Monday, March 9, 2009

"Too Big"

AIG warns of serious consequences if it does not get more bailout money. This is what happens when regulators are asleep at the wheel. Note that on page two of the document:
AIG's business model - a sprawl of $1 trillion of insurance and financial services businesses, whose AAA (credit rating) was used to backstop $2 trillion dollar financial products trading business - has many inherent risks that are correlated with one another. As the global economy has experienced multi-sector failures, AIG's vast business has been weakened by these multi-sector failures. [my emphasis added]
Well, duh. What did you think would happen when you highly levered correlated risks?? This either points to the extreme arrogance of these people in ignoring the potential for systemic risk or the lack of competence in understanding that risk existed in their "vast business." To be sure, risk exists in all businesses and cannot be eliminated. Nor should we expect that firms will never take risks, otherwise they will never innovate or expand. But, businesses should be prudent in understanding their risks and regulators should be cognizant of the risks that are being taken.