AIG’s failure to pay all of its contractual obligations in full would likely constitute a selective default resulting in a downgrade. That downgrade not only would have triggered potential terminations and collateral calls at AIG’s Financial Products unit (AIG FP), but also would have resulted in substantial value destruction at AIG’s insurance companies. Large annuity distributors likely would have stopped selling AIG products, replacing them with better-rated, more stable competitors. High-end life insurance sales would have decreased significantly,  BIS Review 73/2010  3  and remaining sales would have been vulnerable to adverse selection. Withdrawals and surrenders among existing customers would have increased, depleting cash reserves and creating pressure for asset sales at depressed levels. As a result of a downgrade, many of AIG’s insurance companies may have been unable to write new business, and state and foreign insurance regulators may have begun seizing AIG insurance company assets in their respective jurisdictions. Conditional lending would not have allowed AIG to remain a going concern, but rather would have pushed it into bankruptcy. II. Continuing pressures on AIG  By the end of September 2008, AIG had drawn $ billion from the Fed Facility. While successful in providing AIG with the liquidity it needed to avoid default and bankruptcy in the short term, over the longer term AIG’s borrowings from the Fed Facility were perceived by some to be potentially unsustainable.
In addition, an economic or financial crisis often would prompt a rethink of our approach to policy-making and of relevance, a re-evaluation of the statistics we use as the basis for our decisions. In this regard, the recent Global Financial Crisis is no different. Allow me to highlight two lessons from the recent financial crisis. First, the crisis highlighted that our understanding of the financial system was insufficient. Financial innovation had resulted in a significant increase in financial intermediation taking place outside the regulated banking sector – what is today known as shadow banking. Excessive risk-taking and leverage, by both regulated and shadow financial institutions, had significantly increased the vulnerabilities in the financial system. Focus on the stability of BIS central bankers’ speeches  1  individual institutions alone was not sufficient. Instead, attention is required on the stability of the financial system as a whole. These underscore the importance of improving data coverage to keep pace with the constantly evolving economic and financial landscape. Second, the unprecedented scale and scope of the crisis demonstrated that the interplay between exposures in the regulated financial system, the unregulated shadow banking system and the real economy can have interrelated implications. Financial imbalances – in the form of excessive leverage and asset price bubbles – had built up amid stable inflation prior to the crisis. Consequently, the long drawn out process of deleveraging and balance sheet repair by financial institutions, households and governments have suppressed aggregate demand amid less effective expansionary policies.