September 20, 2008
Lipson via Hoffman on a bankruptcy perspective on AIG
Posted by Usha Rodrigues

ConOp has a great post on the bankruptcy angle on AIG. A taste:

Why did the Fed bail out AIG but not Lehman?

The conventional answer—which is true but incomplete—is that AIG was too big to fail. But that begs two questions: Too big how? And why?

In part, AIG was too big to fail because it could owe an astronomical amount—allegedly about $300 BN—on credit default swaps issued to support mortgage-backed securities.

The problem, however, is not just the amount AIG owes, but the fact that these obligations are not like other obligations. They occupy a series of loopholes that make them unusually dangerous. Perhaps the greatest loophole of all came in the 2005 amendments to the Bankruptcy Code. Although designed ostensibly to “get tough” on profligate debtors, those amendments also made certain that CDS holders would get special treatment in bankruptcy—special treatment that may have made the Fed bailout inevitable.

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