AIG is already on the brink of default. Now we have a problem. You see, AIG is big. Very big. And while the failure of Lehman certainly causes pain, the failure of AIG takes down the system. AIG is to Lehman what the turkey is to the sweet potato soufflé at Thanksgiving dinner. These boys are the counterparty to"> AIG is already on the brink of default. Now we have a problem. You see, AIG is big. Very big. And while the failure of Lehman certainly causes pain, the failure of AIG takes down the system. AIG is to Lehman what the turkey is to the sweet potato soufflé at Thanksgiving dinner. These boys are the counterparty to" />

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September 15, 2008

Too Big to Fail

How quickly things change. The financial world is being rocked anew with word that AIG is already on the brink of default. Now we have a problem. You see, AIG is big. Very big. And while the failure of Lehman certainly causes pain, the failure of AIG takes down the system. AIG is to Lehman what the turkey is to the sweet potato soufflé at Thanksgiving dinner. These boys are the counterparty to hundreds of billions of derivatives held by big banks and worldwide financial institutions, and if they can't fulfill obligations, then all those financial institutions end up with holes in their balance sheets big enough to cause them to fail.

Given that this development comes so close to Lehman's failure and one day before an FOMC meeting, the odds have increased substantially that we see a cut tomorrow. I noted that the Fed would cut when it became politically expedient to do so. How much more expedience do you need than crash aversion? My first instinct after changing my view on a rate cut was to close my SPX short, and with spoos trading down another 1.5% overnight, that's exactly what I did. I captured a juicy 80 index points in 24 hours, and going flat also gives one the advantage of clear thinking. I may very well put the short back on before morning, but at the moment I just want the luxury of lack of exposure.

Oddly enough, precious metals are sinking this evening. One would think that as the odds of government intervention rises, so would the price of metals, so I am also pondering whether to fade the evening move and add to my silver stash. Reader thoughts would be welcomed.

 

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