Why AIG Had to be Nationalized

Chris Kaufman uses the example of AIG as a reason not to nationalize:

If voices of wisdom aren't enough for skeptics, the example of AIG may be. AIG is not a bank, but it faces a lot of the same problems that banks do. And nationalization has done little to help the insurer, which has been losing bailout dollars with dizzying speed, and is seeking more cash from the U.S.

I'm not sure I understand this. The losses exist. They will have to be taken by some combination of bondholders, shareholders, and taxpayers -- plus, conceivably, depositors (in the case of banks) or policyholders (in the case of insurers). It's possible that the efficiencies and strictures of private ownership might, at the margin, reduce the magnitude of the losses -- although the recent history of Wall Street gives us no real reason to believe that to be the case. But even if the losses are reduced, they're still enormous.

There is no doubt that, absent nationalization, AIG would be bankrupt by now. And the systemic consequences of an AIG bankruptcy would have made Lehman look like a walk in the park. For starters, Wall Street would be in much worse shape than it's in right now, since AIG Financial Products insured hundreds of billions of dollars of assets on banks' balance sheets, and has been putting up precious magin as the value of those assets has continued to decline.

On top of that, AIG's bonds would be largely worthless at this point, and the write-downs on those bonds would have caused another few hundred billion dollars in wealth destruction at precisely the financial entities which most need healthy assets.

And most importantly, the failure of AIG would probably have caused what the failure of Lehman brothers didn't -- a catastrophic cascade of counterparty failures in the multi-trillion-dollar CDS market, from which the global financial system might never have been able to recover.

Against all that, we have some very large and painful losses for the US taxpayer, which will never fully recover the money it's put into AIG. But compared to the alternative, we're all much better off.