Posts tagged ‘aig’

Looking for Something to Short? Here's a Suggestion:

Via Zero Hedge and the WSJ:

The $604 million issue from consumer lender Springleaf Financial, the former American General Finance, will bundle together about $662 million of loans secured by assets such as cars, boats, furniture and jewelry into ABS, according to a term sheet. Some loans have no collateral.

Personal loans haven't been a part of the mainstream ABS market since securitizations from Conseco Finance Corp. in the late 1990s, according to Michael Dean, co-head of Fitch Ratings' ABS group. That market dried up as the recession hit and, under the weight of bad subprime loans, Conseco filed for bankruptcy in 2002.

Springleaf's issue comes as prices on traditional issues backed by auto loans, credit cards and student loans have soared as investors pile into debt with extra yield over Treasurys. As those yields fall, ABS investors have been giving unusual assets that were previously shunned a second look....

The 190,627 loans in the Springleaf deal have an average FICO credit score of 602, in line with many subprime auto ABS. But the average coupon of 25% on Springleaf's personal loans is above that on even "deep subprime" auto loans, probably because there is no collateral for 10% of the issue, an analyst said.

Bonus points for AIG's involvement in this offering  (btw, now that AIG has repaid obligations to taxpayer, expect a corporate name change in 3..2..1..)

We had a credit bubble in part where the market likely under-priced certain risks.  Bubble bursts and risks take their toll.   Economy floundered.  The Fed reduced interest rates to zero.  Frustrated with low interest rates, investors have begun seeking out risk, likely driving down the price of risky investment.  Repeat.

A Partial Retraction on AIG

The story the other day that AIG was considering suing the taxpayers because the taxpayers did not give them a nice enough bailout was so vomit-inducing that I did not even look much further into it.

A couple of readers whom I trust both wrote me to say that the issues here are a bit more complex than I made them out to be.  The Wall Street Journal sounds a similar note today:

Every taxpayer and shareholder should be rooting for this case to go to trial. It addresses an important Constitutional question: When does the federal government have the authority to take over a private business? The question looms larger since the 2010 passage of the Dodd-Frank law, which gave the feds new powers to seize companies they believe pose risks to the financial system.

That vague concept of "systemic risk" was the justification for the AIG intervention in September 2008. In the midst of the financial crisis, the federal government seized the faltering insurance giant and poured taxpayer money into it. The government then used AIG as a vehicle to bail out other financial institutions.

But the government never received the approval of AIG's owners. The government first delayed a shareholder vote, then held one and lost it in 2009, and then ignored the results and allowed itself to vote as if the common shareholders had approved the deal.

In 2011 Mr. Greenberg's Starr International, a major AIG shareholder, filed a class-action suit in the U.S. Court of Federal Claims in Washington alleging a violation of its Constitutional rights. Specifically, Starr cites the Fifth Amendment, which holds that private property shall not "be taken for public use, without just compensation." The original rescue loans from the government required AIG to pay a 14.5% interest rate and were fully secured by AIG assets. So when the government also demanded control of 79.9% of AIG's equity, where was the compensation?

Greenberg is apparently arguing that he would have preferred chapter 11 and that the company and its original shareholders likely would have gotten a better deal.  Perhaps.   So I will tone down my outrage against Greenberg, I suppose.  But nothing about this makes me any happier about bailouts and corporate cronyism that are endemic in this administration.

Corporate Crony Entitlement

This story is simply  unbelievable.  Shareholders of AIG should have been wiped out in 2008 in a bankruptcy or liquidation after it lost tens of billions of dollars making bad bets on insuring mortgage securities.  Instead, AIG management and shareholders were bailed out by taxpayers.

It is bad enough I have to endure those awful commercials with AIG employees "thanking" me for their bailout.  It's like the thief who stole my TV sending me occasional emails telling me how much he is enjoying it.

Now, AIG managers and owners are considering suing the government because the the amazing special only-good-for-a-powerful-and-connected-company deal they got was not good enough.

Directors at American International Group Inc., AIG -1.28% the recipient of one of the biggest government bailout packages during the financial crisis, are considering whether to join a lawsuit that accuses the U.S. government of too-onerous terms in the 2008-2009 rescue package.

