Dear Mr. Berko: I understand your explanation of how leverage of 30-to-1 was responsible for the collapse of Merrill Lynch and other brokerages that owned hundreds of billions of dollars of mortgages. And I understand why the Federal Reserve Board had to guarantee the solvency of some of these brokerages. But what I don't understand is why the Fed has to support AIG. This is an insurance company and they don't own a huge mortgage portfolio. — G.S., Oklahoma City

Dear G.S.: Few people realize the importance of the insurance industry to the mortgage market and why the Federal Reserve Board had to step up to the plate and "billionize" American Insurance Group Inc. If the Fed hadn't acted to shore up AIG, our entire financial system would have collapsed like a house of cards in a hurricane, and the ensuing economic devastation, not just in the United States, would have frozen the world into an economic ice age.

As we peel back the economic onion, we are beginning to understand how each layer above insulates the layers below. As the layers continue to peel back, the onion's mass becomes so exponentially dense until the weight at its core takes on the features of a black hole. When this is all over, Federal Reserve Board Chairman Ben Bernanke will be spoken in future history books with the same reverence as Archimedes, Leonardo da Vinci, Nicolaus Copernicus and Albert Einstein. And former Federal Reserve Board Chairman Alan Greenspan, who opened the economic seacocks and cavalierly tossed a foundering ship to Bernanke, must, like Guy Fawkes, be hung in effigy every year.

The relationship between AIG and Merrill Lynch, Lehman Bros., Bear Stearns, as well as other insurers to the investment banking houses, demonstrates the dangerous interconnectivity of a faulty fiscal architecture designed by Wall Street androids with Ivy League MBAs. The genesis of this crisis began with the implementations of the 1968 Fair Housing Act, which was designed to protect Americans from discrimination in mortgage lending practices based upon race, religion and national origin. It gained momentum a dozen years ago with liberal interpretations of the Equal Credit Opportunity Act that fostered rampant abuse and greed. Soon Lehman Bros., Merrill Lynch, Bear Stearns and others were subsuming the mortgage markets like Nazi storm troopers, figuratively and literally creating hundreds of billions of dollars of collateralized debt obligations. These collateralized debt obligations are bonds backed by pools of mortgages that should never have been issued because their credit worthiness and underlying collateral are virtually nonexistent.

So Lehman Bros., Merrill Lynch, etc., in order to protect themselves against almost certain future default, purchased insurance contracts called credit default swaps from companies like AIG. While the extent of credit default swaps issued by other insurers is unclear, we do know that AIG insures more than $500 billion worth of credit default swaps, which includes an estimated $70 billion to $80 billion worth of subprime mortgages. I'm told that Merrill holds about $8 billion of AIG credit default swaps and that Lehman Bros., Wachovia, Bear Stearns, other investment banks and European banks also own credit default swaps from AIG and other insurers.

When the housing bubble popped, all those collateralized debt obligations started to nosedive in value. Because AIG did not have the cash to pay off its credit default swaps, the Fed was forced into action because the banking system would have collapsed under a new fusillade of loss.

What's more, those losses are not just confined to the United States. The British were lured by the hubris of Wall Street. Their housing market has also collapsed and mortgage defaults are echoing throughout the British Isles. Italy, Spain and France are similarly affected but to a much lesser degree. So the Fed stepped up to the plate, not only to support AIG but to protect Goldman Sachs and Morgan Stanley, who lack a dependable depositor base to provide capital for ongoing operations.

While the subprime-collateralized debt obligation contagion spread the housing market continued to deteriorate. Many home loans once considered less risky began to implode. Mortgages called "ALT-A" loans, loans to folks with good credit but no proof of income, began to detonate. In normal times, 2 percent of ALT-A loans are troubled. Today, that number is reaching 20 percent. Delinquent subprime loans that historically average a 9 percent rate of default are now 30 percent.

Because many midsize banks were tantalized to the trough, the trickle down from Wall Street has bloodied Main Street. The midsize banks issued new preferred stocks, collecting cash from investors and bought high-yielding collateralized debt obligations. Those preferred stocks are beginning to collapse, resulting in so many good people on Main Street being ravaged by the greedy people on Wall Street.

Please address your financial questions to Malcolm Berko, P.O. Box 1416, Boca Raton, FL 33429 or e-mail him at malber@comcast.net. To find out more about Malcolm Berko and read features by other Creators Syndicate writers and cartoonists, visit the Creators Syndicate website at www.creators.com.

COPYRIGHT 2008 CREATORS SYNDICATE, INC.

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