If You Can't Dazzle Them With Fiscal Brilliance...

...bury them in economic bullshit. Daryl Cagle's latest 'toon sums it up nicely.

Yeah, What Digby Said

troof.

If you like useless expensive wars, financial scandals, stock market crashes, foreclosures and economic instability as far as the eye can see, vote Republican. They've got everything you need.

We Gots Dealz, Yo

WaMu is auctioning itself off tonight like a street-corner prostitute.

Morgan Stanley is considering a merger into Wachovia.

Lloyds of London is buying UK housing lender HBOS.

As I said, massive consolidation into Too Big To Fail companies is coming. Massive. Consolidation.

[UPDATE] DeutscheBank is putting hold on its credit default swaps. The Credit market is coming unglued in real time. It's all changing this week.

What will tomorrow bring?

[UPDATE 2] Nancy wants TEH PROBE! (P.S. Obama just called McSame out for looking like a dipshit when he offered his blue-ribbon commission. We know what happened. There was no regulation. There's no need for a probe. JUST FIX THE DAMN PROBLEM. Nice one, Nan.)

Oh, And In Non-Wall Street Based Carnage

Terrorists hit the US Embassy in Yemen.

Suspected Al Qaeda militants disguised as security forces launched an explosive assault on the U.S. Embassy in Yemen's capital, Sanaa, Wednesday killing 10 Yemeni police and civilians, officials said.

The attack involved two car bombs, a spokesman for Yemen's embassy in Washington said. Six attackers, including a suicide bomber wearing an explosive vest, were also killed in the attack, Mohammed al-Basha said.

There were at least four explosions -- including at least one car bomb -- and sniper fire, a senior State Department official said.

Yemeni officials said the first car contained people in police uniforms who exchanged fire with Yemeni security forces, the officials said.

The second car exploded after it passed an outermost gate to the Embassy but before it reached a second protective barrier, the officials said.

But al-Basha said there were two cars packed with explosives involved in the attack.

The heavily fortified compound in the capital of Yemen -- the ancestral home of al Qaeda leader Osama bin Laden -- has previously been targeted in attacks.

It's always Al Qaeda, just like all soft drinks are "Coke" and all tissues are "Kleenex".

Still On The Fence About Sister Sarah?

Allow me ten minutes for a rebuttal.



If you're not scared out of your mind after seeing this, you should be.

One heartbeat away.

Global No-Confidence Vote: Deal Or No Deal Pt 3

Deal or No Deal has gone global, folks!

Yesterday AIG got the mother of all deals, an $85 billion dollar loan to buy the company enough time to sell off assets. The government now has an 79.9% stake in the world's largest insurance company, and it's going to be selling chunks of AIG to try to make that money back.

Fearing a financial crisis worldwide, the Federal Reserve reversed course on Tuesday and agreed to an $85 billion bailout that would give the government control of the troubled insurance giant American International Group.

The decision, only two weeks after the Treasury took over the federally chartered mortgage finance companies Fannie Mae and Freddie Mac, is the most radical intervention in private business in the central bank's history.

With time running out after A.I.G. failed to get a bank loan to avoid bankruptcy, Treasury Secretary Henry M. Paulson Jr. and the Fed chairman, Ben S. Bernanke, convened a meeting with House and Senate leaders on Capitol Hill about 6:30 p.m. Tuesday to explain the rescue plan. They emerged just after 7:30 p.m. with Mr. Paulson and Mr. Bernanke looking grim, but with top lawmakers initially expressing support for the plan. But the bailout is likely to prove controversial, because it effectively puts taxpayer money at risk while protecting bad investments made by A.I.G. and other institutions it does business with.

What frightened Fed and Treasury officials was not simply the prospect of another giant corporate bankruptcy, but A.I.G.'s role as an enormous provider of esoteric financial insurance contracts to investors who bought complex debt securities. They effectively required A.I.G. to cover losses suffered by the buyers in the event the securities defaulted. It meant A.I.G. was potentially on the hook for billions of dollars' worth of risky securities that were once considered safe.

If A.I.G. had collapsed -- and been unable to pay all of its insurance claims -- institutional investors around the world would have been instantly forced to reappraise the value of those securities, and that in turn would have reduced their own capital and the value of their own debt. Small investors, including anyone who owned money market funds with A.I.G. securities, could have been hurt, too. And some insurance policy holders were worried, even though they have some protections.

