AIG Bailout: $85B in Loans, 80% AIG Taxpayer Owned
Here are 4 items regarding the AIG bailout that are worth thinking about:
1) AIG is the world's biggest insurer. AN uncontrolled bankruptcy would have dramatically exacerbated the current recession -- possibly turning it into a depression;
2) The NY based firm was also a huge Credit Default Swap insurer/underwriter. The tems of CDS require collateral to be posted, depending upon such factors as credit rating and credit spreads;As home prices fell, spreads widened, and companies went down, AIG's collateral requirements went up significantly.
3) Hence, this is more of a liquidity problem than an actual insolvency. This is the first bailout that adhered to Walter Bagehot's dictum "Central Banks should lend freely at a penalty rate;"
4) Moral Hazard, successfully avoided in the Lehman Brothers bankruptcy, was put aside given the massive size of AIG -- if any firm was TBTF -- too big to fail -- it is AIG.
The Federal Reserve released:
The Federal Reserve Board on Tuesday, with the full support of the Treasury Department, authorized the Federal Reserve Bank of New York to lend up to $85 billion to the American International Group (AIG) under section 13(3) of the Federal Reserve Act. The secured loan has terms and conditions designed to protect the interests of the U.S. government and taxpayers.
The Board determined that, in current circumstances, a disorderly failure of AIG could add to already significant levels of financial market fragility and lead to substantially higher borrowing costs, reduced household wealth, and materially weaker economic performance.
The purpose of this liquidity facility is to assist AIG in meeting its obligations as they come due. This loan will facilitate a process under which AIG will sell certain of its businesses in an orderly manner, with the least possible disruption to the overall economy.
The AIG facility has a 24-month term. Interest will accrue on the outstanding balance at a rate of three-month Libor plus 850 basis points. AIG will be permitted to draw up to $85 billion under the facility.
The interests of taxpayers are protected by key terms of the loan. The loan is collateralized by all the assets of AIG, and of its primary non-regulated subsidiaries. These assets include the stock of substantially all of the regulated subsidiaries. The loan is expected to be repaid from the proceeds of the sale of the firm’s assets. The U.S. government will receive a 79.9 percent equity interest in AIG and has the right to veto the payment of dividends to common and preferred shareholders.
Here's a few excerpts from major media --
Bloomberg:
The U.S. government agreed to lend as much as $85 billion to American International Group Inc. in exchange for a 79.9 percent stake to save the country's biggest insurer from collapse.
The Federal Reserve "determined that, in current circumstances, a disorderly failure of AIG could add to already significant levels of financial market fragility and lead to substantially higher borrowing costs, reduced household wealth and materially weaker economic performance,'' the Fed said.
The agreement, supported by the Treasury Department, will keep New York-based AIG in business, averting a failure that could have threatened more financial companies and added to chaos in world markets. Losses industrywide could have totaled $180 billion if AIG collapsed, according to RBC Capital Markets. AIG needed the loan after its credit ratings were cut and shares plunged 79 percent since Sept. 11.
WSJ:
That the government would prop up AIG financially offers a stark indication of the breadth of the insurer's role in the global economy. If it were to have trouble meeting its obligations, the potential domino effect could reach around the world.
For one thing, banks and mutual funds are major holders off AIG's debt and could take a hit if the insurer were to default. In addition, AIG was a major seller of "credit-default swaps," essentially, insurance against default on assets tied to corporate debt and mortgage securities. Weakness at AIG could force financial institutions in the U.S., Europe and Asia that bought these swaps to take write-downs or losses.
AIG's millions of insurance policyholders appear to be considerably less at risk. That's because of how the company is structured and regulated. Its insurance policies are issued by separate subsidiaries of AIG, highly regulated units that have assets available to pay claims. In the U.S., those assets can't be shifted out of the subsidiaries without regulatory approval, and insurance is also regulated strictly abroad.
NYT:
If A.I.G. had collapsed — and been unable to pay all of its insurance claims — institutional investors around the world would have been instantly forced to reappraise the value of those securities, which in turn would have reduced their own capital and the value of their own debt.
“It would have been a chain reaction,” said Uwe Reinhardt, a professor of economics at Princeton University. “The spillover effects could have been incredible.”
Financial markets, which on Monday had plunged over worries about A.I.G.’s possible collapse, reacted with relief to the news of the bailout. In anticipation of a deal, stocks rose about 1 percent in the United States on Tuesday and were up about 2 percent in early trading in Asian markets Wednesday morning.
To give you an idea of how interconnected AIG is with the rest of the financial universe, Bloomberg reports that "Lehman Brothers Holdings Inc.'s London landlord, Songbird Estates Plc, said rent payments on the bank's offices in the Canary Wharf financial district are insured by American International Group Inc.
The AIG news is unprecedented, and will likely dominate tomorrow's trading. Futures are up only now down modestly.
