If we have learned anything over the last few days from the sudden demise of Lehman Brothers, it is that the markets are impatient and hate uncertainty, even if it leads to messy results.
American International Group (nyse: AIG - news - people ) is desperately trying to raise more capital to avoid meeting the same fate.
AIG has found a protector in the State of New York and its governor, David A. Paterson. Patterson, along with Eric R. Dinallo, New York’s superintendent of insurance, have made an exception to the rules governing the regulation of insurers that will allow AIG to tap into its own reserves that will perhaps enable it to obtain some sort of credit facility or additional capital. It will be used to help maintain the company’s credit rating. It may also be used as collateral.
AIG is in dire need of liquidity to tide it over until it raises additional financing.
New York’s governor has asked the Federal Reserve to provide short-term funding to AIG in order to send a strong message to Wall Street: The problems at AIG are not rooted in its fundamental business, but stem from a crisis of confidence. Should the Federal Reserve agree, it would be an unprecedented step, as it has never before provided liquidity to an insurer. Goldman Sachs (nyse: GS - news - people ) and JP Morgan Chase (nyse: JPM - news - people ) are also believed to be working together to try to arrange a $75 billion bridge loan that would involve a number of lenders.
Certainly, the Fed drew a line with Lehman, declining to provide actual support in terms of assuming potential losses. AIG knows that the government’s wallet has been slammed shut, so what it is seeking is a collateralized $40 billion bridge loan that would be paid back immediately upon it raising capital. A collateralized bridge loan would present no risk to taxpayers. The creation of a credit facility has also been discussed.
AIG is more than an insurance company. It is arguably the biggest player in the financial services industry. Most of the problems with its balance sheet were caused by AIG Financial Products Corp., a division that, like many investment banks, participated in financial risk-taking, including investments in credit default swaps written on collateralized debt obligations. These investments are now considered to be toxic. As of July 31, AIG’s total collateral related to this portfolio was $16.5 billion, and this figure is likely to climb.
If AIG fails, the implications would be truly extraordinary. It certainly won’t mean all of its underlying subsidiaries are unsound. The insurance divisions that make up its core would likely be salvaged, as they can be separated from the rest of the organization.
After the markets closed Monday, Fitch Ratings downgraded AIG’s long-term and short-term issuer default rating, as well as its senior unsecured debt and commercial paper program ratings. Fitch said AIG’s financial flexibility and ability to raise holding company cash are “extremely limited due to recent declines in the company’s stock price, widening credit spreads, and difficult capital market conditions."
Standard & Poor’s lowered its counterparty credit ratings (including long-term) and financial strength ratings on most of AIG's insurance operating subsidiaries. Moody's Investors Service downgraded the senior unsecured debt rating of AIG as well as the ratings of several AIG subsidiaries.
It would be in the interest of public policy for the regulators to separate the non-performing assets and problematic parts of the company from those that should and can continue. This would mean separating the insurance interests from the financial product divisions.
It wouldn’t make sense to let an insurer fail that is fully capable of paying claims and has adequate capital and financial strength. If there is an insolvency, it would be in the public’s best interest to allow the insurance entities to continue, however it will require a restructuring and even liquidation of the other assets within its portfolio. If that were not to happen, it would be destructive, as AIG is the largest commercial insurer in the U.S.
Should the company be split up, which is more than likely, it will probably hold onto its core property casualty business, spin off its auto insurance and life/annuities businesses, while selling its aircraft leasing division.
On Friday and Saturday, AIG was in discussions with Warren Buffett of Berkshire Hathaway (nyse: BRK - news - people ). Speculation was that they were negotiating a sale of the aircraft leasing division (Buffett owns NetJets). But at the same time, Berkshire Hathaway owns several large insurance entities, including Geico, so it may be interested in buying some of AIG’s insurance. It is doubtful, however, that Buffett would be interested in buying the whole enterprise.
A few minutes ago, CNBC's David Faber reported on the air that Buffett is "no longer" in talks with the insurer "about an investment or anything else."
"Don't count on Warren Buffett to "rescue" AIG as its white knight."
AIG [AIG 3.75 
Faber reports that people familiar with the situation tell him that talks between Buffett's Berkshire Hathaway and AIG did take place last Friday and Saturday, but there's been nothing since then and nothing is happening now on that front.
Faber says AIG is focusing its attention on getting billions in bridge financing from the Federal Reserve, to allow for massive asset sales.
Current Berkshire stock prices:
Class A: [US;BRK.A 125000.0 
Class B: [US;BRK.B 4175.0
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