to the incredibly scary position we were in two years ago.
In retrospect even the most vehement opponents of the bailout should be pleased that taxpayers will be made whole. Undoubtedly the opponents will also argue that no business should ever get to the point where it is so important that it has to be bailed out by the Feds, but therein lies the problem with the purists’ faith in the free market.
AIG’s near-demise was a direct result of its participation in what was an almost-completely-unregulated business: credit default swaps and other derivative instruments. The significance of AIG’s position as the leading firm in the business was such that its failure could have crippled the international banking system, with unknown, but likely far-reaching – and very bad – consequences for the world economy.
In retrospect, some experts believe other options could have, and should have, been considered before a bailout, but we’re much smarter now than we were then.
What does this mean for you?
We dodged a bullet. But we’d have been much better served if the bullet had never left the barrel. As difficult, and onerous, and frustrating as regulations can be, the collapse of AIG serves notice that not enough regulation can be just as bad – or even worse – than too much.