"It would have been a chain reaction," said Uwe Reinhardt, a professor of economics at Princeton University. "The spillover effects could have been incredible."

Ahh, but the game isn't over yet. Not by a long, long way. For you see, today is a new day...and we have a new contestant on the other side of the pond, UK megabank HBOS is about to be bought out by Lloyd's of London.

Embattled mortgage lender HBOS PLC confirmed Wednesday that it is in advanced talks about being taken over by Lloyds TSB PLC in what would be a further reshaping of the financial industry amid the credit crisis.

The brief announcement to the London Stock Exchange gave no details, adding that the talks may not lead to an agreement.

Lloyds is the fifth-largest U.K. bank by market capitalization and the U.K.'s third-biggest home mortgage lender. HBOS, parent company of Halifax and the Bank of Scotland, writes about a fifth of the home mortgages in the U.K.

Here on this side of the pond, the bailout of AIG has failed to stop the bloodbath. The Dow is down 350+ at noon and speculation is swirling around who is next. Odds are it's WaMu, but the bloodbath is rolling across the board.

U.S. stocks tumbled as bank lending seized up in the wake of the government's takeover of American International Group Inc. and investors fled to the relative safety of Treasuries.

Goldman Sachs Group Inc. and Morgan Stanley, the two largest U.S. securities firms, plunged more than 14 percent after Oppenheimer & Co. analyst Meredith Whitney cut profit estimates. General Electric Co., the world's third-biggest company, fell 7.7 percent and U.S. Steel Corp. slid 11 percent. Yields on three-month bills sank to a 54-year low and a measure of corporate borrowing costs surged to the highest since the crash of 1987.

``It's ugly,'' said Michael Mullaney, a Boston-based money manager for Fiduciary Trust Co., which oversees $10 billion in stocks and bonds. ``It's about the worst I've seen it in 25 years. You have to have free-flowing credit to lubricate the system. That's not happening right now.''

The S&P 500 lost 36.6, or 3 percent, to 1,176.99 at 11:24 a.m. in New York, its lowest in almost three years. The Dow Jones Industrial Average decreased 275.36, or 2.5 percent, to 10,783.66. The Nasdaq Composite Index sank 69.71, or 3.2 percent, to 2,138.19. More than 10 stocks retreated for each that rose on the New York Stock Exchange.

About $2.8 trillion of market value was erased from global stocks this week, triggered by Lehman Brothers Holdings Inc.'s bankruptcy. Russia halted stock trading for a second day and poured $44 billion into its three biggest banks in a bid to halt the worst financial crisis in a decade.

The global credit crunch is in overdrive. The AIG bailout has locked up the credit markets across the globe, and the markets are in freefall in Asia, Europe, and America.

We're watching Deal Or No Deal come up No Deal all over the world. Credit swaps are locking up. Trillions of credit has evaporated across the globe and will continue to evaporate at a time where credit liquidity is the only thing keeping the markets going, being able to trade phantom fiat cash for other phantom fiat cash...the world's biggest IOU swap meet just ground to a screaming halt.

The Fed is scrambling to raise cash itself. It's in real trouble, having to resort to a special auction of T-Bills in order to save its bacon.

The Treasury will sell more debt to enable the Federal Reserve to expand its balance sheet, a sign of the strains created by the biggest extension of central-bank credit to financial companies since the Great Depression.

The program starts today with a $40 billion auction of 35- day bills, a day after the government agreed to take over American International Group Inc., the Treasury said in a statement in Washington.

The proceeds will ``provide cash for use'' by the Fed as it seeks to boost liquidity in credit markets struggling from $515 billion in writedowns and losses since the start of last year. The announcement illustrates the potential drain on the government's finances in taking over AIG, Fannie Mae and Freddie Mac, and taking on $29 billion in Bear Stearns Cos. assets.

``It is becoming imperative for the Fed to take actions to enlarge its balance sheet,'' said Tony Crescenzi, chief bond market strategist at Miller Tabak & Co. in New York.

