Dance like no one's watching

By Erik Holm and Christine Richard

Sept. 16 (Bloomberg) — A collapse of American International Group Inc., the insurer seeking to raise as much as $80 billion, would have consequences for financial firms around the globe, analysts and investors said.

Wall Street’s top firms, and the biggest companies in Europe and Asia, have bought protection on $441 billion of fixed-income assets from AIG to guard their investments against potential bankruptcies. A failure by New York-based AIG may cause those protections to vanish. AIG insures some of the largest assets in the world, and does business in more than 100 countries.

“They have tentacles into everything, and they are certainly critical to the ongoing health of the financial markets, or lack of health,” Anton Schutz, president of Mendon Capital Advisors Corp. in Rochester, New York, said in an interview today with Bloomberg Television.

Wall Street’s largest firms met at the New York Federal Reserve for a fifth day today, discussing ways to save AIG, said a spokesman for the New York Fed. AIG, with $1 trillion in assets, piled up net losses totaling $18.5 billion in the past three quarters on writedowns tied to the collapse of the U.S. subprime mortgage market.

“If AIG goes under, there could be a domino effect,” said Andrea Cicione, a credit strategist at BNP Paribas SA in London. “AIG is very connected to the financial system and it is very connected to the real economy.”

Merrill Lynch

Financial insitutions are tied to AIG through its financial- products unit, which wrote protection on a decline in the value of collateralized debt obligations, or CDOs.

Merrill Lynch & Co., which agreed to be acquired by Bank of America’s Corp. this week, held $6 billion of collateralized debt obligiations hedged with insurers at the end of the most recent quarter, according to filings.

“It’s impossible to know which insurance company they’re referring to, though if it is AIG, it may have emboldened AIG to go to the Fed,” said Janet Tavakoli, president of Tavakoli Structured Finance in Chicago.

AIG fell as much as 74 percent in New York trading today after the insurer’s credit ratings were cut, threatening efforts to raise funds to keep the company afloat and roiling global financial markets. It fell $1.82 to $2.94 at 12:04 p.m. in New York Stock Exchange composite trading.

AIG is the largest corporate insurer in the U.S., and sells protection against some of the biggest risks, insuring planes and commercial shipping and providing coverage against terrorist attacks.

AIG’s Reach

The company gets more than 40 percent of its revenue from property and casualty customers. AIG provides coverage for offshore oil drilling platforms in the Gulf of Mexico, warrantees for televisions in Brazil, and insurance that complies with Islamic law in Bahrain.

AIG probably has one day to raise $75 billion to $80 billion, New York Governor David Paterson said today on cable- television channel CNBC. A collapse would be felt beyond the insurance industry, he said.

“It affects jobs, it affects policyholders, it affects drivers,” he told CNBC. “This is a catastrophic problem waiting if we’re unable to contain it.”

The Fed urged AIG to seek private capital and discouraged the insurer from expecting a loan from the central bank, according to two people with knowledge of the discussions. Goldman Sachs Group Inc. and JPMorgan Chase & Co. are working with AIG to determine how much the insurer needs, said two more people, all of whom declined to be identified because negotiations are private.

`Systemic Risk’

“AIG poses a systemic risk because it’s a large counterparty in the financial system,” said Prasad Patkar, who helps manage the equivalent of $1.8 billion at Platypus Asset Management in Sydney. “It’s too big to be allowed to fail.”

Without outside help from the U.S. government or investors, AIG will be forced into bankruptcy, said Maurice “Hank” Greenberg, its former chairman and chief executive officer. Greenberg, who controls the largest stake in the insurer, saw his holdings decline by $3.1 billion last week.

AIG would be able to sell assets to raise the funds it needs “given some time,” Greenberg said on CNBC today. Allowing it to fail would create a “systemic” issue, he said.

To contact the reporters on this story: Erik Holm in New York at eholm2@bloomberg.net; Christine Richard in New York at crichard5@bloomberg.net.

Last Updated: September 16, 2008 12:05 EDT

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P.S. If there’s one thing I learnt from the Asian Financial Crisis, it’s when you owe the bank $1M, the bank owns you.  When you own the bank $1B, you own the bank.  I don’t think the US can afford for AIG to go down.