AIG: The Mother of All Bailouts

Panic vs. holding on: Guess which strategy is winning

"Never sell into a panic" is a standard piece of advice on Wall Street.

Since August, it has been fine advice to ignore.

Today we had yet another panic in the market, amid the continuing erosion of confidence in virtually everything -- the U.S. economy, the global economy, the financial system, the political leadership, the market itself, etc.

The Standard & Poor’s 500 index slumped 34.27 points, or 4.7%, to 700.82, its lowest close since Oct. 1996. The index now is down 55.2% from its peak in October 2007.

Was it a mistake to sell today? Let’s review recent market history:

-- The first major panic of the financial-system meltdown was the selling wave that took the S&P 500 down 23% from Sept. 30 to Oct. 10. The close Oct. 10 was 899.22. If you would have sold at that level, you would have saved yourself from a further 22% loss through today.

-- The second major panic, from Oct. 20 to Oct. 27, took the S&P index down 13.8%, to 848.92. Selling at that point would have saved you from a further 17.4% drop.

-- The third major panic saw the S&P lose 25.2% from Nov. 4 to Nov. 20, when it ended at 752.44. Bad time to sell? Those who held tight are down a further 6.9%.

CNBC’s Jim Cramer was bashed by some Wall Street pros for telling listeners on Oct. 6 to sell any stock holdings that they couldn’t afford to hold for at least five years.

The S&P 500 closed at 1,056.89 on Oct. 6. Investors who took Cramer’s advice that day have been saved from a further 34% loss of capital.

On Oct. 17, billionaire investor Warren E. Buffett wrote an op-ed piece for the New York Times encouraging people to buy high-quality stocks. He cited his cardinal rule of investing, which was to "be greedy when others are fearful." Since then, the S&P index is down 25.5%.

Isn't the market dirt-cheap by now? The problem is, it’s pointless to talk about fundamentals, such as corporate earnings. As S&P chief investment strategist Sam Stovall concedes, "Earnings don’t matter," because no one will believe any earnings estimates as long as the economy continues to slide.

In the absence of fundamentals, Stovall says, "All we can really go on is the technicals" -- chart-watching -- to try to guess where the market might bottom.

He believes the market decline should stop somewhere between 625 and 675 on the S&P 500. If the index goes to 625, that would be an additional 10.8% drop from here.

Bill Strazzullo, a partner at Bell Curve Trading in Freehold, N.J., says investors may have to ponder "the unthinkable" -- the S&P back to around 500, which was near the jumping-off point for the spectacular market surge that began in 1995 and continued through 1999.

"You have to ask yourself, what is the real risk here?" Strazzullo says. "The thing we are least concerned about is the market running away on the upside." In other words, even if the decline stops, he says, he can't identify a single catalyst that could spark a wild new bull market any time soon.

"On the other hand," Strazzullo says, "I am worried about another 25% to 30% move down," if panic feeds on itself as it did last fall.

Cramer had it right in October, even if all he did was tell people something they already should have known: The stock market is no place for money you will need in the next five years.

That's as true with the S&P at 700 as it was at 1,056.

-- Tom Petruno

Photo: Panicked investors on Wall Street on Oct. 24, 1929 -- amid the first selling wave of the 1929-32 crash. Credit: Associated Press

AIG: The Mother of All Bailouts

ABC News’ Betsy Stark reports: Before this is over, AIG may earn the dubious distinction of being the mother of all bailouts.

The U.S. taxpayer was on the hook for $150 billion before today's $30 billion lifeline from the Troubled Assets Relief Program’s round four of government efforts to save AIG. What taxpayers have gotten in exchange is an 80 percent stake in a monstrous global insurance company now trading on the open market as a penny stock, i.e., worth well less than a dollar a share.

AIG has lots of good businesses that still make money but not nearly enough money to cover the cost of AIG's disastrous bets on "credit default swaps." In the simplest terms, AIG sold insurance policies on the trillions of dollars of mortgage-backed securities that made financial firms a fortune as housing prices went up. And for a time it made AIG a fortune, too.

But now that the tide has gone out, to borrow Warren Buffett's metaphor, we see that while AIG insured approximately $450 billion of these securities, incredibly, it failed to set aside any funds to cover potential losses. Why? Credit default swaps were not considered a traditional insurance product, so they were not regulated. So AIG was not required to set aside money for potential losses. And here's the kicker (as explained so well by Joe Nocera in his Feb. 28 column this weekend in the New York Times): The customers who bought these products all felt safe  because these securities carried the coveted AAA rating, conferred because AIG was, once upon a time, so well run that its default swaps deserved a AAA rating.

OK, but why does the federal government -- i.e., American taxpayers with plenty of problems of their own -- continue to bail out this company that behaved so irresponsibly? Isn't this is a classic example of the government throwing good money after bad?

Today the Treasury Department conceded this $30 billion bailout may not be the last. "This will take time and possibly further government support if markets do not stabilize and improve," Treasury warned in a press release. But it went on to explain its belief that AIG's long tentacles have the government in a choke hold: "Given the systemic risk AIG continues to pose and the fragility of markets today, the potential cost to the economy and the taxpayer of government inaction would be extremely high. AIG provides insurance protection to more than 100,000 entities, including small businesses, municipalities, 401(k) plans and Fortune 500 companies that together employ over 100 million Americans. AIG has over 30 million policyholders in the U.S. and is a major source of retirement insurance for, among others, teachers and nonprofit organizations. The company is also a significant counterparty to a number of major financial institutions."

In other words, the government believes it faces a terrible choice: Bail out AIG or risk bailing out all the businesses, cities, retirement funds and individual Americans AIG still insures.

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