Yesterday the Fed announced an $85 billion loan to AIG, in exchange for a 79.9 percent government stake in the largest U.S. insurer. The Fed also has set up several other emergency lending programs to provide Wall Street firms with ready access to funding.

``The program will consist of a series of Treasury bills, apart from Treasury's current borrowing program'' and ``will provide cash for use in the Fed initiatives,'' the department's statement said.

Fed T-Bill rates have dropped to their lowest level in over 50 years because of this. The Fed is falling apart, its balance sheet is in real trouble now.

Deal Or No Deal is hitting Moscow too.

Russia poured $44 billion into its three largest banks and halted stock trading for a second day in a bid to stem the worst financial crisis since the devaluation and default a decade ago.

The Finance Ministry extended the repayment period on loans available to OAO Sberbank, VTB Group and OAO Gazprombank to three months from one week. The benchmark Micex stock index plunged as much as 10 percent, bringing its three-day decline to 25 percent. The KIT Finance brokerage said it's in talks with investors to sell a stake after failing to meet obligations.

Russia's markets are facing the biggest test since the government defaulted in 1998. The decade-long economic boom is fading, foreign investors have pulled at least $35 billion from the nation's stocks and bonds since the five-day war in Georgia last month, and the collapse this week of Lehman Brothers Holdings Inc. and American International Group Inc. prompted a flight from emerging markets.

``I will tell my clients today to continue to abstain from buying Russian assets'' until economic problems are solved, said Zina Psiola, who manages a $1 billion Russian equities fund at Clariden Leu AG in Zurich.

The cost of lending has soared to a record, with the MosPrime overnight rate reaching 11.1 percent today, deterring speculative bets in equities. Russian stocks have lost more than $425 billion in value since reaching an all-time high May 17.

Since Friday the global financial system has gone into crisis mode. The system is beginning to show huge cracks. Everyone is scrambling to try to save their markets. Deal Or No Deal is being repeated in every corner of the markets on Earth today.

The system is crashing before our eyes. New York. London. Moscow. Hong Kong. Tokyo. All over.

Deal Or No Deal has gone berserk. The game is grinding to a halt because nobody knows what deals are worth anymore...and nobody can make any more deals.

You are witnessing the death throes of the system. Today. Right now. In real time. We're watching the global economic engine seize up because like a car with no oil, the parts are locking up. That oil -- global credit liquidity -- has dried up and turned to toxic sludge. Deal or No Deal has become just No Deal...because deals cannot be made. History books will look back on this week and we'll wonder.

Because we're about to get crushed by the flailing corpse of the global economy. The big one is upon us as we speak.

The final verdict is No Deal.

More than ever folks...

Be prepared.

Cross-Posted at the Frog Pond.

The Art Of The Deal

Like I alluded to earlier, AIG got a nice little going-away present.

Fearing a financial crisis worldwide, the Federal Reserve reversed course on Tuesday and agreed to an $85 billion bailout that would give the government control of the troubled insurance giant American International Group.

The decision, only two weeks after the Treasury took over the federally chartered mortgage finance companies Fannie Mae and Freddie Mac, is the most radical intervention in private business in the central bank’s history.

With time running out after A.I.G. failed to get a bank loan to avoid bankruptcy, Treasury Secretary Henry M. Paulson Jr. and the Fed chairman, Ben S. Bernanke, convened a meeting with House and Senate leaders on Capitol Hill about 6:30 p.m. Tuesday to explain the rescue plan. They emerged just after 7:30 p.m. with Mr. Paulson and Mr. Bernanke looking grim, but with top lawmakers initially expressing support for the plan. But the bailout is likely to prove controversial, because it effectively puts taxpayer money at risk while protecting bad investments made by A.I.G. and other institutions it does business with.

What frightened Fed and Treasury officials was not simply the prospect of another giant corporate bankruptcy, but A.I.G.’s role as an enormous provider of esoteric financial insurance contracts to investors who bought complex debt securities. They effectively required A.I.G. to cover losses suffered by the buyers in the event the securities defaulted. It meant A.I.G. was potentially on the hook for billions of dollars’ worth of risky securities that were once considered safe.

