The Rally & That AIG "Thing"

Today's rally notwithstanding, traders are worried that the whole AIG thing has raised the political risk for the economic recovery.

Bernanke went out of his way last night on 60 Minutes to emphasize that the country needed to have the "political will" to get us out of this crisis.

The subtext: we need to stay aggressively on top of this and we may have to enact more programs, and the government—read "Congress"—has to be willing to keep enacting new programs if there is not a favorable reaction to the existing ones, including the TALF and the private/public partnership Geithner will be unveiling this week.

What's AIG got to do with this?

Because the outrage over the pay packages—justifiable or not—threatens to greatly increase the chances that the government will simply refuse to provide any more help, if it is needed.

So what will likely happen? Much hand-wringing, but as Erin Burnett has noted the contracts appear to be legally binding.

What can the government do?

They could withdraw support and force AIG into bankruptcy, but the betting is that this is not likely to happen. They are stuck with supporting AIG.

So focus on the long-term problem: how quickly can AIG sell assets and realize some value? The process has been slow, mostly due to lack of financing. The company's largest international units, AIA and ALICO, have been for sale for months. Nothing. There's been talk of doing an IPO of the non-life insurance operations, but nothing has come of that either.

The ability to sell assets will directly depend on an improvement in the markets. If that happens, AIG can sell assets sooner and at a higher price.

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