The directors will hear arguments on Wednesday both for and against joining the $25 billion suit, a person briefed on the matter said. The suit was filed in 2011 on behalf of Starr International Co., a once very large AIG shareholder that is led by former AIG Chief Executive Maurice "Hank" Greenberg. It is pending in a federal claims court in Washington, D.C....

Starr sued the government in 2011, saying its taking of a roughly 80% AIG stake and extending tens of billions of dollars in credit with an onerous initial interest rate of roughly 15% deprived shareholders of their due process and equal protection rights.

This is especially hilarious since it coincides with those miserable commercials celebrating how AIG has successfully paid off all these supposedly too-onerous obligations.  And certainly Starr and other AIG investors were perfectly free not to take cash from the government in 2008 and line up some other private source of financing.  Oh, you mean no one else wanted to voluntarily put money into AIG in 2008?  No kidding.

Postscript:  By the way, employees of AIG, you have not paid off all the costs of your bailout and you never will.  The single largest cost is the contribution to moral hazard, the precedent that insurance companies, if sufficiently large and well-connected in Washington, can reap profits on their bets when they go the right way, and turn to the taxpayer to cover the bets when they go wrong.

Too Big To Fail

Just in case you believed all the BS around the passage of Dodd-Frank that in the future there would be no such thing as too big to fail, just look at yesterday's JP Morgan hearings in Congress.  

U.S. lawmakers on Wednesday interrogated J.P. Morgan Chase Chief Executive James Dimon in a much-anticipated and sometimes-heated exchange after the bank registered more than $2 billion in derivatives losses

No one grills Exxon-Mobil executives when the company loses a couple of billion to a nationalization somewhere or grills Sears executives as the blunder their way towards bankruptcy.  These are private business losses.  The only reason to grill JP Morgan is if Congress still considers the American taxpayer to be ultimately on the hook for trading losses (above and beyond deposit insurance requirements, which the Bear Sterns and AIG bailouts certainly were).

The Great Bailout

Peter Tchir via Zero Hedge

The AIG moment was the first time that the US threw any pretense of real capitalism out the window.  Bear Stearns at least was done by JPM with government help.  Fannie and Freddie were taken over, but they were always quasi government entities.  It was AIG that was truly special.  The government didn't even attempt to see if the banks had managed their exposures at all.  The government didn't even care if they had.  They panicked and saved the banks from their own folly - they didn't give capitalism a chance.  The US has never truly recovered from that.  The entire system looks to government support more and more.  Since AIG the Fed has been running at least one massive easing program or another constantly.  The government is lurching from spending program to spending program to keep the economy churning.

At the first signs of weakness we beg for the FED or ECB or the government to do something big and fast.  The European credit crisis seemed a final chance to put some capitalism back into capitalism.  To allow dumb decisions to pay the price for failure.  To reward the institutions that had properly navigated through the risks.  There was even a brief moment when it looked like Germany would do that - would force those who failed to pay the price and support those who had taken the best steps.  But now with Dexia bailed out and some super SIV on the way, it looks like we are once again heading down a path of not allowing failure - in fact we are once again rewarding failure and living beyond your means.  It isn't communism, but it certainly doesn't fit any classic definition of capitalism.

Taxpayers to Fund Bank of America Derivatives Losses?

Or maybe it is more correct to say that the taxpayer is being set up to keep BofA counter-parties whole. From Bloomberg, via Zero Hedge:

Bank of America Corp. (BAC), hit by a credit downgrade last month, has moved derivatives from its Merrill Lynch unit to a subsidiary flush with insured deposits, according to people with direct knowledge of the situation.

The Federal Reserve and Federal Deposit Insurance Corp. disagree over the transfers, which are being requested by counterparties, said the people, who asked to remain anonymous because they weren’t authorized to speak publicly. The Fed has signaled that it favors moving the derivatives to give relief to the bank holding company, while the FDIC, which would have to pay off depositors in the event of a bank failure, is objecting, said the people. The bank doesn’t believe regulatory approval is needed, said people with knowledge of its position.

Three years after taxpayers rescued some of the biggest U.S. lenders, regulators are grappling with how to protect FDIC- insured bank accounts from risks generated by investment-banking operations. Bank of America, which got a $45 billion bailout during the financial crisis, had $1.04 trillion in deposits as of midyear, ranking it second among U.S. firms.

