AIG: Could the Cancer Have Been Contained?

Here's a theory on how American International Group, the global company with a once trillion-dollar balance sheet, could have avoided bankruptcy and, in turn, a federal bailout. The idea, expressed by the Wall Street Journal''s Holman Jenkins is, at the very least, a thought provoking piece of Monday-morning quarterbacking.

"What should really be regretted," says Jenkins, "is that policy makers at the time did not have the bureaucratic daring to treat the offending AIG affiliate known as AIGFP (AIG Financial Products, once owner of trillions in credit default swaps) the way they did Citigroup or J.P. Morgan, simply extending a taxpayer guarantee to the questionable assets."

"In all likelihood," he theorizes, "taxpayers would not have lost a dime on the AIG bailout - they would have earned millions in fees (because the swaps ultimately went up in value)."

It's very appealing, and it's the same thought echoed by many in Congress, such as Massachusetts Democrat Stephen Lynch, at last week's hearings. But is it accurate?

Those who were at or close to those crucial meetings say, "No." In essence, they say that AIG was like a pyramid, and that taking out one of the bottom bricks would have sent the whole edifice tumbling.

"Our understanding is that AIG's holding company guaranteed the obligations of AIGFP," says then New York Insurance Commissioner Eric Dinallo who sat in on the talks. In a BNET Finance interview, Dinallo, now a candidate for New York attorney general, says that the two couldn't have been separated without bankruptcy. And that, as then Treasury Secretary Hank Paulson says in his book "On the Brink," was too risky to consider.

AIGFP was only the first domino, say people who were close to the negotiations. The ultimate trigger for the crisis was a $30 billion lending squeeze on Sep. 13, 2008. Banks reeling from the fall of Lehman Brothers and facing a cash crunch returned the securities they had borrowed from AIG, and wanted their cash back. AIG had foolishly invested this cash in securities backed with subprime real estate mortgages, and by then this market had frozen.

AIG's only alternative: hit its bank lines. But the rating agencies, Standard & Poor's and Moody's Investors Service, saw this and downgraded AIG. That move led to collateral calls from Goldman Sachs and other banks. And AIG, with so many interlocking parts, couldn't obtain the cash soon enough to save itself, either from the raters or its trading partners.

And according to today's New York Times, AIGFP wasn't the only piece of the trillion-dollar insurer to engage in risky trading. AIG's American Life Insurance Company, or Alico, had also engaged in trading risky credit default swaps. Alico is now being looked at by MetLife, which is interested in buying it for $15 billion.