With how quickly things were changing this week, I recused myself from commenting while things were flying, instead preferring to gather data and hopefully provide some insightful analysis. Since – cross your fingers – we don’t look setup to have another wild weekend of will-they-won’t-they debate about intervention involving a major financial institution, here goes part one…

Lehman (LEH) and AIG were actually on opposite ends of the coin. I believe Lehman had adequate liquidity for the time being, but inadequate equity capital to support its devaluing asset base. Eventually, the game had to run out – and when potential investors looked at the feasibility of sinking funds into an institution with negative net worth, they balked. This gave everyone offering Lehman short-term funding an excellent reason to stop doing so, and so the house came down.

AIG had the opposite situation working against it – a very good capital base, but too much of it tied up in non-cash assets. Because of its numerous financial guaranty transactions, AIG had created the possibility where it would have to post massive amounts of cash as additional collateral. Now, I completely realize that part of a management’s job is to provision for adequate liquidity, and I’m not trying to absolve them of general incompetence in destroying as much shareholder wealth as they did, but this isn’t about AIG or their management. This is about the ratings agencies, whose greed masked cluelessness during the boom times and whose fear ultimately led to the pinnacle of recklessness when things turned bad. I read the summary note that S&P issued putting AIG on negative CreditWatch, and was completely blown away by how these efficient market lackeys have abdicated their responsibility to provide fundamental judgments of credit worthiness, and have instead let the tail of market pricing wag the dog of intrinsic worth.

From the horse’s mouth…

On Sept. 12, 2008, Standard & Poor’s Ratings Services placed its ratings on American International Group Inc. (NYSE: AIG) (AA-/A-1+) and subsidiaries on CreditWatch with negative implications.
This action follows a significant decline in AIG’s share price and an increase in credit spreads on the company’s debt. Standard & Poor’s believes that AIG has sufficient capital and liquidity to meet its policy obligations and potential collateral requirements, which are significantly greater than the expected cash losses on the mortgage-related assets. However, additional market value losses will place some strain on the company’s resources.