“The concern is that there is always an enormous temptation to dump the losers on the insured institution,” said William Black, professor of economics and law at the University of Missouri-Kansas City and a former bank regulator. “We should have fairly tight restrictions on that.”

Obviously I am not a huge fan of bank regulation, but if the taxpayer is going to insure deposits, then the government has got to set and enforce capital restrictions on how those deposits are invested.  How many times do we have to learn this lesson?  The S&L crisis and the Texas bank collapse of the 1980's was caused by the exact same BS, investing taxpayer insured deposits in increasingly risky investments.

Normally, in a free economy, we expect lenders to enforce rules and discipline on those to whom they lend, just as fire insurers in the 19th century developed the first building codes and inspections to protect their themselves.  But if depositors are insured, they are not going to get worked up too much about BofA -- I am a depositor but I know the Feds will make me whole if the bank crashes.  Deposit insurance provides comfort to depositors and pays some dividends in heading off bank panics, but at the same time it relieves the bank of any accountability for how the deposits are invested unless the US government takes on that role.  Of all the BS regulations financial firms have to put up with, this is the one that should actually exist, and the implication in this article is that despite thousands of pages of new regulation, these basic protections still don't exist.  Sure, they exist in law, but there seems to be nothing to stop an agency from issuing exemptions, and this Administration has shown itself to love giving exemptions.

This reminds me a ton of the AIG bailout.  For some reason, there are a group of Wall Street companies (cough Goldman cough) that seem to have immense political power to protect investments in which they are a counter-party.  To this point, people have been expecting that the BofA holding company might soon fail, but the underlying banks would be fine and just sold off in pretty good shape.  Most of the trash is apparently at the holding company level.

The losers in all this are the counter-parties to these various derivatives, who would rather have a better set of assets to grab if the ship starts sinking.  Of course, they don't have any right to this -- they didn't make these original deals with the depository banks, they made them with Merrill Lynch and other trash BofA has bought.  But never-the-less, the Fed seems fired up to give these guys a special deal.  It reminds me of the Solyndra deal where the Administration allowed certain private parties to move ahead of the US Government on the creditor list, though at least in Solyndra's case these parties actually put some money into the pot for the privilege.  This seems to be a straight giveaway, and it is no surprise that the FDIC is apoplectic.

James Taggart is Alive and Well

In my Forbes column this week, I publish an essay I wrote for an Americans for Prosperity event commemorating Milton Friedman's birthday.  A brief excerpt:

Having once been successful through excellence, leading businesses typically get lazy and senescent, and become vulnerable to more innovative, lower-cost or more nimble new competitors.  Sears lost its electronics sales to Circuit City, which in turn succumbed to Best Buy, which is now struggling to compete with Wal-Mart, who is being challenged by Amazon.com.

Unfortunately, businesses that were once successful can feel a sense of entitlement, believing that this new competition is somehow unfair, or that consumers are somehow misguided in taking their business elsewhere.  When they have money or political connections, these businesses may run to Congress and beg for special protections against competition, or even new subsidies, mandates, stimulus projects, and bailouts.

Where is the threat to capitalism and individual liberty coming from today?  Is it from some aggrieved proletariat, or is the threat from bailed out Wall Street firms, and AIG, and GM, and Chrysler, and ethanol manufacturers, and electric car makers, and windmill builders?

 

Power Imbalance: The Difference Between Liberal and Libertarian Philosophy

My new column is up at Forbes, and it is one of my favorites I have written for a while  (at least it seems so with my current scorpion-induced double vision).  It begins with Krugman's recent statement that the Left understands the Right and libertarian positions better than the Right and libertarians understand the Left.

I first demolish this as a pretentious crock, but then wander to more important topics

But I do understand the leftish position well enough to identify its key mistake.  As I mentioned earlier, we libertarians are similarly concerned with aggregations of power.   We have, at best, a love-hate relationship with large corporations, for example, enjoying the bounties they can bring us but fearing their size and power.

But what the Left ignores is that there is absolutely no power imbalance as large as that between the government and its citizens.    After all, you may get ticked off when Exxon charges you $4.00 a gallon for gas for reasons that aren't transparent to you, but you can always tell Exxon to kiss off and buy from someone else, or ride a bike, or stay home.    Because Exxon does not have armies and police and guns and prisons.

