2008 0916 - Meeting of the Federal Open Market Committee  - 85p

CHAIRMAN BERNANKE:

• there are increasing concerns about the insurance company AIG.

...I would like to put on the table a request for authorization for swap lines. I prefer not to put a limit on it, so I know I’ve got my own bazooka here. [Laughter]

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Of course, we also have the issue of AIG.

• The AIG problem is at least starting as a liquidity crisis.
• The problem with AIG is that the parent company doesn’t have a lot of liquidity resources and doesn’t have easy ability to funnel liquidity up from their subsidiaries because most of the subsidiaries are regulated entities.

So AIG is running into two problems:

• One, they are unable to roll their commercial paper and,
• two, as their ratings are downgraded—they were downgraded by Moody’s yesterday, I think from AA minus to A minus, but don’t quote me on that—they have to post a lot more collateral against their derivatives exposures and also with respect to their GIC (guaranteed investment contract) business.

So AIG is in a situation in which the parent is basically going to run out of money—today, tomorrow, Thursday, or very, very soon.

Now we say it’s a liquidity thing, but a lot of times when people look closer at the books they find out that the liquidity crisis may also be a solvency issue.

I think it is still a little unclear whether AIG’s problems are confined just to liquidity.

It also may be an issue of how much this company is really worth. 

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Mr. Warsh: If in a matter of weeks that AAA rating and that security could turn out to be worthless, then that would force institutions to evaluate two things.

• First, narrowly, how much AIG exposure do I have?
• Second, more broadly, if that’s AIG, what about the rest of the insurance companies?

That is, Lehman Brothers, Merrill Lynch, and Bear Stearns are touching and are in the middle of many more flows of data, and there are real losses being felt.

But if an AAA company like AIG were really fundamentally insolvent, the direct losses to a range of institutions, particularly those that are not just wholesale institutions but are retail institutions, could be very significant.

I don’t think we know the answer yet to the question of whether AIG speaks to a broader loss of confidence that could affect the foundations of the U.S. financial system.

CHAIRMAN BERNANKE:

• Almost all major financial institutions are facing significant stress, particularly difficulties in raising capital, and credit quality is problematic, particularly in residential-related areas.
• One member noted that it is not evident that markets are clearly differentiating between weaker and stronger firms at this point.