Business week – The idea certainly seemed all right to throngs of Americans who were outraged by news that American International Group (AIG) paid out millions of dollars in executive bonuses after it was rescued with taxpayer cash.

But would no bailout be even worse? Financial analysts and federal officials have warned that doing nothing to save AIG—or banks or the auto industry—would be a catastrophe, an economic domino effect of bank losses, stock market chaos, and job cuts. No one—at least no one in the government—has the stomach for that.

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New York (HedgeCo.Net) -   After handing AIG another $30 billion in taxpayer-funded, government bailout funds, U.S. Federal Reserve Chairman Ben Bernanke defended the decision, with the worn-out argument that the insurer’s failure may trigger an economic domino effect.

“We know that failure of major financial firms in a financial crisis can be disastrous for the economy,” Bernanke said in a testimony to the senate Budget Committee on Tuesday.  “We really had no choice.”

So far, the government has come to AIG’s rescue four different times, pumping over $160 billion into the insurance giant.  In an attempt to appease furious lawmakers who disagree with the latest handout, Bernanke said, "If there’s a single episode in this entire 18 months that has made me more angry, I can’t think of one (other than) AIG."

AIG reported an industry wide record $61.7 billion quarterly loss this week, attributing that to losses on their credit default swaps; worthless pieces of paper that “guarantee” mortgage-backed securities.    AIG sold these credit default swaps, which supposedly insured about $440 billion in bonds.  In reality, AIG did not have the funds to cover these investments.  When the securities inevitably plummeted in value, AIG couldn’t cover what they promised.  Unfortunately, credit default swaps, which were invented in the late 90’s by several employees at J.P. Morgan Chase as a means to make quick cash, are not regulated by the U.S. government. 

Many feel AIG has acted irresponsible, and that no amount of government funds will turn the poorly run business around.  AIG even “cleverly attached a hedge fund to their insurance company, taking advantage of a gap in federal and state oversight,” Bernanke added.

In exchange for the funds, the government will receive $26 billion in preferred stock in two AIG subsidiaries – American Life Insurance Co. and American International Assurance Co.  AIG will not have to pay interest on the outstanding loan.

Julie Scuderi
Senior Editor for HedgeCo.Net
Email: julie@hedgeco.net

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Reuters – Private equity investor Thomas H. Lee may shrink or shut down two funds that had $1.5 billion in assets after suffering losses of about 40 percent this year, the Wall Street Journal reported on Thursday, citing people familiar with the situation.

Hard-hit hedge funds run by Lee farmed out investor money to about 110 other funds, including SAC Capital Advisors and D.E. Shaw Group, according to the paper.

While Lee designed the so-called funds-of-funds to have low volatility with steady, consistent returns, he borrowed heavily to multiply the size of his bets, piling up debt of as much as $3.2 billion, the sources told the paper.

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