Note: Where available, the PDF/Word icon below is provided to view the complete and fully formatted document
Disclaimer: The Parliamentary Library does not warrant or accept liability for the accuracy or usefulness of the transcripts. These are copied directly from the broadcaster's website.
Reserve Bank board meets amid AIG angst -

View in ParlViewView other Segments

Reporter: Stephen Long

ELEANOR HALL: Economics correspondent Stephen Long joins me now in The World Today studio to
discuss the implications of AIG's huge losses and the challenges facing the Reserve Bank as its
board meets today to deliberate on Australian interest rates.

Stephen, AIG was given a lifeline by the US Government last year - how has it managed to end up in
this position now?

STEPHEN LONG: Well, Eleanor as with all of the bailouts that we have seen so far, even the huge
amounts of money thrown in by the Government didn't go anywhere towards matching the enormous
losses and write-downs.

Basically AIG was a house of cards and it has collapsed. The problem is it did something that an
insurance company should never do and that was get into trading, speculative trading of fancy
financial products, financial derivatives and other similar contracts.

The other thing it did very unwisely is it acted as an insurer through the credit default swaps
markets for these collatorised debt obligations and other fancy products that the Wall Street banks
invented that were backed by subprime mortgages and dodgy debt.

ELEANOR HALL: We haven't seen the end of the CDO situation yet, have we?

STEPHEN LONG: Oh, no, no. The losses are still mounting and that is the problem and there is
similar issues with a lot of insurance companies it must be said. Not to the same degree of
problems that we are seeing with AIG.

But Swiss Reid which is the world's largest reinsurer, that is an insurer of insurers, has posted a
loss equivalent to about $AU2.3-billion in the last quarter and it has had to have a huge bailout
from Warren Buffett the rich investor. And there are big concerns about this insurance and
reinsurance market and that it could be the next leg down in the credit crisis.

ELEANOR HALL: So what would happen if AIG or other reinsurance companies were to fail?

STEPHEN LONG: Well, it would make the collapse of Lehman Brothers last year, which sent the world
into a tailspin, look like a picnic. Basically AIG is so strategically important that it would
bring down the entire financial system were it to fail.

That is because it is a counterparty through those insurance contracts to a whole lot of products
and asses that the banks have; and so if that insurance wasn't there the losses in the banking
system would be just enormous and it would just bring down the entire financial system.

Beyond that there is a real economy effect as well because it is a major reinsurer and insurer so
if it was to fold, ships wouldn't sail, planes wouldn't fly, houses wouldn't be built, companies
wouldn't operate because they couldn't get the insurance or their insurers couldn't get backing.

And so that is why it is absolutely important and that is why the US Government really has
signalled from very, very early on in the AIG debacle that it would do anything within its power to
avoid this company failing.

ELEANOR HALL: Although that doesn't seem in any way to have reassured stock markets.

STEPHEN LONG: Well, as I said the problem is that there are just new risks emerging all the time in
these interconnected financial markets and people are seeing the link now between insurance
companies and the financial markets and it is just part of this tangled web, this terrible mess.

So yes, and HSBC shouldn't be underestimated either - a major world bank in serious trouble.

ELEANOR HALL: The board of the Reserve Bank met this morning to decide whether or not to cut
interest rates in Australia again. There seemed earlier in the week to be a wide range of views
among economists about what the bank should do, but what impact will this news about AIG have?

STEPHEN LONG: The news about AIG will have a material impact and it materially increases the
likelihood that the Reserve Bank will cut rates.

Now it is pretty clear from what Reserve Bank officials have said in their public statements and
commentary over the past few weeks that they wanted to pause. They wanted, if they at all could, to
take a break and see what impact the four percentage points of rate cuts they have already
delivered and the fiscal stimulus would have.

But each time they go into a meeting thinking we will pause or we will just cut by a little bit,
there is more bad news it seems before each meeting, and it should be borne in mind that before
many of the meetings they have had recently, they have gone in with a recommendation from staff for
a small cut and increased it.

This time they may have gone in with a recommendation for a small or zero cut. We'll see what
happens this afternoon.

ELEANOR HALL: Stephen Long, our economics correspondent. Thank you.