AIG Rejects Private Equity, Potentially Committing a Fatal Error

In a bold move, AIG reportedly turned down a significant investment from private-equity because it would have meant turning over control of the company.  The insurer, facing a potential liquidity crisis if it is downgraded by the ratings agencies, is now seeking access to $40 billion in loans from the Fed until it can raise capital on friendlier terms.  Relatively new CEO Robert Willumstad doesn't appear to be keeping up with current events.  The Fed is no longer in a particularly charitable mood.  AIG's stock was down 50% and spreads on the company's credit default swaps soared last week.  S&P futures are currently down 40 points, and the entire banking system teeters on the brink of collapse as it struggles with the implications of a Lehman bankruptcy.  Although the Fed is now taking equities as collateral in the primary dealer credit facility and any investment grade debt in the Term Securities Lending Facility, it is only taking these measures to avert a complete and total meltdown in the capital markets.  It is not likely to look favorably on an insurer that had an opportunity to raise capital and chose not to because it didn't like the price.  After all, the Fed passed on a bailout guarantee for a Lehman acquirer and is allowing the investment bank to fail.  Six months ago the market rallied because it believed that the Fed's decision to grant investment banks access to the discount window implied that the Fed wouldn't let an investment bank fail.  The market won't rally tomorrow.  Spreads in the credit markets are likely to widen.  As the stock market gets pummeled, AIG's situation will only grow more grave unless the restructuring plan it will announce tomorrow is set in stone.  The market is likely to view any signs of ambiguity in the plan with the same disdain as it viewed Lehman's plans.  Mr. Market may respond with the following:  "Sure you're going to sell some assets, but you should have done that yesterday.  You should've just hit the bid because if that bid comes back, it is bound to be lower.  So what if you have access to the discount window?  So did Lehman.  They didn't make it.  Wait. What???  You turned DOWN an equity investment?  Because you didn't want to lose control of the company?  Here's a clue.  You guys aren't doing a very good job.  You're stock is in the toilet.  Your credit default swaps are indicating that you are in extreme distress.  You should've handed over the reigns.  No way those private equity guys could do a worse job!"  

Tomorrow will be a rough day in the market.  If things get too ugly the Fed might cut interest rates again, which would plant the seeds for the inflation of some other kind of bubble.  We've already been through tech and housing.  What next?  I'm betting on a mattress bubble, because that's where I'm keeping my money.