AIG Bailout Means Drastic About-Face for Feds

"The insurance policies written by AIG companies are direct obligations of its regulated subsidiary insurance companies around the world," the company said in a statement. "These companies are well capitalized and meet or exceed local regulatory capital requirements. The companies continue to operate in the normal course to meet obligations to policyholders. In particular, AIG noted its long tradition of service in Asian markets, which are key to AIG's future growth."

Virtually every Fortune 500 company does business with AIG. Let's say you are a toymaker. To protect your company from liability suits -- maybe a defective toy that ends up choking toddlers -- you take an insurance policy.

If AIG went bankrupt, the fear of regulators was that nobody will rise up to fill its shoes. That means that major companies around the world wouldn't have insurance and be protected from the normal risks of doing business. So that toymaker might decide to stop production of its toys because the risk would be too great. Airlines might decide to stop flying because nobody was insuring their planes. The impact would ripple throughout the world.

And yet some say the government's bailout still won't be enough to save AIG.

"AIG is now a walking-dead company," said Peter Boockvar, an equity strategist at the trading firm Miller Tabak & Co. "Who is going to want to do business with AIG?"

This latest bailout renews the debate over how far the government should go to save companies that make risky decisions and lose. The so-called moral hazard argument says that if companies know the government will save them, they are more likely to engage in risky behavior.

The Bush administration sent a clear message over the weekend that it wouldn't just bail out any company when it decided not to aid Lehman Brothers, the nation's fourth largest investment bank. After the faltering firm failed to find a buyer over the weekend, it filed for bankruptcy Monday morning.

Treasury Secretary Henry Paulson and Federal Reserve Chairman Ben Bernanke were explicit: There is no political will for yet another government bailout.

Too Big to Fail

Speaking at the White House Monday, Paulson said he "never once" considered it appropriate to use taxpayer dollars to help save Lehman, which he considered a different case from Bear Stearns.

But in the end, AIG's $1 trillion in assets and more than 116,000 employees was just too much to let go under.

The Federal Reserve said in a statement last night that it had determined that "in current circumstances, a disorderly failure of AIG could add to already significant levels of financial market fragility and lead to substantially higher borrowing costs, reduced household wealth, and materially weaker economic performance."

Sen. Chris Dodd, D-Conn., chairman of the Senate Banking Committee, asked the Bush administration "to become much more aggressive about addressing the root cause of this entire economic crisis -- namely, the foreclosure crisis. Only when foreclosure rates start to drop significantly will we see home prices begin to level out and our markets regain much-needed stability."

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The financial system is far from out of the woods.

Focus has now shifted to Washington Mutual, the country's largest savings and loan. Could it now be also called too big to fail?

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