Monday, September 15, 2008 0 comments ++[ CLICK TO COMMENT ]++

AIG Downgraded 3 Notches by S&P

Bloomberg reports that AIG has been downgraded 3 notches by S&P:

American International Group Inc.'s long-term counterparty rating was cut to A- from AA- by Standard & Poor's...

S&P also lowered AIG's short-term counterparty credit rating to A-2 from A-1+, and cut its counterparty credit and financial strength ratings on most of AIG's insurance operating subsidiaries to A+ from AA+.

All the scrambling all day today was to handle the repercussions of the downgrade. AIG will now have to post collateral or pay cash as their contracts require.

Investors and the media exaggerated the damage the monoline bond insurers could have done (this is assuming that their muni bond business was ok.) The real threat to the system is from some company like AIG. Not only is AIG massive with something like $500 billion in CDS notional exposure (if I remember correctly) but it is also involved in mortgage insurance, life insurance, auto insurance, and so forth. My understanding is that it is also one of the largest derivatives counter-parties. In contrast, the monolines were mostly isolated to muni bond insurance and structured finance product insurance.

For example, assuming AIG does business in that area, it is probable that AIG will have to pay claims for the latest hurricane, Ike, that devastated parts of Texas. Imagine if AIG doesn't have the money to pay claims. It would be a disaster for the economy of that region. Imagine all the citizens, not to mention small businesses, that really need the insurance payments to get back on their feet. Insurance regulators are strict and AIG's operations are likely run in isolation, but nevertheless, the parent going bankrupt will likely cause some damage to policyholders (I'm just citing this as a hypothetical example and have no reason to suspect that Ike claims will not be paid by AIG.)

The mistake that management made--I'm not talking about the root problem but the recent problem with capital shortage--is likely due to their lack of understanding of the contracts they wrote. The new CEO just took over but that's no excuse for the slow response from AIG. I suspect that management didn't realize the potentially disastrous implications from a ratings downgrade. AIG had ample time to raise capital. Maybe it wouldn't have been enough to prevent a downgrade but it would have limited the size of the downgrade. Unfortunately, it was very slow and even said it was not selling its valuable aircraft leasing operation, among others, a few months ago.


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