World’s biggest socialist economy goes public

AIG, the world’s biggest insurer, has been rescued by the Federal Reserve. They’ve lent them $85bn, and in return they get to own 80% of the company. Given that the market capitalisation of AIG was $10bn (on Tuesday’s close, according to the NY Times), I’m guessing that the $8bn or so of “value” (owning the company) that the US Government owns was thrown in for free in return for the loan.

In any other country, that would be called nationalising a key industry, but in the US, home of free markets, I’m not sure what you call it. Just a week after the government rescued Fannie Mae and Freddie Mac, though, I’m beginning to think that the US is just as socialist as any of the Scandinavian countries, but with only one important difference; it’s only socialism for the shareholder and credit-holder, rather than the employee.

More seriously, having lived through the impact of a medium sized insurer (HIH) on an economy (that was about a $5bn hole) I’m pretty glad that the world’s biggest insurer wasn’t allowed to fail. Most commentary has been about the impact a failure might have on the world banking system, given AIG (I’m not sure how this happened when it’s an insurance company, not a bank) played a major role in the credit swap market. But insurance companies play a huge role in the financial system without being banks. It’s not a coincidence that Lloyds of London started up just when European commerce was starting to get serious in the 17th century.

It’s not until insurance fails that you realise how vital it is for an economy to function. Being able to insure against risks that they don’t want to take (product liability, workers compensation, directors insurance, as well as the more traditional fire insurance) makes companies willing to take the risks on their own business.

Many companies in Australia have insurance of one sort of another with AIG. They insure Directors and Officers insurance, product liability, standard fire insurance, that kind of thing. AIG subsidiaries also reinsure insurance companies for catastrophes all over the world – so if we had a serious cyclone in Australia, AIG would be paying some claims, assuming it was still solvent.  They are an important player in the economy, but assuming an orderly transfer of liability to their competitors, the economy could probably cope.

In many countries, though, particularly in Asia, they are the biggest or second biggest life insurer. That means that they are the repository of the middle class’ long term savings. And a crisis of confidence there could mean a huge blow to the economy.

Here in Australia, our regulator, APRA, has strict rules about local subsidiaries being capitalised appropriately without requiring parental support. So our local AIG subsidiaries will probably be OK in the short term. But in less than a week, they’ve gone from being well-run, medium sized contributors to the economy, to being sick companies with zero growth prospects that their competitors are stealing customers from. It’s hard to manage a company in that context, and no matter how well capitalised they are, there starts to be some risk when business completely dries up.

So I’m grateful to the American taxpayer, for turning socialist and rescuing AIG. I suspect, though, that they brought much of it on themselves (or their government did) for lax regulation of insurance companies in the first place.