A Brief Explanation of Today's Nightmare on Wall Street

AIG (American International Group) is a huge insurance company - it lost 60% of its value today. It has lost 180 billion dollars of market value since it's high many months ago. Over 100,000 people work for AIG in about 100 countries.

Why AIG matters:

The trouble is not with hurricane damage or property loss that AIG insures - the problem is with credit default swaps that AIG insures and that are likely to go under and have been going under. In short: AIG insures things like corporate bonds - those bonds are defaulting and AIG will have to pay up with capital they don't have at the moment. AIG needs time to tap into assets that they do have - if their credit rating falls far enough (meaning they cant raise enough cash vs. the debt they that they are being called to insure) then they will be become insolvent and they will go bankrupt as soon as tomorrow (Tuesday). This would be an absolute total catastrophe for the US economy and it can't be allowed. Nearly every bank has exposure to AIG; it's that simple. Just moments ago the S&P put AIG on 'credit watch negative' and time is very short - just hours in fact before AIG is ruined.

AIG needed 40 billion dollars yesterday in immediate cash help; they did not get it. At the end of the day today CNBC reports that they may need more like 75- 100 billion dollars because of what is happening in the next paragraph. The Fed Reserve has no plans at the moment to approve a bridge loan to AIG.

Today is monumental in the history of Wall Street and for the nation. The drop in the Dow was the most in 7 years but that in itself was not the story at all. Lehman Brothers was one of the largest and most respected investment banks in the world. It no longer exists. Bear Stearns is no more. Merril Lynch has been saved by Bank of America. However, Bank of America already bought out Countrywide for way too much money and is likely to be in more trouble with short sellers. Goldman Sachs the darling of Wall Street, sometimes thought of as the best company in the world by people in the investment industry, has lost 19% of its value today and about 40% over the past couple of months. Washington Mutual lost 35% today. Morgan Stanley fell 14% today. Billions of dollars disappeared into thin air on Wall Street today. Fear and uncertainty are rampant.

The Fed meets tomorrow and whatever they do will be important; it is unlikely that they will react with rate cuts because oil prices have fallen and a strong dollar is a priority to continue that trend. When the Federal Reserve cuts interest rates - inflation is more likely to rise with all else remaining equal.

You may also wish that one of the four people running for executive office in America had significant economic or financial experience; none of them do. To make it all worse both Obama and McCain are sending exactly the wrong message to try to convince dumb people to vote for them - they want more regulation; more "transparency" on Wall Street. The only chance to save key institutions at the moment may be to use huge cash reserves that private equity firms would be happy to invest. The problem: Current regulation requires any entity owning 25% or more of any bank to be regulated like a "bank". No private equity firm would subject themselves to those rules; therefore their much needed cash is off the table and on the sideline. Regulation is prohibiting the market from working and government is too big and far too slow to help resolve the situation. It's not the end of the world yet; it is just another very bad day. The only question left: how many times can the sky fall?