Pressure mounts for government to act on AIG

By Emily Kaiser and Kevin Drawbaugh - Analysis

WASHINGTON (Reuters) - U.S. officials who said "No" to Lehman Brothers may be forced to bend on American Insurance Group Inc (AIG.N) because no one is quite sure what would happen if it failed and few want to find out.

This much is clear: A collapse of AIG would sting many of the world's biggest companies across virtually every business sector and could cause chaos in the $62 trillion market for credit default swaps, where it is a major player.

The world's biggest insurer has operations in more than 100 countries and its interests run the gamut from terrorism insurance to sports sponsorships.

"AIG's fingers run deep through the financial system," said Mark Zandi, chief economist at Moody's Economy.com. "If the AIG domino falls, it could take out a lot of other dominoes."

AIG's shares plummeted once again on Tuesday after its credit ratings were cut, heightening concerns that it might file for bankruptcy. Both the Treasury Department and Federal Reserve were tight-lipped about steps they might take to help.

Zandi, who had previously said the government had good reason to deny taxpayer money to bail out Lehman Brothers, said officials were no doubt poring over AIG's books to assess the risk of doing nothing. It was unclear to him whether they should step in to rescue AIG.

AIG insures more than one-third of the Forbes 400 richest Americans, according to its annual report. Its aircraft leasing unit boasts a fleet of 900 jets. It ranks as the world's seventh-largest asset manager. It is even the main sponsor of British soccer club Manchester United.

"Here's a firm that touches industry, individuals and Wall Street simultaneously," said Jack Ablin, chief investment officer at Harris Private Bank. "If nothing else, a bankruptcy of AIG, even if it doesn't torpedo the financial system, is going to leave a tangled mess for regulators, attorneys and investors to sort out."

THE BIG UNKNOWN

Treasury Secretary Henry Paulson has made it clear that he has little appetite for expensive bailouts after the government seized mortgage finance firms Fannie Mae and Freddie Mac and pledged $29 billion to swing a deal for Bear Stearns.

He was adamant last week that he would not open federal coffers to Lehman Brothers, and he held firm to his word despite intense pressure from Wall Street. Lehman Brothers Holdings Inc LEH.N filed for bankruptcy on Monday, triggering a global financial market rout.

Lehman's demise served as a painful reminder the biggest financial heavyweights are closely linked through the trillions of dollars worth of transactions they conduct every day. When one player goes down, everyone who did business with that firm faces potential losses. That is the big fear with AIG.

AIG at $1 trillion in assets is substantially larger than Lehman Brothers and it does business with "virtually every financial institution in the world," money manager Michael Lewitt wrote in the New York Times on Tuesday.

"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 AIG collapsed," he wrote.

Even if the government refuses to risk taxpayer money to prop up AIG, public funds may still be needed if an AIG collapse drags down banks that are covered by the Federal Deposit Insurance Corp, depleting its resources. The FDIC has a $45 billion deposit insurance fund.