[UPDATE 9/17: Turns out Biden and Obama are just as con­fused on the AIG bailout as McCain is. I've added in their con­flict­ing state­ments below.]

1/ John McCain, speak­ing yes­ter­day to NBC’s Matt Lauer, as reported by ABC’s Ron Claiborne:

“No, I do not believe that the Amer­i­can tax­payer should be on the hook for AIG and I’m glad that the Sec­re­tary Paul­son has appar­ently taken the same line.”

NBC’s Matt Lauer pressed McCain: “So, if we get to the point, in the middle of the week when AIG might have to file for bank­ruptcy, they’re on their own?”

McCain replied, “Well, they’re on their own. We cannot have the tax­pay­ers bail out AIG or any­body else, this is some­thing that we’re going to have to work through.”

1a/ And Joe Biden, speak­ing yes­ter­day to NBC’s Mered­ith Viera:

No, I don’t think [AIG] should be bailed out by the fed­eral gov­ern­ment. I’ll tell you what we should do. We should try to cor­rect the prob­lems that caused this.

2/ John McCain, speak­ing today to ABC’s Robin Roberts:

I didn’t want to do that. And I don’t think any­body I know wanted to do that. But there are lit­er­ally mil­lions of people whose retire­ment, whose invest­ment, whose insur­ance were at risk here.

2a/ And Barack Obama, in a state­ment today:

The fact that we have reached a point where the Fed­eral Reserve felt it had to take this unprece­dented step with the Amer­i­can Insur­ance Group is the final ver­dict on the failed eco­nomic phi­los­o­phy of the last eight years…. While we do not know all the details of this arrange­ment, the Fed must ensure that the plan pro­tects the fam­i­lies that count on insur­ance. It should bol­ster our economy’s abil­ity to create good-​paying jobs and help work­ing Amer­i­cans pay their bills and save their money. It must not bail out the share­hold­ers or man­age­ment of AIG.

Politico’s Jonathan Martin quotes the fol­low­ing state­ment from the McCain cam­paign this morn­ing that attempts to square the two positions:

The focus of any such action should be to pro­tect the mil­lions of Amer­i­cans who hold insur­ance poli­cies, retire­ment plans and other accounts with AIG. We must not bailout the man­age­ment and spec­u­la­tors who cre­ated this mess. They had months of warn­ings fol­low­ing the Bear Stearns deba­cle, and they failed to act.

Don’t be deceived by this. As any­body who’s been paying atten­tion to the sit­u­a­tion will know, insur­ance poli­cies and retire­ment plans have noth­ing to do with the bailout. AIG’s insur­ance and retire­ment plans are run through AIG sub­sidiaries, which every­one agrees are well cap­i­tal­ized and which, at least in the case of the insur­ance oper­a­tions, are gov­erned by strict reg­u­la­tions that severely limit the risk to people like you and me. Noth­ing I’ve read in the last couple of days sug­gests that these were ever in danger, even if AIG went into bankruptcy.

Rather, the reason for the Fed bailout is, quite simply, the mas­sive coun­ter­party risk that an AIG fail­ure would cause. As news­pa­per graphic design­ers across the globe are strug­gling to explain to their read­ers today, AIG is a huge player in the market for credit default swaps, which means that they effec­tively sell insur­ance to cor­po­rate bond­hold­ers against the pos­si­bil­ity that the com­pa­nies who issued the bonds will default. In other words, CDS help big finan­cial play­ers limit the risk of their fixed-​income (i.e. bond) investments.

CDS are not in and of them­selves evil or duplic­i­tous instru­ments; in fact they help shift risk to the people and com­pa­nies who want to take it on and away from people who do not. But the major prob­lem with CDS is that the market for them is com­pletely opaque and unreg­u­lated, thanks in large part to the efforts of one of John McCain’s chief eco­nomic advi­sors, Phil Gramm. (A more minor prob­lem–which reared its head ear­lier this year–is that CDS con­tracts don’t require ini­tial own­er­ship of the under­ly­ing bonds, thus the instru­ments can quite easily be used to spec­u­late on a company’s demise.)

The Fed bailed out AIG because the com­pany could not raise the $14.5 bil­lion in col­lat­eral it needed to avoid bank­ruptcy. And unlike the insur­ance plans or retire­ment port­fo­lios, the CDS con­tracts would be at risk in the event of bank­ruptcy. If all of a sudden a huge swath of CDS con­tracts were effec­tively can­celed, then you’d have a huge swath of the finan­cial market hold­ing all kinds of risk that it was trying to avoid in the first place. And as soon as that hap­pened, that whole swath would likely start sell­ing off those newly risky invest­ments all at once, caus­ing a huge seize-​up in the credit mar­kets. And the credit mar­kets, remem­ber, are how com­pa­nies get short-, medium-, and long-​term loans to fund their daily oper­a­tions (read: things like pay­roll for their employ­ees). And so if AIG went under, the neg­a­tive effects would work their way very quickly from Wall Street down to Main Street.

At least, I think that’s how it all goes. In any case, you can assure your­self that Henry Paul­son and Ben Bernanke wouldn’t be doing this if it were at all avoid­able. I mean, just think what this means: a Repub­li­can admin­is­tra­tion has effec­tively nation­al­ized one of the world’s largest insur­ers. It’s funny how a little finan­cial panic makes social­ists of us all.