So AIG is applying to the Federal Reserve for bridge financing to allow it to enter a restructuring deal with KKR. AIG got itself into big trouble writing credit default swaps for the mortgage market, and is now facing massive losses on Hurricane Ike. That the Fed is even considering the move shows just how much the lines between different types of financial firms have blurred in this brave new world of novel financial instruments and megamergers.
Ben Bernanke is in a tough place. Opening the loan facilities to the insurance business will further strain a loan portfolio already crammed full of risk--just as the Fed has announced that it will start accepting equity as collateral. But if AIG doesn't restructure, it may have to start dumping its massive asset portfolio. This, of course, will further erode the value of the securities held by solvent banks, meaning that more of them will likely show up at the Fed's discount window with their beggar's bowls out.
This is where I'm supposed to end with a snappy, sure summation of what the Fed should do. But all I know right now is that I'm sure glad I don't have Ben Bernanke's job.
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