Question

Bank of America got bailed out, but Lehman Brothers was allowed to fail. The insurance company American International Group (AIG) was rescued, but in July federal authorities refused to bail out a significant lender to small and medium-sized businesses, the CIT Group (not to be confused with Citigroup, which did get bailed out). What is the logic behind these decisions? Who is being bailed out—and who should be? Was the AIG bailout necessary in your view?

Answer 1

The bailout Strategy:

The consistent principle behind this strategy is that no large bank can fail. This is why the relatively small CIT Group wasn’t rescued from potential bankruptcy but Bank of America was. The decision not to bail out Lehman Brothers, which led to panic in financial markets, is now considered a mistake. However, policymakers drew the wrong lesson from the Lehman episode: that all large bank failures must be prevented. They failed to recognize the important distinction between disruptive and controlled failures.

AIG took risks with unregulated products like a hedge fund while using cash from people's insurance policies. The government had no choice but to bail it out. Its demise would have created the same kind of economic collapse that occurred when Lehman Brothers went bankrupt in September 2008.

AIG had become a major seller of credit default swaps in an attempt to boost its profit margin. These swaps insured the assets that supported corporate debt and mortgages. If AIG went bankrupt, it would trigger the bankruptcy of many of the financial institutions that had bought these swaps.

AIG was so large that its demise would impact the entire global economy. For example, the $3.6 trillion money-market fund industry invested in AIG debt and securities. Most mutual funds owned AIG stock. Financial institutions around the world were also major holders of AIG's debt.

AIG bailout was necessary to prevent its bankruptcy and further stress on the global economy.

Found one good article on Google for further reading:

http://www.dollarsandsense.org/archives/2009/0909wolfson.html