If A.I.G. had collapsed — and been unable to pay all of its insurance claims — institutional investors around the world would have been instantly forced to reappraise the value of those securities, and that in turn would have reduced their own capital and the value of their own debt. Small investors, including anyone who owned money market funds with A.I.G. securities, could have been hurt, too. And some insurance policy holders were worried, even though they have some protections.

“It would have been a chain reaction,” said Uwe Reinhardt, a professor of economics at Princeton University. “The spillover effects could have been incredible.”

My question is what has fundamentally changed here?

Not much. The underlying cause of the the problem, the housing depression, is still rampant. That hasn't changed, nor has it been even remotely addressed. It will remain with us through at least next year if not well into 2010.

The Fed policy of Too Big To Fail? Hasn't changed at all. Lehman just didn't qualify as systemic enough. You can bet that the next wave of mergers and acquisitions in the financial sector will be hotly contested.

Everyone will want to get to the Too Big Too Fail stage. Everyone in the financial sector will now think they are Too Big To Fail, or be bought out by somebody who thinks they are. That's how the industry works now.

Come to think of it, that's how the airline, auto, and a bunch of other sectors of our economy work now. Everyone's going to try to get to that magical Too Big To Fail level...which means thanks to the wonders of Moral Hazard we will now have companies taking even more risk, not less, than they were before in order to try to make it big. The Fed's actions show you will get a bailout only if your actions are egregious enough to qualify as a systemic risk if you are allowed to fail.

There's no downside now. You'll see this happening across not just the financial industry but all of them. Why not? There's again, no downside to making yourself Too Big To Fail now.

So that's what we'll see. Unless strict new regulations are imposed (and you can bet with both McSame and Obama in the pocket of Wall Street, meaningful new regulations simply will not happen.) we'll continue to be in this mess. The pressure will be there to do something, but we'll hear the same excuses that we're hearing now: "There are already been too much Federal intervention in the markets, less is needed, not more." The GOP surely will say that, including McSame. Obama? He'll be made to get with the program.

Only eventually something systemic will have to go. The Fed is running out of money it can give away. It pumped $155 billion into the financial sector in just the last few days. How long can this keep up?

As long as the Fed can keep printing billions. As long as China and India and the EU decide that the US is Too Big To Fail. As long as the game of Deal Or No Deal comes up with new deals to make and new suckers to exploit.

But when the music stops, the bill that comes due will wreck the country. And the longer we refuse to face it, the worse it will be.

The Fed is hawking T-Bills this morning to raise $85 billion it does not have right now. Once again Asia is paying for our bailout. When they stop buying T-Bills, the game ends.

And the new one begins.

StupidiNews!

• I hope to have power back today along with most of the Cincy area.
• Deal Or No Deal? AIG got one hell of a Deal.
• The Drill Bill passes the House, but faces an uncertain future in the Senate.
• Even the Financial Times says the good times are over on Wall Street.
• Did Sarah Palin use Yahoo email to get around state law?

AIG Aftermath

Things are moving quickly now. CNBC and Bloomberg are both reporting there's now a Fannie/Freddie style Fed conservator/takeover bid in the works where the government will end up running AIG.

American International Group may work out some kind of deal with the Federal Reserve to shore up its finances by the end of the day, CNBC has learned.

Under pressure from New York Governor David Paterson and AIG policyholders, the Federal Reserve is considering reversing its decision on Monday and providing some kind of financial aid to the troubled insurer.

Bloomberg reported late Tuesday that the Fed was considering some kind of conservatorship for AIG, which sent the firm's shares down in after-hours trading.

The Fed met with the company's advisers throughout the day and came to a better understanding of what is needed to help the company through its current crisis, people familiar with the negotiations said.

These people said there is hope that a Fed-funded plan could be reached by the day's end.

This goes FAR beyond a bailout. This is the complete Fannie and Freddie package, complete with stockholders getting wiped out as the debt is dumped on them.

As a result AIG is now trading under half of its closing value of $3.75 this afternoon, it's down to $1.80 a share and falling in after hours trading as of 5:30 PM.

If this falls through it's over, but if a conservatorship happens...then what? We've already nationalized the mortgage industry. We're well on the way to nationalizing the investment industry as well...and then the banks themselves are quite possibly next.

This is insanity. You can't buy the entire industry. Observe Bank of America snapping up everything it can get its hands on: it's going for Too Big To Fail. Look for more massive consolidation in the financials.

