Mortgages Uncovered

AIG is basically saying that it has now insured over $307bn of primary residential mortgages and corporate loans mostly from European banks. What has happened is that banks have bought insurance from AIG for protecting themselves against bad risk loans and defaults.

One of their primary motives in doing this was to reassure their regulatory authorities such as e.g. The Financial Services Authority for UK banks, that their loans are minimal risk in order that they could lend more that is now relative to their capital resources.

However, with AIG in trouble, sudden worries are raised about their ability to honour their financial commitments in their insurance contracts, known as ‘super senior credit default swaps’.

So, with the sudden downturn of AIG credit ratings the perceived risk now on bank’s loans insurance by them is now high!

So the associated bank’s who have insured with AIG are suffering from weaker balance sheets which means that their regulators will force them to raise additional capital.

The US Treasury and Federal Reserve cannot allow AIG to fail or following the immediate collapse of several banks a huge knock on effect that would produce a dangerous risk to the stability of the whole global financial system will ensue and things will really get critical on a massive scale.

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