What if the government bailed out of the bailouts?

Financial Crisis Posted on

What if the government got out of the bailout business?

The idea certainly seemed all right with throngs of Americans who were outraged by news that American International Group paid out millions of dollars in executive bonuses after it was rescued with taxpayer cash.

But would no bailout be even worse? Financial analysts and federal officials have warned that doing nothing to save AIG — or banks or the auto industry — would be a catastrophe, an economic domino effect of bank losses, stock market chaos and job cuts. No one — at least no one in the government — has the stomach for that.

Here's what might happen if companies deemed "too big to fail" were allowed to do just that.

AMERICAN INTERNATIONAL GROUP

For bailout backlash, it's hard to beat AIG. The government has made four separate loans and cash infusions to the crippled insurer, including $30 billion earlier this month. Total tab: $170 billion.

Public outrage reached new heights when word spread that AIG had paid executives $165 million in bonuses. President Barack Obama ordered his treasury secretary to grab back what he could, and one senator even suggested the recipients kill themselves.

So why not pull the plug? Because AIG has 74 million customers and operates in 130 countries, and letting it implode would positively unhinge financial markets around the world.

AIG built a murky, unregulated business issuing insurance for mortgage-backed securities and other debt held by banks. When the housing bubble popped and those securities went bad, AIG was left on the hook for billions of dollars in claims it couldn't pay.

Letting AIG die would make all of that insurance worthless. Banks around the world would be forced to take massive losses. Some could collapse, unnerving markets, driving up unemployment and maybe turning the recession into a depression.

The U.S. got a taste of that scenario in September, when bad debt forced investment bank Lehman Brothers into the biggest bankruptcy in U.S. history. Thousands of other firms were exposed to Lehman's complex financial contracts, and the resulting fear and uncertainty sent stocks plunging.

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