Today was the ultimate Dead Cat Bounce for the Dow.

There Is Win. There Is Awesome.

And there is this story.

Anyway: A wonderful lady picked him up at a bar, and she went to his hotel room, and she slipped him a mickey. When he woke up, his entire ridiculous jewel-encrusted ultra-tacky wardrobe was stolen — “$120,000 in money, jewelry and other belongings,” according to the Pioneer Press. Ha, it costs $120,000 to look like that? Who knew!

It was the night of Sarah Palin’s big dumb speech at the RNC. This guy, Gabriel Schwartz — “a single attorney and a fixture in Colorado Republican politics,” according to the Pioneer Press — was staying in Minneapolis at the fancy Hotel Ivy. He reportedly took this girl back to his $319-per-night room and she told him to get undressed while she made the drinks. This is a wonderful scene from some James M. Cain book, but rather than wearing a salesman’s suit, the mark is dressed like some castout from the Village People or the Stray Cats or god knows what.

“Victim reported suspect made victim drinks, told him to get undressed, which is the last thing he remembers,” a police narrative said. “Upon waking, victim discovered money, jewelry gone; total loss over $120K.”

A police report notes the crime occurred between 4:22 and 5:46 a.m., and Palmer said investigators believe Schwartz had been drugged, although he declined to discuss details.

Aside from the watch, ring, necklace, earrings and belt, Schwartz also reported a $1,000 purse or wallet, a $1,500 cell phone, $500 in cash and a couple of rings worth $50 had been taken.

Ha ha ha ha ha ha ha ha ha ha. We salute you, wonderful girl thief of Minneapolis. You are America’s Real Hero. Everything about you is a delicious testament to the American Dream … the American Dream of duping a vulgarian lawyer.

The only thing that would make this better is an anonymous donation of $120,000 to Obama's campaign. Oh my my my my my. There is karma in the universe after all.

If McSame Has Lost These Guys...

...then he's screwed. Observe.



Fork, meet John Sidney McSame The Third. John Sidney McSame The Third, meet done.

When Traversing Roads On Your Steam Velocipede...

While supplies last. (h/t AmericaBlog)

Documenting The Atrocities

Another liveblog of the markets today.

9:35 AM -- Five minutes in. AIG is already at less than two dollars, Dow down 125.

9:45 AM -- Some fighting back. AIG hovering around $2.50, Dow down 70.

9:50 AM -- Goldman Sachs missed its earning target by about 70%. Stock down 10%. AIG still hovering around $2.50, Dow off 60 points.

10:20 AM -- AIG and Dow still hovering, but WaMu is actually up about 10 cents.

10:30 AM -- AIG struggling up to $3. Dow treading water. Rumors of a Fed rate cut are limiting the damage.

10:45 AM -- AIG still at $3, Dow still slightly down, just treading water until the Fed decides on a rate cut now later today. Anything less than a half point cut will cause the market to drop like a stone.

11:00 AM -- News breaking that the Fed is meeting to discuss AIG, a Fed bailout is now "back on the table." AIG stock is climbing to $4 a share and threatening to break into positive territory.

11:05 AM -- Dow back above 11,000 mark. Investors are "confident the Fed will take significant action today."

11:20 AM -- Moral Hazard clause in action. Many talking heads are saying if AIG doesn't get a substantial taxpayer bailout that it's over, and that the Fed has no choice. More treading water, Dow slightly under 11k.

11:30 AM -- Dow back down 50, AIG back down 2 bucks to under $2.50, back to where we were at 10.

11:35 AM -- Market is depressed back to the 10 AM level doldrums because the private sector solution to AIG's money problems is now "definitely dead". It's a Fed bailout or bust now.

12:00 PM -- Dow up 20, AIG back close to $3. Still treading water until a rate cut/bailout decision is made. McSame says "taxpayers should not be on the hook" for AIG. For the first time in years I agree with the guy. Go figure.

12:35 PM -- Dow and AIG are still treading water. Nobody wants to make a move right now until the rate cut/bailout situation is resolved.

1:15 PM -- Dow's up 70 or so, AIG above $3, but still down a third for the day. Obama's planning to give a big speech on the economy today in Golden, CO.

