AIG failure would be disastrous for global markets

By Lilla Zuill and Kristina Cooke

NEW YORK (Reuters) - A revised bailout of American International Group (AIG.N) may be just another "band-aid" solution, but more than five months after it was first rescued by the government the option of letting the insurer fail would still be considered too big a shock to already fragile global markets.

AIG's board on Sunday approved a broad revision of the U.S. government's $150 billion (105.5 billion pounds) rescue. It was the third time the government has reached out to the struggling insurer and the latest rescue is expected to put greater funds at AIG's disposal to keep it afloat as it readies to report a roughly $60 billion loss early on Monday.

While putting more taxpayer money at risk is unlikely to be palatable in the current economic environment, analysts said the U.S. government had little choice. Without government intervention, AIG's expected losses would prompt credit ratings downgrades -- triggering even more debilitating losses for the insurer, and its trading partners.

"The government really does not have the option of letting AIG totally blow up," said Robert Haines, senior insurance analyst at CreditSights,

AIG's foray into the roughly $28.5 trillion credit default swap market left it heavily exposed to losses on toxic mortgage assets that it had guaranteed against default.

AIG, through a financial products unit, sold more than $450 billion of protection on securities to U.S. and European banks. With government support, some of those derivatives have been unwound, but the company still has about $300 billion of this exposure, according to Credit Sights.

Haines said that European banks in particular, counterparties on many of AIG's outstanding derivative contracts, "would be hammered if the U.S. walked away."

Donn Vickrey, an analyst with Gradient Analytics, who has closely followed the financial deterioration at AIG said while "European banks are about two-third of the problem ... it would be a domino effect across the globe.