If you trust your government and its officials in what they say regarding the overall health of the system, there may be some good news out there on a systematic-risk basis regarding American International Group (NYSE: AIG).  Treasury Secretary Timothy Geithner, Federal Reserve Chairman Ben Bernanke, and New York Fed President William Dudley are signaling the weakness of oversight over AIG and systematic risks and what needs to be done ahead via regulation and oversight.  But there is a more important notion here that is more of an inference in what all three officials might be signaling rather than any official statements.  What they are generally saying is that the AIG systematic risks from creating the 1930’s has passed now that the government expects to get its money back.  If this interpretation gets carried over into additional speeches, then it is growing more and more likely that you already have seen “most of the worst.”

Bernanke said that allowing AIG to just fail would have created a 1930’s wave of failures from local governments to major institutions to policyholders.  He is saying now that the Federal Reserve is now in the uncomfortable situation where it gets to oversee the preserving of AIG’s value and its dismantling.  Further, he noted that receivership might have been a better option has the oversight powers been in place.

Geithner is saying today that the Treasury should decide when to wind down non-bank financial firms.  Ben Bernanke is also saying we need resolution procedures for non-bank financial firms.   Geithner is also noting that all “systemic-risk firms and markets” need to be brought under strong oversight and regulation, and this should also have limits on how much risk a single firm can take.

Dudley noted that he also expects that the New York Fed will be repaid in full.  This “in full” is a key notion if he really means it as fact rather than as a political deflection while so much scrutiny from Capitol Hill is coming down.

Of course, much of the talk today surrounds the “distasteful bonuses” of AIG.  We could address executive pay further, but frankly we are tired of it.

The key take here may depend on how you interpret what these men say today.  But if Uncle Sam is adamant that he’ll get paid back that money, then one more future systematic-risk events has been taken off the table.

There is one more key notion here that is being said, but isn’t being formally said.  If you take the officials’ statements at face value, then AIG won’t be AIG down the road.  We have been considering the AIG common stock for some time as nothing more than a call option or warrant that is way out of the money.

Jon C. Ogg
March 24, 2009

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