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With the financial system crumbling, it seems as if ratings agencies can’t cut credit ratings fast enough.  Facing intense scrutiny from regulators because of their part in the build up and subsequent collapse of the subprime market, ratings agencies aren’t holding back when it comes to ratings downgrades.

It’s actually a little bit amusing that in some circles they are actually receiving some criticism for being a little to quick on the draw.  Standard & Poors and Moody’s Investor Services have their sights squarely on the bond insurance industry which will likely face another round of downgrades as they continue to face losses from insuring toxic Collateralized Debt Obligations.

Fitch Ratings Services would also probably be considering another round of downgrades if not for the fact that many companies in the industry have asked them to cease rating their companies. You could say they lost some clients for being the first ratings agency to point out the considerable difficulties that the industry faces today.

A major problem of the financial system has been the conflict of interest between rating agencies and the companies that hire them.  Give a bad rating and the company being downgraded is likely to cut ties with them if one of the other agencies is willing to give a higher rating.

Credit ratings are the bread and butter of financial institutions.  It determines how their interest rates will be in order for them to raise capital in the bond markets as well as having a significant impact on their stock prices.

Capital reserves can quickly dry up in this type of economic climate and firms with low ratings will find liquidity practically nonexistent.  One need only look at the example of AIG to see this how quickly an industry giant can be brought to it’s knees.

It’s becoming an endless cycle downwards, as bond insurers get downgraded, it has a significant impact on the financial system as all the bonds they insure get downgraded as well.  The financial institutions that hold these bonds will have to writedown these losses due to the market devaluations to their portfolios.

This then leads to their ratings downgrades as well as the impact of the devalued bonds slowly makes it’s way through the financial system.  Unfortunately the problems facing the bond insurers are far from over as their fate and the rest of the financial system as well will likely be tied to the fate of the housing market.

American International Group(AIG), the world’s largest insurer and a financial giant with over a $1 trillion in assets has seen it’s fortunes diminish in the face of huge losses from the subprime collapse.  While most of these losses stem from it’s finance division, it is also having severe repercussions to it’s still profitable insurance units.

A survey by Insurance Journal of 1,000 insurance producers including 782 who say they have accounts with AIG found that 343 producers have had clients ask them to move their account out of AIG. That’s 43.8 percent of producers with AIG accounts.

“Since the rating agencies apply the same financial rating to the subsidiaries as they assign to the parent, it really doesn’t matter where the subsidiaries stand financially - they fall with the parent,” said Chris Boggs, associated editor of MyNewMarkets.com. “Also, and not to deride any person or their opinion, some of this has to do with a misunderstanding of the complexity and size of AIG. To some agents, like to some clients, AIG is AIG, and if AIG is in trouble that’s all they hear. Anything said in defiance of the agent’s or client’s opinion is just spin in the view of some.”

It’s a rough time for AIG right now, there’s blood in the water and the sharks are circling.  A lot of people can’t jump ship fast enough.

Much of this has to do with the complexities of most financial companies, insurance companies aren’t just insurers and banks aren’t just banks anymore.  Insurance is supposed to be regulated by the individual states but asking a state commissioner to regulate a company as complex as AIG is pretty much impossible.

Having severe liquidity problems, AIG was forced to ask the government for a loan but it’s far from a bailout.  At 8.5% above the LIBOR, it’s a very expensive loan and with the government to take an 80% equity stake in the company it is unlikely to have a happy ending.

The government plans to take control only to see to the orderly breakup of the huge company but until that is completed, all of it’s subsidiaries no matter how profitable are being painted by a single brush.  While it’s insurance units may have little connection to the subprime meltdown, their fortunes will be tied to their parent holding company.

The world’s largest insurer, American International Group(AIG), is on the brink of collapse.  It is estimated that the company needs to raise somewhere in the neighborhood of $70 billion in capital to stay afloat.

It is going to be difficult for them to raise that kind of money as two leading credit agencies slashed their ratings on AIG yesterday.  The company has been in talks with Goldman Sachs and J.P. Morgan Chase, two of the largest investment banks remaining after the the demise of Lehman Brothers and buyout of Merrill Lynch yesterday.

Whether they will agree to help AIG with their liquidity problems is uncertain.  There is also late breaking news that the Federal Reserve is considering a loan package to keep them from bankruptcy.

If the Fed does open it’s wallet to AIG, they will also be opening themselves up to criticism as to why they extended government help to AIG but not to Lehman Brothers, which filed for Chapter 11 bankruptcy protection yesterday.  With AIG holding over a $1 trillion in assets, it has been estimated that a collapse of this magnitude would to cost the financial services industry over $180 billion in losses.

A major consideration could very well be that while the collapse of Lehman will hurt mainly investors, the collapse of AIG could have adverse effects on many regular Americans, namely their policy holders.