The import of this story about AIG, Inc. is both less and more than it appears on first reading. It’s not a real news item because it merely reflects regulatory disclosures by AIG (which is 80% owned by the US Treasury). But it does show where a lot of continuing exposure to financial losses is concentrated, and also how the process of buying and selling risk contributed to these problems.

A colleague of mine asked a question about it this morning, pointing out this passage:

AIG said it was unable to provide full details on the value of assets backed by the swaps because of confidentiality agreements with counterparties and lack of information about debtors on loans tied to the contracts.

“I understand how extremely normal this is in normal times. Insofar as this is systemic, how many entities are in a position akin to, if not exactly like, AIG’s — that is, they can’t or won’t disclose that information for the same reasons, and nine months after the whole thing went kablooey, how many of those companies still have screwy valuations for that reason?”

Being unwilling to provide counterparty information due to confidentiality covenants (which are the cover story for not wanting to disclose their strategies to their competitors) is perfectly fine with me. But frankly, being unable to do so because of lack of transparency on the debtors of their counterparties scares me.

When you look at the whole world as an underwriting pool of uncorrelated risks (AIG is an insurance company, after all), you tend to get sanguine that you can manage them statistically. (Which in turn leads to the business practice of writing swaps without understanding what the counterparty is really up to. In a perverted way, it’s rational because all that due diligence is expensive.) Then when all the risks break the rules and start moving together, you’ve not only screwed yourself but the whole world as well.

Since no one has any clue how to manage this systemic risk, the only available approach is to overreserve against it. Which is part of what AIG is doing here by disclosing these essentially unquantifiable but material risks. That’s the essence of why I’ve been predicting a 5-10 year depression for two years now. Over-reserving behaves exactly like an increase in real interest rates.

But in answer to his question and those of curious readers, I have to say that AIG is probably close to unique. Every bank in the world is sitting on a lot of uncertainty in their asset portfolios. The difference is that AIG is in the position of having guaranteed much of that risk. There was a tremendous amount of anger at the fact that taxpayer money pumped into AIG largely got pumped right out again, into a lot of institutions that are far from unhealthy (Goldman was one), and a lot of which are not in the US.

But that was exactly the nature of AIG’s liabilities. In a funny way, they made the job of rescuing the financial system easier because they were a single conduit through which taxpayer money could be pumped, as opposed to going out and individually recapitalizing hundreds of banks around the world.

AIG is pretty close to the most hair-raising thing that’s ever happened in financial history. Remember that weekend in September when Paulson, Bernanke and Geithner trotted up here loaded for bear, intending to throw Lehman Brothers to the wolves? I have it from people who were in the room, that they turned white when they realized what was on the inside of AIG.