TPM put up a timeline of the collapse of AIGFP. Most of the information is gleaned from the WaPo series from last year. One thing that is interesting to me is the video (I think this is the one, HT: Ritholtz) of Hank Greenburg when he comments about the extent of their CDS portfolio. He gives a bit of a different timeline than the WaPo piece. Since there are all these self-interested parties trying to shore up their reputations, I'm really not sure who's right. One thing I would note is that the CDS market was growing by like 100% a year at the time when they stopped writing CDS according to the timeline. From the time Greenberg began to be under investigation by Spitzer (when his influence probably began to wane), to the time they stopped writing CDS, their exposure could have doubled or more.
Anyway, to my solution. My reading of the problem is that AIG has suffered more from additional cash sent to counterparties as the result of ratings downgrades than it has from losses on their CDS portfolios. Now, I'm sure that they were aggressive in writing these and did face significant actual losses on these portfolios, but sending money to Goldman et al is the big source of their trouble. If AIG were AAA due to government backing (like Fannie or Freddie), then less capital would be required and AIG (and the government) could get their money back.
I see two main problems with this, first, AIG brought in people to wind down their contracts. If they've already taken a loss on the contracts, then they're SOL. The other problem is the political economy problem. Wall Street firms received most of this money and they would likely lobby Congress, the Fed, or Treasury department so that they don't have to give the money back. I think Spitzer was right saying those firms should have had some kind of haircut, but he usually isn't so it might just be an abberration.
My solution is really simple enough that I'm not quite sure why no one has brought it up. The firm is essentially backed by the government, so why not?
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I fear the main reason for keeping AIG afloat at all costs is that it's effectively supporting all these banks you refer to. Making them AAA and pulling the cash back to AIG just worsens the liquidity positions at GS and others, potentially leading to further destabilization.
I would argue the whole point is, therefore, to funnel cash into AIG counterparties.
I'm sure it would destabilize them and harm their liquidity positions, but it SURE WOULD stabilize AIG. (my meaning is better conveyed vocally, I did my best with the caps)
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