Did Uncle Sam Stack The Deck With AIG's Bailout?

One question left unanswered in the mad rush to keep the economy from sinking into oblivion is whether AIGs federal bailout unfairly skewed the playing field against its competitors.

Indeed, has anyone in Washington thought about the long-term market impact of having a major carrier backed by seemingly unlimited taxpayer funds? And is it fair to pit a federally-backed AIG against competitors that didn't gamble their futures on toxic securities and credit default swaps based on reckless subprime loans?

At least one insurance organization is sounding the alarm. As reported by our own Dave Postal and Matt Brady in Washington, the American Insurance Association tried to press the issue with a letter to Congress. (Click here to read the complete story.)

AIA voiced concern that government ownership of private companies does not produce regulatory policy at the state or federal level that gives those institutions a marketplace advantage over their competitors as government seeks to protect its investment.

AIA said Uncle Sam must make sure taxpayer bailout funds are not used for unintended purposessuch as gaining market share from those getting capital the old-fashioned waybecause this would present a substantial risk of market distortion.

Congress must exercise its oversight responsibility to ensure that the limited purposes of these initiatives do not result in outcomes that distort private markets and create conflicts with the governments role as market regulator, the AIA pleaded in its letter.

It might already be too late. After all, many big players in the industry are shrugging off antitrust concerns to complain loudly that American International Group–thus far the only insurer to get federal bailout money–is unfairly undercutting them on commercial coverage pricing to maintain market share despite buyer concerns over the organization's long-term viability.

AIG is able to pull this off, its critics charge, because of the $150 billion (and counting) in federal funds at its disposal.

Of course, supporters of the bailout contend that had AIG been left to the not-so-tender mercies of the free market, its almost certain demise would have sent devastating shock waves throughout the entire economy.

But no one is arguing that AIG's commercial insurance entities would have been compromised, as they were well-capitalized and somewhat insulated from the woes befalling its corporate parent, thanks to firewalls set up by state regulation. There are many in the industry who believe that AIG should have been allowed to fail, reasoning that others would have picked up the slack in an already overcapitalized property-casualty insurance market.

I'm not so sure about that–certainly not in the short term. But I can appreciate the concerns voiced by critics about the long-term impact on the competitive landscape. It's chaos theory at work, in that whatever good intentions and rational justification Washington had in bailing out AIG, unintended consequences were unavoidable.

Should AIG have just been allowed to collapse under the weight of its foolish derivatives trading? What would have happened had Uncle Sam refused a bailout?

What will the impact of a taxpayer-capitalized AIG be on the p-c market over the long haul? Will it fuel a longer and deeper soft market than free competition would have dictated?

Will it drive other insurers into financial distress as they struggle to compete with the bottomless federal pockets backing AIG?

These are all critical questions for the year ahead. Do any of you have an answer? I doubt anyone in Congress does.