Every single time we give the government the power to right a perceived imbalance, we give the government more power than the private entity we are trying to contain.  In effect, we make things worse.   Because we want the government to counter-act the power of oil companies, Congress now has the power to dump large portions of our food supply into motor fuel, to the benefit of just a few politically connected ethanol companies.

One of the reasons the Left often cannot adequately articulate the libertarian position is that the notion of bottom-up emergent order tends to be difficult for many to understand or accept (this is mildly ironic, since the Left tends to defend the emergent order of Darwinian evolution against the top-down Christian creation vision).

The key to much of libertarian economics is not that libertarians trust private actors, but that libertarians trust natural correction mechanisms in free markets far more than it trusts authoritarian power of the government.   When, for example, large corporations become sloppy and abusive and senescent, markets will eventually bring them down.

In fact, when government is given power, nominally to correct such imbalances, they tend to use it to protect those in power as often as they do to protect the disenfranchised. Government restrictive licensing of hair dressers, interior designers, and morticians; bailouts of GM, Chrysler, and AIG; corporate welfare to GE and ADM; and use of imminent domain to hand private property to favored real estate  developpers -- all are examples of finding government cures for perceived private power imbalances that are worse than the disease.

Isacc Asimov, in a book called Foundation that Paul Krugman recently rated as one of the most influential on his life, related this fable:  Once there was a man and a horse, who were both imperiled by a wolf.  The man approached the horse, and said that if the horse would put its superior speed at his disposal, he could kill the wolf.  And so the horse agreed to take the man's saddle and bridle, and helped the man kill the wolf.  The horse said, "great job, now remove your saddle and we can both be free," and the man said "never!"

I hope the moral of the story is clear.  In trying to deal with the threat of the wolf, the horse gave the man so much power he became an even bigger threat.  So too when we look to government to solve our problems.

Read the whole thing, as they say

Bank Regulation

This article by Mark Perry seems right to me -- the lightest touch (and probably the most effective) approach to bank regulation is to return to a regime that puts its major emphasis on capital requirements.

We can talk all day about causes of the recent financial crisis, but in my mind the root cause was taking real property with a volatile underlying value (e.g. homes) and leveraging the absolute crap out of it.   In the initial transaction, home buyers were allowed to come to the table with less and less equity, until deals were being cut with more than 100% debt.  This stupidity was a true public-private partnership, as the government kicked off the party and encouraged its growth via various community development policies as well as policies atFannie and Freddie, but private originators as well as home buyers eagerly jumped into the fray.

This debt backed by property that was already too highly leveraged was thrown into portfolios that were themselves highly leveraged, and then further leveraged again through CDS's and other derivatives.  And then the CDS's were put into leveraged portfolios.  I would love to figure out the effective leverage in the AIG portfolio.  For ever $1 million in real property that secured the mortgages they insured, how much equity did they have?  A thousand bucks?  Less?

These investors felt protected by diversification that didn't really exist.  The felt safe with AAA ratings from agencies who really didn't understand the risks any better than anyone else did.  They relaxed assuming everything was watched by government regulators who were in way over their heads.  But more than anything, they felt protected by history.  The system of putting mortgage risks into tranches, such that the top tranches could only be affected by default rates consider then to be wildly improbable, had never to that point failed to deliver its promise.   Default rates had always stayed withing expected norms.

And this is the most dangerous risk -- the risk that something will happen that has never happened before.  Default rates that seemed impossible suddenly became reality.  Tranches that were untouchable suddenly were losing large chunks of their value.  Sure, there were warning signs, but at the end of the day what happened was that events occurred that were worse than people had thought was the worst case scenario  (there is a whole body of interesting behavioral study on how humans tend to overestimate their understanding and underestimate the width of a probability distribution).

As new financial products are created and the economy evolves and the government pursues new forms of interventions in commerce, new failures can occur that have never happened before.  And never has there been invented a micro-regulatory approach that guards against new-type failures (they don't even do a very good job against old-style failures).  Capital requirements are the one approach that guard against catastrophic failures even for unanticipated risks.

It can be argued that this will raise the cost of capital, at it is true interest rates at any one point of time would have to go up.  But one can argue that the low interest rates of the 2000's greatly understated the true cost of capital, and that those additional costs were paid in a sort of balloon payment at the end of the decade.

