Understanding the impact on the Australia market regarding the situation with AIG is easy. Just think back to HIH and how it affected the Australian market and then multiply by 1,000%!
AIG is an insurance company that has operations in around 130 countries. Its customers involve commercial, institutional and customers in the most extensive property-casualty and life insurance networks in the world of any insurer. Bankruptcy would not only have been bad for shareholders but catastrophic for its customers.
Only this morning, my colleague received an email from her financial planner in Australia saying not to panic about her life insurance with AIG Australia. There were implications not only for the US but for Australia and the globe as well.
In Australia alone, AIG markets mutual funds, retirement services, accident & health insurance, life insurance, motor insurance, travel insurance, accident & health insurance, business property coverage, crisis management, employers liability and management liability to name a few of its services.
The HIH fallout in Australia was huge not because of shareholder losses but because of the implications for the customers of HIH who were left without insurance. Builders refused to go to work, businesses were scared of opening up shop and even councils were left with debts.
Now imagine an HIH-type fallout in a much bigger country which is also the most litigious country in the world. Businesses would have come to a stand still, customers left without insurance and then insurance and finance companies around the globe would have felt the fall out.
That's the reason why the US government stepped in with an US$85 billion loan. It's not the best loan in the world. In fact the government is charging an almost ridiculous interest rate, charging 8.5% ABOVE the official Libor (official) rate. Not only that but they have taken all of AIG's assets as collateral to protect them in case AIG defaults. In the case that AIG does get back on its feet and does well, well they've effectively taken an 80% stake of that through a warrants position.
For AIG, they are not out of the woods as yet. This lifeline gives them a chance to wind up some of their business in an orderly manner which will have a much smaller effect on the market then bankruptcy would have. It will probably end up holding onto its core property casualty business. The auto insurance and life/annuities business would probably be spun off and the aircraft leasing division will most likely be sold off.
For investors, it's a word of warning. The financial fallout is not over yet. While Australia is in some part buffered from what's happening in the US, it's certainly not immune and it means that our financial institutions may struggle for months to come.
The cost of lending has gone up and that means that the cost of doing business has gone up and that's likely to stifle growth for most types of businesses for months to come.
For the smart investors, as always, it's time to keep a sound business mind while the sharemarket succumbs to fear. It's in times like theses that the smart money makes their moves.
Warren Buffett's Berkshire Hathaway is one company that thrives in times like theses by picking up quality businesses at bargain basement prices. Now if only we could have the same type of discipline and psychology in our own portfolios.
Happy investing!
Julia Lee Equities Analyst Bell Direct
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