Everyone make it through yesterday's massacre? Good. Welcome to Day Two: It's as big of a clown show as yesterday.
Mama said there'd be days like this ...
Investors' fears came true Monday night, as insurance giant AIG (NYSE:AIG) had its debt downgraded, sending it frighteningly closer to the brink of bankruptcy. Credit downgrades for insurance companies can trigger calls that require additional capital to be put up. In AIG's case, this means it needs an additional $14.5 billion it doesn't exactly have lying around. With the company already scrambling for cash as is, the need to post more money could prove too onerous for AIG, effectively forcing it into failure.
The implications here could be massive. AIG's balance sheet holds far more than $1 trillion in assets -- about $400 billion more than Lehman Brothers (NYSE:LEH) -- so unwinding all of its contracts, policies, derivatives, and other random financial positions could be stupidly chaotic. One of the big issues here is systemic risk, or the possibility that AIG and Lehman's liquidations could force others to start selling assets in droves, creating a tsunami of pressure on global financial markets.
There could be a solution to this, though: Lend AIG money. A lot of it. Most estimates suggest the company needs something in the neighborhood of $75 billion to stave off a looming bankruptcy. The bad news? It needs that money A.S.A.P., and where it'll come from is anyone's guess. To be blunt, there's little chance of AIG making it through the week unless it finds someone with enough bravado to lend it tens of billions of dollars.
So what now?
Two possibilities arise: Either the Federal Reserve can make an emergency loan, or AIG can borrow from other banks. The first option is a long shot; just hours after the Feds let Lehman fail, it seems mad that AIG would suddenly be entitled to a bailout.
Besides, opening up government coffers to an insurance company like AIG would create a whole new chapter in the credit crunch. If insurance companies get the privilege, who else should? Hedge funds? Pension funds? General Motors (NYSE:GM) and Ford (NYSE:F)? At some point, the Fed has to put its foot down and say "Too bad."
The second option (borrowing from other banks) is also a shot in the dark, but it seems like the only option. The Wall Street Journal reports that the Fed has asked Goldman Sachs (NYSE:GS) and JPMorgan Chase (NYSE:JPM) to put together a loan package for AIG totaling as much as $75 billion. This seems like a sensible (and perhaps the only) solution, but it still comes with several admonitions. For one, it could shift risk to two of Wall Street's only remaining healthy banks, akin to putting your strongest fighters on the front line of the battlefield. Stay tuned, Fools -- AIG's fate should become clearer as the day goes on.
The bad news isn't over
In other news, Washington Mutual (NYSE:WM) had its debt downgraded by Standard & Poor's to essentially the same levels to which two other rating agencies lowered it last week, making its ongoing problems just that much worse. As it did last week, WaMu defended itself after the downgrade, but the trend is clear: Investors aren't in the mood to kick the tires and give banks the strength-test they deserve. When fear looms over the market, capital-raising isn't these companies' only concern. Bank runs become an ever-present danger, too, as customer confidence plunges.
At any rate, the latest developments make a few things clear: The Federal Reserve is pretty much over the bailout business, essentially telling Wall Street, "Sorry, this is your problem." What that means for AIG and WaMu should shape how the market pans out in the coming weeks.
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