I am still thinking this through -- I don't think any regular reader would be mistake me for someone who favors regulation in general, but I am coming around to some extent on the notion that banks are different.  I would ideally like to see a self-policing market where companies that choose to cut equity too fine just go bankrupt.  But the reality of the political-financial complex today is that this never happens -- costs of large failures are socialized, and executives who made bad choices get fat gold parachutes and Treasury jobs.

Postscript:  I have arguments all the time about whether the financial melt down was mainly caused by government or private action.  Was it a public or private failure.?  My answer is yes.

One thing that those of us who promote private action over public can never repeat enough is this:  Our support for private action does not mean that private actors don't screw up, that there are not bad outcomes, that people don't make bad decisions, etc.  They do.  Lots of them.  When these constitute outright fraud, there should be prosecution.  For the rest of the cases, though, libertarians believe that in a free society there are automatic corrections and sources of accountability.

Make a bad product - people stop buying it.  Sign a union contract with wages that are too high - you go bankrupt.  Treat your workers shabbily - and the best of them go work for someone else.  Take on too much risk - you will fail and lose all your capital.

The problem with our financial sector is not that it is not regulated -- it is the most regulated sector of the economy.   The problem is that, as always happens, there has been substantial regulatory capture.  There has been an implicit deal cut by large financial institutions - regulate me, but in return protect me.  In a sense, as is typical in a corporate state, large corporations and government have become partners.

As a result, many of the typical checks and balances on private action in a free economy have been disrupted.  In effect, certain institutions became too big to fail, and costs of failure and risk taking were socialized.

That is why the answer is not one or the other.  Certainly the massive failures were driven by the actions of private actors.  But they were driven in part by incentives put in place by the government, and their stupid behavior was not checked because traditional private avenues of accountability had been neutered by the government.    This is why the recent financial crisis will always remain a sort of political Rorschach test, where folks of wildly different political philosophies can all find justification for their position.

Perils of Populism

One of the perils of being a populist, as John McCain is finding out, is that the public is allowed to change its mind, but politicians who attempt to follow them end up looking bad.

the four-term senator says he was misled by then-Treasury Secretary Henry Paulson and Federal Reserve Chairman Ben Bernanke. McCain said the pair assured him that the $700 billion Troubled Asset Relief Program would focus on what was seen as the cause of the financial crisis, the housing meltdown.

"Obviously, that didn't happen," McCain said in a meeting Thursday with The [Arizona] Republic's Editorial Board, recounting his decision-making during the critical initial days of the fiscal crisis. "They decided to stabilize the Wall Street institutions, bail out (insurance giant) AIG, bail out Chrysler, bail out General Motors.... What they figured was that if they stabilized Wall Street - I guess it was trickle-down economics - that therefore Main Street would be fine."

I am not sure this is much of a defense.  Even without McCain's access to such financial luminaries, I and many others predicted at the time the $700 billion slush fund would be used as, well, as slush fund to bail out the politically well-connected.  I must admit I didn't see the GM/UAW bailout coming, but its not wildly surprising in retrospect.

Unfortunately for all of us, McCain's competition in the next election, JD Hayworth, is even less appealing.

Follow the Money

aigbailout

via Paul Kedrosky (click to enlarge)

I guess the disputed $175 million in deferred compensation payments should be on here as well, though the line would be too infinitesimally thin to draw.   The CDS stuff gets the attention, but the securities guarantees are the largest flow.  Are these guarantees of traded securities, like bonds and equities?  If so, it sure is a happy notion for all of us taxpayers with portfolios that are well under water that we are going to send some of our money to help bail out the losses in the Goldman Sachs portfolio.

Wrapped in the Flag of "Systemic Risk"

A couple of questions about AIG:

1.  Is there any real legal difference between the contractual commitment by AIG to pay bonuses to employees and their contractual commitment to pay off mortgage bond guarantees to companies like Goldman Sachs? **

2.  In a bankruptcy, how senior would contractual promises of deferred compensation to employees be?  Everyone comes after the government, of course, but would such claims be more or less senior to, say, commitments to pay counter-parties?

** before claiming one commitment was outrageous and unjustified, one needs to be clear which commitment he is referring to, since both commitments in retrospect seem crazy to me.  It is just that one party (ie Goldman Sachs), which has the added advantage of being represented by many of its former employees in the Treasury department, has convinced Congress and the Administration that not paying them carries systemic risk to the economy.

