Silent Archimedes

Diversify investments you must! Or AIG you will become…

Posted by silentarchimedes on September 17, 2008

American International Group, Inc.

American International Group, Inc.

The fall of AIG (American International Group, Inc.) will be studied in economics classes for many many years to come. It is such a precipitous fall that it’s another one of those corporate stories where employees and investors alike get blindsided. However, as with most of these corporate tragedies, there are always warning signs leading up to the collapse. When the federal goverment announced yesterday they were bailing out AIG by infusing $85 billion to take control of 79.9% of it, it marked the biggest victim in the latest credit/mortgage/insurance crisis. Since AIG is the biggest insurance company in America, it had some of the most exposure to credit and financial services. This should have been a warning sign when other icons like Bear Stearns collapsed. As a matter of fact, when the bailout by J.P. Morgan was announced on March 24, 2008, AIG actually rose over $1. It did drop a few dollars in the next few days but because the entire market was down. This shows how little investors know about the financial details of a corporation. Here is the AIG chart:

AIG's quick fall from over $50 to $2

AIG Daily Chart - the quick collapse from $50 to $1

Ever since I started investing out of college during the peak of the dot com era, all the advice kept saying was to diversify your investments. To invest in very stable and safe companies that provided stable returns to balance the riskier investments. They suggested to invest in General Electric (GE), and Proctor and Gamble (PG), Philip Morris (PM), and, yup, AIG. As we know, GE has also had its troubles since Jeff Immelt took over for the legendary Jack Welch as CEO. But the collapse of AIG has to be one of the most shocking ever. Just look at AIG’s performance since 1985:

AIG Stock Chart - 1985 to current

AIG Stock Chart - 1985 to current

However, the point of diversifying is well taken. It just shows that not any one company is immune to troubles at a macro and micro level. That such stable entitites as AIG and GE can also hit walls. That you have to do your research and do it well. That even if you do do your research there is still risk. The fall of AIG also reminds us of two other great corporate tragedies, Lucent Technologies (LU, and now ALU), and Enron. Although AIG’s troubles have more to do with macro-issues such as the financial industry and the world credit crunch, an implosion as I’d like to call it, Lucent’s and Enron’s were more of a micro-level collapse, an explosion as I’d like to call it. Lucent’s collapse had more to do with management’s inability to sustain sales in a tech bubble and using ill-advised methods, such as loans to companies with no prospects of profit, to its own customers. Enron’s collapse was similar in that management used devious and sleight of hand tricks to show improving sales, even when analysts began doubting them.

Lucent chart before buyout by Alcatel

Lucent chart before buyout by Alcatel - From high of $80 in 1999 to under $1

The collapse of Enron

The collapse of Enron

The fed bailout of AIG is ironic. One can argue that the AIG troubles are the fault of the Feds to begin with. This whole mortgage and credit crunch crisis can be laid at the foot of Alan Greenspan and the dollar making Fed machine. When the dot com burst and 9/11 occurred, the U.S. went into a recession. The most historically logical thing to do would have been to just let the economy play itself out. The craziness of the dot com bubble was not correctly monitored by the Feds, else people would not have lost all their fortunes to paper money. So if the Feds did not get involved during greedy times, why get involved during recessionary times? It was very poor management. So instead of letting the recession play itself out, the Greenspan Feds simply pumped more and more dollars into the economy and dramatically decreased the regulations required for access to credit. The huge amount of extra credit in the economy created the housing bubble which burst and the credit crunch ensued. What will be interesting is what Ben Bernanke and the Feds do now. Does he bail out the economy again at the expense of our future or does he play tough and do the right thing? So far, the Bernanke Feds have given mixed signals. They’ve been trying to play a slightly tougher hand than Greenspan, by saying no more bailouts. But saying and doing are two different things. Since then they have bailed out Freddie Mac, Fannie Mae, and now AIG. All three, way too big to let fail. Although they decided to leave interest rates alone this week, we will see how much moxie they have when the markets keep falling while inflation keeps rising. Additionally, it appears that the annual summer correction of gold and oil is over. It will be interesting to see what happens as we head into winter.

So what is the moral of this story? Yes, one must diversify its investments. However, do not just diversify in specific corporations and industries. Also diversify into mutual funds, bonds, and CDs. Diversify in non-dollar investments, like gold, silver, other commodities, and currencies. The economic times of America will be very very unpredictable in the next ten to twenty years as globalization plays itself out. America will either remain alone at the top of the economic ladder, or new leaders such as the rising East, like China and India, become competing economic behemoths. Be in position to capitalize on this. Read books about it. For suggestions click on the Economics category to the left of my blog. I have been reading economic books like crazy lately and writing reviews on them. Let me know if you have any questions , suggestions or comments.

Happy investing!

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