September 16, 2008
Was AIG an emergency?
Posted by Gordon Smith

In his excellent post on the (il)legality of the AIG takeover, David suggests a last-ditch argument to legitimize the U.S. government's action: "emergencies are emergencies, and when that happens the rules go out the window, and hopefullly regular elections mean that the officials the people trust are dealing with the emergency." This prompts the question, was this an emergency?

The problem here was with AIG's derivatives business, not with its insurance business. Consider this explanation from the lead WSJ story on the takeover:

AIG was a major seller of "credit-default swaps," essentially insurance against default on assets tied to corporate debt and mortgage securities. Weakness at AIG could force financial institutions in the U.S., Europe and Asia that bought these swaps to take write-downs or losses.

AIG's millions of insurance policyholders appear to be considerably less at risk. That's because of how the company is structured and regulated. Its insurance policies are issued by separate subsidiaries of AIG, highly regulated units that have assets available to pay claims. In the U.S., those assets can't be shifted out of the subsidiaries without regulatory approval, and insurance is also regulated strictly abroad.

Tuesday afternoon, after the market closed, AIG put out a statement saying its basic insurance and retirement services businesses are 'fully capable of meeting their obligations to policyholders.' AIG said it was trying to 'increase short-term liquidity in the parent company,' but said that didn't 'include any effort to reduce the capital of any of its subsidiaries or to tap into Asian operations for liquidity.' Asia is one of AIG's largest markets.

In short, this move is not aimed at protecting AIG's policyholders, but rather at protecting the financial institutions that purchased AIG's credit-default swaps.

Moral hazard, anyone?

UPDATE: The WSJ's Real Time Economics discusses the "rarely used legal authority under Section 13(3) of the Federal Reserve Act to lend to 'any individual, partnership or corporation' in 'unusual and exigent circumstance' provided the borrower 'is unable to secure adequate credit accommodations from other banking institutions.'" So the titular question of this post appears to be the right one. Larry Ribstein takes up the question: "But is this really 9/11? One might say that it’s more like Pee Wee Herman: a bunch of grownup companies living in a child's world in which real estate prices always go up. When they go down, should we prop up the stage set anyway?"

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