1:25 PM -- WaMu is up 10% on news of a possible deal with JP Morgan Chase.

2:00 PM -- Former AIG CEO Hank Greenburg is leading a group of investors who may be making a play to buy out AIG in a proxy fight. Could this be the white knight? Does it even matter if the white knight arrives when there's an army of problems waiting? AIG still floating around $3.

2:15 PM -- NO RATE CUT. Dow is dropping, AIG down to $2.50, no word on an AIG bailout yet.

3:25 PM -- Dow up substantially, up 150. AIG above $4 now, once again threatening to go into positive territory.

3:35 PM -- Reality rears its ugly head. AIG down 30% again at $3.25, Dow up 70.

3:40 PM -- Bloomberg is reporting the Fed is now officially considering making a deal to save AIG later today, reversing its stance. Happy markets, yay capitalism.

3:45 PM -- Word is Lehman's core business has just been bought by Barclays, and that's got the market juiced in the final 15 along with the possible Fed bailout.

4:00 PM -- Final score, Dow up 141, AIG down to $3.75. Street is licking its chops waiting on the details of the "bridge loan to nowhere". The Street has now "factored in" AIG getting $70-$90 billion dollars before the market opens tomorrow from the Fed.

We'll see how that goes.

Global No-Confidence Vote: Deal Or No Deal Part 2

September 15, 2008...Black Monday...was just the beginning, folks. The Dow may have lost 500 points, but the S&P lost 4.71%, an even worse day on the broader markets. And once again, I cannot stress enough that Lehman Bros. was not the real problem.

It was just one more domino in the chain, one more player in the great game of Deal Or No Deal. Lehman Bros. got No Deal...and the global markets are in freefall as a result.

But today could be worse. Today's Deal or No Deal contestant is the largest insurance company in the world, American International Group or AIG. It's time to play the game.

And AIG is in serious, serious trouble.

American International Group Inc. fell 38 percent in early New York trading after the insurer's credit ratings were cut, threatening efforts to raise funds to keep the company afloat and roiling global financial markets.

S&P lowered AIG's long-term counterparty rating three grades to A- because of ``reduced flexibility in meeting additional collateral needs and concerns over increasing residential mortgage-related losses,'' the rating company said yesterday. Moody's cut AIG's senior unsecured debt two grades to A2. Fitch Ratings lowered its assessment to A from AA-.

The downgrade of AIG is the latest tremor to shake the global financial industry, less than a day after Lehman Brothers Holdings Inc. filed for Chapter 11 bankruptcy protection and Merrill Lynch & Co. sold itself to Bank of America Corp. for about $50 billion. Stock markets from Tokyo to London tumbled as investors weighed the impact of a potential collapse of the largest U.S. insurer by assets.

``There's a systemic risk if AIG isn't saved,'' Benoit de Broissia, an equity analyst at Richelieu Finance in Paris, said in a Bloomberg Television interview. Richelieu has about $6.2 billion under management.

I've been talking about systemic risk in the Global No-Confidence Vote series for months now. Systemic risk is just that: a risk that threatens the entire system. Fannie and Freddie going under was the ultimate systemic risk. The Fed had no choice but to save it. But AIG poses a large systemic risk as well. What do I mean by systemic?

Take a look at the aftermath of Hurricane Ike as an example. Millions of Americans got a harsh lesson in systemic risk this weekend, including myself. Recovery efforts are needed from Houston to Detroit, power outages, gas shortages, food and water interruptions, critical supply problems. Here in the Cincy area there are still hundreds of thousands without power, even with power crews being called in from other states.

Now imagine a hurricane so bad that the entire lower 48 was hit with 75 MPH+ winds that caused damage, power outages, and supply interruptions across the entire country at the same time. All states would need their power crews. All power companies would be facing angry customers. Getting supplies into areas would be nearly impossible because they would be needed everywhere. All Governors would be scrambling for Federal emergency assistance. FEMA would be overloaded.

Supplies of food, water, and gas would dwindle to nothing. There would be no easy way to get supplies back in. Tens of millions of Americans would have to fend for themselves. The system would break down. The threat would be systemic. We would degenerate into riots, martial law, and chaos after only a few weeks. It would take months to get the system back up again...if it was even able to come back up at all.

