The tactic would have undercut our primary goal in providing AIG with necessary liquidity – enabling AIG to pay creditors, maintain consumer, regulator, and counterparty confidence, and avoid default. A default would have triggered AIG’s bankruptcy, with all of the systemic risk that bankruptcy would have entailed. While these tactics have been used in certain sovereign debt restructurings, they can be used there only because sovereigns cannot go bankrupt, and only with months of pre-planning. Any attempt to condition our lending would have created further uncertainty in a time of panic as to which of AIG’s counterparties would get paid and which would be forced to take substantial losses. One of our objectives was to calm market participants, and uncertainty (and the allegations of favoritism that surely would have followed) does not do that – it fuels fear. Would the conditions extend only to AIG’s Credit Default Swap (CDS) counterparties, or might the Federal government make value judgments as to other AIG contracts? Would senior unsecured debt holders be forced to take concessions? And most importantly, would a creditor who was pressed for a discount simply refuse and declare a default? Conditional lending would have heightened the risk of an AIG default, which is what we were trying to – and did – avoid. The default risk would have been exacerbated by the credit rating downgrade that almost certainly would have followed any effort by AIG to coerce creditor concessions.
Banks sharply curtailed their lending. A full fledged panic had started and was spreading rapidly; the financial system was facing the threat of collapse. In light of the circumstances at the time, a bankruptcy filing by AIG would have had disastrous consequences. Federal Reserve Chairman Bernanke has stated that it could well have “resulted in a 1930’s-style global financial and economic meltdown, with catastrophic implications for production, income, and jobs.” Because of the decisions made that morning, we can never really know. Let us be clear, though, about the risks that the policymakers did know. Policymakers knew that AIG’s largest creditors were other financial firms and that those firms clearly would have been directly impacted by an AIG bankruptcy filing. But the gravest risks were not the direct exposure of other financial firms to AIG. The gravest risks related to the indirect consequences of a bankruptcy of AIG, indirect consequences that would impact millions of Americans. AIG’s role as one of the world’s largest and storied insurance companies meant that its failure likely would have had a contagion effect, causing damage as it spread throughout the insurance industry. Policy holders would be hurt. Municipalities, who were already reeling from a lack of financing options for their building projects, would have seen their financial protection disappear. Workers whose 401(k) plans had purchased $ billion of insurance from AIG against the risk that their stable value funds would decline in value would see that insurance disappear.