AIG - saviour of European banks

Whatever you might say about Americans, you have to acknowledge their generousity. Since autumn, they have collectively poured in $150 billion into the insurance company - AIG. Who are the main beneficiaries of this huge fiscal transfer? Banks, particular ones in Europe.

Before the Lehman crisis exploded, AIG were up to their necks in a dubious business called regulatory arbitrage. In principle, banks are supposed to keep minimum levels of capital - which is, crudely speaking, the difference between bank assets (loans) and liabilites (deposits and other funding sources).

A reasonable capital adequacy ratio should limit risky lending and provide a cushion if things go bad and the bank makes losses. However, capital adequacy ratios are 'risk-weighted". Riskier investments, say mortgages, have a higher weight and require more capital. Less risky assets, like government bonds, have a lower weight ans use less capital.

However, banks, especially the European ones, circumvented these regulatary capital requirements by buying insurance for their riskier assets. This allowed banks to reduce the risk weighting on dubious investments, such as subprime related assets, and extend more loans with less capital. These insurance contracts went under the fancy title of credit default swaps.

Of course, the risk didn't go away. It was merely transferred from the banks to the insurance company. Guess who was the insurance company writing those contracts? Yes, it was AIG. In effect, European banks had collectively passsed off all their risk to a solitary insurance company in another country.

When default rates on risky investments, like subprime loans, began to increase, Banks started to invoke their credit default swaps. They wanted their insurance payouts. Unfortunately, AIG didn't have the financial reserves to payoff the losses from the largest housing bubble in history. It was basically bust.

Here is where the US government generously stepped into the breach. On behalf of the American people, it has pumped in the cash to keep AIG from going bankrupt, and keeping the European banking system from also crashing.

I love America. I despise this anti-American pose that has infected Europe. After hearing about the AIG bailout, I love America even more. What I can not understand is why haven't the rest of Europe fallen to their knees, facing westwards, and begged forgiveness for all the mean things recently said about the US. We should be pleading for them to keep AIG alive, because if the US government pulls the plug, then Europe can kiss good-bye to its banking system.