That seems to be the new key to government largess:  Carrying systemic risk.  It used to be one wanted to be poor or female or black to merit special consideration in the government spending sweepstakes.  But nowadays, in our post-racial society, the key is to be the one who can wrap himself in the flag of "systemic risk."  Here is AIG's entry into the "we have systemic risk, so give us taxpayer money" essay contest.

The Earmarked Bankruptcy

The normal process for bureaucratic allocation of, say, highway funds, does not always work that well.  Seriously, you don't have to convince this libertarian of that.  But it is at least intended to try to balance priorities and allocate the funds marginally rationally.   Which points out the problem with earmarks -- they are overrides by Congress of the normal allocation and prioritization process for political ends.  By definition, the projects in earmarks would not have normally been funded by the usual operation of the prioritization process.

Which brings me, oddly enough, to AIG  (and to GM).  When companies can no longer meet all of their obligations, they generally file for chapter 11 bankruptcy. This is an extremely well-worn process, both in the courts and the business community, that attempts to save as much value as possible and to allocate that value, based on law and a set of rules everyone understands in advance, to the various stakeholders.   The folks who are involved in this process are pretty hard-headed folks, less out for revenge and retribution as for maintaining value and capturing as much as possible for whatever group one might represent.

Now Congress and the Administration are getting themselves involved in the bankruptcy process, by trying to avert actual chapter 11 filings by AIG and GM.  By doing so, they are effectively overriding the bankruptcy process.  Just as with earmarking, they claim this override is for some good of the country.  But, just as with earmarking, you can assume it is to benefit some politically-favored group.  At GM, the feds are saying that we don't want employees or the equity holders to take a haircut, as they would in Chapter 11, so we will transfer the loss to taxpayers, and perhaps bondholders (could there be any politically less favored group than taxpayers?).  Same at AIG.   Is it any surprise that the number one beneficiary of the Pauslon bailout of AIG was Goldman Sachs?  The Left thought they smelled a rat when the administrations contracted with ex-Cheney-run Haliburton in Iraq, but no one is going to bat an eye when the Treasury department, populated with ex-Wall Street types, is bailing out all its employees' old firms?

On the subject de jour, the AIG executive bonuses, many of these were just as guaranteed, contractually, as were payments on AIG policies and bond guarantees.  I don't know how such obligations are treated in chapter 11 (are they treated as more or less senior than other obligations?) but I do know the decision to keep them or ditch them would be made against a goal of maintaining long-term value, and not public witch-hunting.

This is the real problem, even beyond the taxpayer cost, of this new form of Congressional or Administration-led pseudo-bankruptcy:  Winners and losers are determined by political power and perceptions of short-term political gain, rather than against a goal of maintaining value and following well understood and predictable rule.  This process throws all the old predictable rules and traditions out the window.  Investors and folks with contracts used to know just how senior their obligations were in a corporate failure.  Now, they have no idea, as their position in the bankruptcy may in the future depend more on how much they donated in the last presidential election, or how good their PR agent is.

Republicans to Receive Bailout from Congress

Congressional Democrats announced today that they had agreed to a bailout plan for Republicans after last week's devastating election results.  While exact details are unavailable, sources tell us that the Republicans will be given 4 seats in the Senate and 15 in the House.  Nancy Pelosi said in a statement today: "We've established pretty clearly over the last several months that failed strategies and management should not necessarily have to result in losses in market share, particularly for well-connected Washington insiders."

Asked for comment, Democratic strategist James Carville was giddy.  "This is brilliant.  It really doesn't give up anything of substance to the Republicans.  But it will sap the energy from the Republican Party for making any substantial changes, and make it more likely they will continue the failed strategies that led to this most recent loss.  After their recent failures, the Republicans were on the verge of being forced to reinvent their whole organization.  This bailout should reduce the likelihood of that substantially."

When asked if bailouts of AIG, General Motors, Ford, Chrysler, Freddie Mac, Fannie Mae, and Bear Stearns wouldn't similarly reduce the urgency to change failed approaches, Carville answered "no comment."

Wa' Happen?