That is the level of risk an AIG collapse would pose to the entire global financial system. How bad would it be?

This bad.

When Lehman Brothers filed for bankruptcy on Monday, it became the latest but surely not the last victim of the subprime mortgage collapse. Lehman owned more than $600 billion in assets. Financial institutions around the world have already reported more than half a trillion dollars of mortgage-related losses and that figure will most likely double or triple before the crisis exhausts itself.

But there is a bigger potential failure lurking: the American International Group, the insurance giant. It poses a much larger threat to the financial system than Lehman Brothers ever did because it plays an integral role in several key markets: credit derivatives, mortgages, corporate loans and hedge funds.

Late Monday, A.I.G. was downgraded by the major credit rating agencies (which inexplicably still retain an enormous amount of power in the marketplace despite having gutted their credibility with unreliable ratings for mortgage-backed securities during the housing boom). This credit downgrade could require A.I.G. to post billions of dollars of additional collateral for its mortgage derivative contracts.

Fat chance. That's collateral A.I.G. does not have. There is therefore a substantial possibility that A.I.G. will be unable to meet its obligations and be forced into liquidation. A side effect: Its collapse would be as close to an extinction-level event as the financial markets have seen since the Great Depression.

A.I.G. does business with virtually every financial institution in the world. Most important, it is a central player in the unregulated, Brobdingnagian credit default swap market that is reported to be at least $60 trillion in size.

Nobody knows this market's real size, or who owes what to whom, because there is no central clearinghouse or regulator for it. Credit default swaps are a type of credit insurance contract in which one party pays another party to protect it from the risk of default on a particular debt instrument. If that debt instrument (a bond, a bank loan, a mortgage) defaults, the insurer compensates the insured for his loss. The insurer (which could be a bank, an investment bank or a hedge fund) is required to post collateral to support its payment obligation, but in the insane credit environment that preceded the credit crisis, this collateral deposit was generally too small.

As a result, the credit default market is best described as an insurance market where many of the individual trades are undercapitalized. But even worse, many of the insurers are grossly undercapitalized. In one case in the New York courts, the Swiss banking giant UBS is suing a hedge fund that said it would insure nearly $1.5 billion in bonds but was unable to do so. No wonder -- the hedge fund had only $200 million in assets.

If A.I.G. collapsed, its hundreds of billions of dollars of mortgage-related assets would be added to those being sold by other financial institutions. This would just depress values further. The counterparties around the world to A.I.G.'s credit default swaps may be unable to collect on their trades. As a large hedge-fund investor, A.I.G. would suddenly become a large redeemer from hedge funds, forcing fund managers to sell positions and probably driving down prices in the world's financial markets. More failures, particularly of hedge funds, could follow.

Regulators knew that if Lehman went down, the world wouldn't end. But Wall Street isn't remotely prepared for the inestimable damage the financial system would suffer if A.I.G. collapsed.

AIG's collapse could very well be a systemic risk problem...a problem that risks the end of the current global financial system. If there's No Deal, there could be far worse consequences than a 500 point Dow loss.

The real problem is that there are dozens of companies that could be the systemic risk that blows a hole in the entire global financial system. If AIG does survive, there will be another company that's in trouble...and another...and another.

There will eventually be a No Deal large enough to take out the system sooner or later. Either the Fed will draw a line, or they won't have the money to save them. That possibility is looking to be sooner...MUCH sooner.

Even if it's not AIG, there will be more contestants on Deal or No Deal, Wall Street Edition. Many, many more.

Which one will break the global derivative market and with it plunge America and the world into a financial nightmare?

Be prepared.

Cross-posted at the Frog Pond.

StupidiNews!

• Still a good 500,000 people without power in the Greater Cincinnati area, including me. No power, no gas pumps, no gas for generators, no power.
• Sarah Palin is pinning Troopergate on Obama, despite the fact the investigation was started well before she became McSame's running mate.
• McClatchy reminds you it was Republicans AND Democrats who are responsible for yesterday's Wall Street Massacre.
• The scariest words in the English language: "Opening arguments today in the OJ Simpson trial began Monday..."
• And a Microsoft Xbox 360 tester has been fired after talking about the console's high failure rate. (Mine went out a couple weeks ago.)