AIG was a party of many transactions where the underlying product was valued theoretically instead of a market comparison.

Let me give a simple example:

Let’s say Company X issued a bond of 100 million USD to cover 1000 second mortgages of 100K each. What is this bond worth now?

Until recently, this bond is worth whatever the Company X says it is. That is because the company can say that “we cannot find a similar match for this in the market and so we are going to value it the best we know how”. I call this ‘fuzzy valuation’.

But what if the ‘similar match’ came on the market?

Let’s say company Y had done the same thing, not the exact same thing, but a bond similar enough.

Now, company X would have to revalue the bond they issued. And knowing how the market has gone through the floor, they surely would have to revalue it lower. If they didn’t, they would be lying on their financial statements, which under Sarbanes-Oxley, sends executives to jail for lying.

Then they have to report a lower value on their books, lowering their stock price.

How does AIG come into all this?

AIG is a party to many transactions. Now that AIG is owned by Uncle Sam, its management has no incentive to continue this fuzzy valuation. If AIG starts reporting honestly, then everyone else will have to, which means lower(and more honest) valuations for all.