AIG Worries Wreak Havoc on Financial Markets

U.S. financial markets saw wide swings today as investors contended with the fallout from Monday's 500-point drop in the Dow Jones industrial average, concerns about insurance giant AIG and news that the Federal Reserve would not cut interest rates.

By the close of the markets, the Dow Jones industrial average had rallied by more than 140 points after seeing three-digit drops earlier in the day.

Overseas markets in Europe and Asia, meanwhile, have seen sharp declines today, with one trader calling the scene a "bloodbath." The Hong Kong market dropped 5.4 percent while the South Korea's Seoul Composite Index plunged more than 6 percent.

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"Even if the Fed takes a more aggressive stance to resolve this crisis, we may see a brief rebound but it's inevitable that we are going towards a prolonged credit crisis period," said Lee Young-won, a strategist at Prudential Investment & Securities.

Asian markets began dropping shortly after both Moody's and Standard & Poor's announced late Monday night that they were lowering AIG's credit ratings, something the insurance company was desperate to avoid.

AIG is just the latest financial institution to find itself on the ropes.

In its struggle to raise capital, AIG, one of the largest insurance companies in the world, is reportedly seeking help from everyone from billionaire investor Warren Buffett to the Federal Reserve. Last month, the company posted a $5.4 billion loss for the second quarter, and this month, its stock price has dropped nearly 70 percent.

"Their liabilities are piling up, and their net worth doesn't sustain it," said Peter Boockvar, an equity strategist at the trading firm Miller Tabak & Co.

An AIG spokesman declined to offer comment about the general health of the company.

Boockvar said that he wasn't sure AIG would be able to survive against odds that include downgrades by credit rating agencies. "Many people won't use an insurance company if they're not triple-A, so you're going to get policies pulled from them and canceled left and right, and that's their bread-and-butter business," Boockvar said.

Though AIG is an insurance company -- its products include auto and life insurance -- the root of its problems lies in the same mortgage crisis that wreaked havoc on the health of investment banks Bear Stearns, which shut down last spring, and Lehman Brothers, which filed for bankruptcy protection this week.

While Bear Stearns and Lehman invested in mortgages, AIG sold insurance contracts -- known as credit default swaps -- to investors to protect them from losses stemming from mortgages that fell into default. With home after home going into foreclosure and the mortgage meltdown in full swing, AIG has had to make good on its insurance guarantees.

That's what has landed the company in hot water, Boockvar said.

"The models that they used never were stress-tested for the scenario we're experiencing now," he said.

The mortgage meltdown of today, Boockvar said, is the equivalent of "a 100-year flood."

Saving AIG

Some say that if AIG is on the brink of failure, the federal government, which this week declined to offer a bailout for Lehman Brothers, would have to step in and save the insurance giant.

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