I know that most non-financial folks, including myself, have their head spinning after this past few weeks' doings on Wall Street.  Doug Diamond and Anil Kashyap have a pretty good layman's roundup on Fannie/Freddie, Lehman, and AIG.  My sense is that their Lehman explanation also applies to Bear Stearns as well.  Here is just one small piece of a much longer article:

The Fannie and Freddie situation was a result of their unique roles
in the economy. They had been set up to support the housing market.
They helped guarantee mortgages (provided they met certain standards),
and were able to fund these guarantees by issuing their own debt, which
was in turn tacitly backed by the government. The government guarantees
allowed Fannie and Freddie to take on far more debt than a normal
company. In principle, they were also supposed to use the government
guarantee to reduce the mortgage cost to the homeowners, but the Fed
and others have argued that this hardly occurred. Instead, they appear to have used the funding advantage to rack up huge profits
and squeeze the private sector out of the "conforming" mortgage market.
Regardless, many firms and foreign governments considered the debt of
Fannie and Freddie as a substitute for U.S. Treasury securities and snapped it up eagerly. 

Fannie and Freddie were weakly supervised and strayed from the core
mission. They began using their subsidized financing to buy
mortgage-backed securities which were backed by pools of mortgages that
did not meet their usual standards. Over the last year, it became clear
that their thin capital was not enough to cover the losses on these subprime
mortgages. The massive amount of diffusely held debt would have caused
collapses everywhere if it was defaulted upon; so the Treasury
announced that it would explicitly guarantee the debt.

But once the debt was guaranteed to be secure (and the government
would wipe out shareholders if it carried through with the guarantee),
no self-interested investor was willing to supply more equity to help
buffer the losses. Hence, the Treasury ended up taking them over.

Lehman's demise came when it could not even keep borrowing. Lehman
was rolling over at least $100 billion a month to finance its
investments in real estate, bonds, stocks, and financial assets. When
it is hard for lenders to monitor their investments and borrowers can
rapidly change the risk on their balance sheets, lenders opt for short-term lending. Compared to legal or other channels, their threat to refuse to roll over funding is the most effective option to keep the borrower in line.

This was especially relevant for Lehman, because as an investment
bank, it could transform its risk characteristics very easily by using
derivatives and by churning its trading portfolio. So for Lehman (and
all investment banks), the short-term financing is not an accident; it
is inevitable.

Why did the financing dry up? For months, short-sellers were
convinced that Lehman's real-estate losses were bigger than it had
acknowledged. As more bad news about the real estate market emerged,
including the losses at Freddie Mac and Fannie Mae, this view spread.

Lehman's costs of borrowing rose and its share price fell. With an
impending downgrade to its credit rating looming, legal restrictions
were going to prevent certain firms from continuing to lend to Lehman.
Other counterparties
that might have been able to lend, even if Lehman's credit rating was
impaired, simply decided that the chance of default in the near future
was too high, partly because they feared that future credit conditions
would get even tighter and force Lehman and others to default at that
time.

A.I.G. had to raise money because it had written $57 billion of insurance contracts whose payouts depended on the losses incurred on subprime real-estate related investments.
While its core insurance businesses and other subsidiaries (such as its
large aircraft-leasing operation) were doing fine, these contracts,
called credit default swaps (C.D.S.'s), were hemorrhaging.   

Furthermore, the possibility of further losses loomed if the housing
market continued to deteriorate. The credit-rating agencies looking at
the potential losses downgraded A.I.G.'s debt on Monday. With its lower
credit ratings, A.I.G.'s insurance contracts required A.I.G. to
demonstrate that it had collateral to service the contracts; estimates
suggested that it needed roughly $15 billion in immediate collateral.

A second problem A.I.G. faced is that if it failed to post the
collateral, it would be considered to have defaulted on the C.D.S.'s.
Were A.I.G. to default on C.D.S.'s, some other A.I.G. contracts (tied
to losses on other financial securities) contain clauses saying that
its other contractual partners could insist on prepayment of their
claims. These cross-default clauses are present so that resources from
one part of the business do not get diverted to plug a hole in another
part. A.I.G. had another $380 billion of these other insurance
contracts outstanding. No private investors were willing to step into
this situation and loan A.I.G. the money it needed to post the
collateral.

In the scramble to make good on the C.D.S.'s, A.I.G.'s ability to
service its own debt would come into question. A.I.G. had $160 billion
in bonds that were held all over the world: nowhere near as widely as
the Fannie and Freddie bonds, but still dispersed widely.

