Investing in the stock market is serious business...

World's Largest Insurer Dangles By a Thread

September 16, 2008

...But sometimes, in moments of crisis, even the Ivy League grads and elite economists on Wall Street revert to their most basic instinct—that of survival. In an environment like that, there's not a lot of room for error.

That's why things went from bad to worse to critical in the span of a few days at American International Group (AIG). Wall Street was already on high alert thanks to the bankruptcy of Lehman Brothers, and then late Monday the S&P, Moody's and Fitch all cut their ratings of the insurance giant. As a result, AIG now has to scramble to raise an additional $40 billion in extra collateral to avoid a total collapse of its operations, which include the controversial insurance of risky Collateralized Debt Obligations. A tall order to begin with, but even more difficult in this environment of desperation.

The 89-year-old insurer has turned to private-equity firms for the much-needed cash infusion, as well as the Federal Reserve. The Fed ultimately extended a lifeline to the struggling insurer, to the tune of $85 billion. But this assistance doesn't come without strings. In exchange for the loan, the government now owns 80% of AIG. As a result, shares are currently trading 20% lower than they were before the bailout, further rattling shareholder confidence.

For 30 years, AIG generated spectacular returns for investors; however, since 2000 the company's fundamentals have deteriorated rapidly. AIG has taken on excessive risk in the past few years, which has chipped away at the company's competitive advantage.

Originally, AIG's successful penetration of international markets contributed extensively to the company's growth. But as AIG grew, the firm took on additional risk as it ventured into mortgage and structured finance markets. This eventually eroded investor confidence in the company's business operations.

AIG has been smacked in the face by the housing meltdown and credit crisis. Its exposure to mortgage-backed securities is the culprit for AIG's demise. I really don't expect this company to turnaround anytime soon, especially without an adequate cash infusion.

Once considered a large-cap safe haven for investors with low-risk tolerance, AIG has done a complete 180-degree turn for the worst. PortfolioGrader Pro, my FREE stock ranking tool, has black-listed AIG. See for yourself: It's an F-stock.

Perhaps you think that AIG is a stock that's been unfairly treated by the markets? You could be right—after all, we've seen how investor sentiment is the driving force behind today's volatility. But the numbers speak for themselves—the company's portfolio is extremely exposed to subprime and Alt-A mortgage-back securities. AIG's reputation has been squashed by the latest bout of financial turmoil. It's going to take a long time to recover—if it ever does.

What's your take on the fate of AIG? What do you think about the latest round of big bank failures? Are regulators doing enough to fix the problem? I'd love to hear your thoughts! Feel free to send me your comments!