The Argument Against Letting AIG Fail

Since I argued that we should have saved Lehman and let AIG go, let me give the opposite side. Or more precisely, let me quote from a post by Mark Thoma of Economist’s View:

It may very well be that financial markets can withstand the failure of AIG, but the potential downside if that assumption is wrong is very large, larger than any policymaker wants to take the blame for. Thus, in such cases, you often observe policymakers pursuing what they feel is the safest policy that moves the ball forward rather than policies that might have a better upside, but also come with the possibility of, say, market meltdown. I’m sympathetic to the argument that we should put AIG through a carefully managed failure, but saying, as above, that letting “AIG’s derivative counterparties take a significant haircut … should not lead to … a crisis” still leaves the door open, even if only a crack, to an outcome that no policymaker wants to be responsible for.

And then he goes on to say:

How sure are we that if we let AIG fail all of the necessary pieces - all the big and little ifs above - will fall into place, how sure are we of any evidence based upon asset valuations when there’s no market price for them, and how sure are we that we’ve thought of all of the things that could go wrong?

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