In addition, other large financial firms "” including Pacific
Investment Management Company (Pimco), the largest bond-investment fund
in the world "” had guaranteed A.I.G.'s bonds by writing C.D.S.
contracts.

Given the huge size of the contracts and the number of parties
intertwined, the Federal Reserve decided that a default by A.I.G. would
wreak havoc on the financial system and cause contagious failures.
There was an immediate need to get A.I.G. the collateral to honor its
contracts, so the Fed loaned A.I.G. $85 billion.

Update:  Travis has an awesome post with his own FAQ about what is going on.  Here is a taste:

Lots of financially naive folks think that we can remove all risk,
inflation, etc. by only ever trading apples for chickens on the barrel
head, and doing away with paper money (so that all money is gold) and
doing away fractional reserve banking, so that when I deposit one gold
coin in the bank, the bank can then take that actual physical gold coin
and loan it to someone else. It turns out that the friction involved in
doing things this way is so huge that the effect would make The Road
Warrior look like a children's bedtime story. You want to borrow money
to buy a car? The bank can't just loan money that's been deposited in
someone else's checking account - the bank has to get that person to
sign a note saying "yes, I understand that this money is on deposit
until that dude buying the card pays the bank back IN FULL". And the
lender, if he wants his money out ahead of time, is SOL. And even then,
there can be a flood, and your car gets totaled, and you get
Legionaire's disease, and you can't make the payments.

or this:

Now, for the next complication, let's also imagine that there are
300 million other people watching all of this, thinking "How bad is
this? Should I go down to the gun store, stock up on .223 and 12 gauge
shells, then stop by the veterinarians to see how much antibiotics I
can cadge before heading to the hills" ?

And the Feds really don't want 300 million armed folks heading
for the national forests, so they first try to tell everyone who owns a
bicycle "Hey, the value of your bike didn't really drop! It's still
worth $9!".

But no one wants to believe that.

So then they go to the guy who's writing insurance policies on
the value of bikes and they say "if you got $100 million, would that
calm things down a bit?".

Why Libertarians are Dancing on Spitzer's Grave

Eliot Spitzer has been brought down for a crime most libertarians don't think should be a crime, by federal prosecutors who should not be involved even if it were a crime, and using techniques, such as enlisting banks as government watchdogs of private behavior, that stretch the Fourth Amendment almost out of recognizable shape.  So why are we libertarians so happy?

He routinely used the extraordinary threat of indicting entire firms, a
financial death sentence, to force the dismissal of executives, such as
AIG's Maurice "Hank" Greenberg. He routinely leaked to the press emails
obtained with subpoena power to build public animosity against
companies and executives. In the case of Mr. Greenberg, he went on
national television to accuse the AIG founder of "illegal" behavior.
Within the confines of the law itself, though, he never indicted Mr.
Greenberg. Nor did he apologize.

In perhaps the incident most
suggestive of Mr. Spitzer's lack of self-restraint, the then-Attorney
General personally threatened John Whitehead after the former Goldman
Sachs chief published an article on this page defending Mr. Greenberg.
"I will be coming after you," Mr. Spitzer said, according to Mr.
Whitehead's account. "You will pay the price. This is only the
beginning, and you will pay dearly for what you have done."

Jack
Welch, the former head of GE, said he was told to tell Ken Langone --
embroiled in Mr. Spitzer's investigation of former NYSE chairman Dick
Grasso -- that the AG would "put a spike through Langone's heart." New
York Congresswoman Sue Kelly, who clashed with Mr. Spitzer in 2003, had
her office put out a statement that "the attorney general acted like a
thug."

These are not merely acts of routine political
rough-and-tumble. They were threats -- some rhetorical, some acted upon
-- by one man with virtually unchecked legal powers.

Eliot
Spitzer's self-destructive inability to recognize any limit on his
compulsions was never more evident than his staff's enlistment of the
New York State Police in a campaign to discredit the state's Senate
Majority Leader, Joseph Bruno. On any level, it was nuts.

As I wrote before, the real crime here is that despite all his history, he was until two days ago a press darling labeled as "Mr. Clean."  In reality, he has always been Mr. Abuse of Power and Mr. Personal Vendetta.  I am happy to see him brought down, even if for the wrong reasons.

Update: A lot more here