>
Previously:
Bloomberg Video: AIG Earnings
http://bigpicture.typepad.com/comments/2008/08/bloomberg-video.html
>
Sources:
Federal Reserve News Release on AIG
http://www.federalreserve.gov/newsevents/press/other/20080916a.htm
Fed’s $85 Billion Loan Rescues Insurer
EDMUND L. ANDREWS, MICHAEL J. de la MERCED and MARY WILLIAMS WALSH
NYT, September 16, 2008
http://www.nytimes.com/2008/09/17/business/17insure.html
AIG Gets Up to $85 Billion Fed Loan; Cedes Control
Craig Torres and Hugh Son
Bloomberg, Sept. 16 2008
http://www.bloomberg.com/apps/news?pid=20601087&sid=aAkvusf5Ld7M&
U.S. Plans Rescue of AIG to Halt Crisis; Central Banks Inject Cash as Credit Dries Up
$85 Billion Loan for Giant Insurer Aimed at Averting Collapse; Historic Move Would Cap 10 Days That Reshaped U.S. Finance; Fed Says AIG Will Sell Businesses in Orderly Manner
MATTHEW KARNITSCHNIG, DEBORAH SOLOMON and LIAM PLEVEN
http://online.wsj.com/article/SB122156561931242905.html
A.I.G. Is Still Profitable, With a Wide Array of Enterprises
JONATHAN D. GLATER
NYT September 16, 2008
http://www.nytimes.com/2008/09/17/business/17aig.html
Tuesday, September 16, 2008 | 10:48 PM | Permalink
| Comments (101)
| TrackBack (0)
add to de.li.cious | 
digg this! | 
add to technorati | 
email this post
TrackBack
TrackBack URL for this entry:
http://www.typepad.com/services/trackback/6a00d8341c52a953ef010534aa33e7970b
Listed below are links to weblogs that reference AIG Bailout: $85B in Loans, 80% AIG Taxpayer Owned:
Comments
hopefully all's clear 'til window dressing day.
Posted by: hooray | Sep 16, 2008 10:52:35 PM
Oh goodie - when do we taxpayers receive our AIG shares? Will they appear in my brokerage account?
Posted by: Jeff M. | Sep 16, 2008 10:54:09 PM
Now that, my friends, is a tax rate we can believe in...80%+ !
Posted by: wnsrfr | Sep 16, 2008 10:56:50 PM
BR: You probably already know this, but you're quoted in the NYTimes this evening and were quoted in my local Minneapolis Star Tribune today. You're everywhere!
Barry Ritholtz — who runs an equity research firm in New York and writes The Big Picture, one of the best-read economics blogs — is going to publish a book soon making the case that the bailout actually helped cause the decline. The book is called, “Bailout Nation.” In it, Mr. Ritholtz sketches out an intriguing alternative history of Chrysler and Detroit.
If Chrysler had collapsed, he argues, vulture investors might have swooped in and reconstituted the company as a smaller automaker less tied to the failed strategies of Detroit’s Big Three and their unions. “If Chrysler goes belly up,” he says, “it also might have forced some deep introspection at Ford and G.M. and might have changed their attitude toward fuel efficiency and manufacturing quality.” Some of the bailout’s opponents — from free-market conservatives to Senator Gary Hart, then a rising Democrat — were making similar arguments three decades ago.
Posted by: Jeff M. | Sep 16, 2008 10:58:10 PM
Yesterday we were worried about moral hazard, but today; no problem let's buy an insurance company. How do you invest in a market like this? The answer is you don't and if you aren't confused, you don't understand.
Posted by: larster | Sep 16, 2008 11:01:12 PM
Thus kicking the can even further down the road. Two questions
1. Will $80 billion be enough, or is that the first installment?
2. When does the Fed take over GM and Ford?
Anybody remember the old days when bailouts only happened on the weekends?
Posted by: Rich Shinnick | Sep 16, 2008 11:02:12 PM
And the Abyss stared back and the Fed flinched, again.
End of first quarter: Free market (1)LEH
Fed (3)FRE, etc.
Posted by: johnnyvee | Sep 16, 2008 11:09:10 PM
So I now have an ownership in Fannie, Freddie and AIG. When can I expect my dividend payments?
Posted by: Pat G. | Sep 16, 2008 11:09:25 PM
Jeff M.,
You've already got the shares. Look in your billfold.
Posted by: Eclectic | Sep 16, 2008 11:13:15 PM
So now we taxpayers are bailing out another failing entity. Without it ever being put to a vote or decided on by an elected officials.
The bailouts nowadays are much different then the ones of a kinder, gentler era like the Chrysler and Lockheed bailouts of the 1970s. Today's bailouts are straight cash.
Chrysler and Lockheed got nothing but loan guarantees, not the actual loans. Whereas before the taxpayer never put up any capital, just backstopped the banks that did so.
Now it is coming straight out of pocket.
Posted by: William Miller | Sep 16, 2008 11:15:40 PM
Anyone have ANY clue how the markets will react to this? I'm going to take a guess - - up big tomorrow? Party days (and free lunches) are here again!
I'm so confused at this point, it's getting close to 100% cash position time. It's not worth the stress to trade in this market. I'm taking my nickels and going home.
Posted by: Jeff M. | Sep 16, 2008 11:16:40 PM
When the Credit Default Swaps come due, it may become clear that rather than a liquidity problem it is an insolvency problem.
But oh, I forgot, the gov't can just print money.
Posted by: algernon | Sep 16, 2008 11:18:52 PM
I'd be shocked if AIG's business model can support Libor+850. Plus it looks like the loan is senior secured. I guess I'll go against the grain and say that it looks like the equity, preferred, and bonds of AIG are pretty much going to be wiped out. AIG is still done as a company, I'm not sure that the moral hazard is that big.
Posted by: Jason | Sep 16, 2008 11:18:53 PM
Make it simple - nationalize all private enterprise - we don't need no revolution in the USSA!
We are all Communists!
Where's Joe McCarthy and his Red Scare???
Posted by: malabar | Sep 16, 2008 11:18:55 PM
Just a thank you about the heads up on AIG in August.
Your Bloomberg video when AIG earnings came out got me out of the long trade -- it was a life saver.
Thank you for all of your hard work !
Posted by: Jeff M. | Sep 16, 2008 11:19:52 PM
So let's say I'm down in the financial district and I gotta take a piss. As a part owner of AIG, can I walk over to HQ and use the facilities? Do I at least get that much out of the deal?
Posted by: Al Czervic | Sep 16, 2008 11:27:51 PM
The only thing in the USA that is "fundamentally sound" is George Bush's pension. Who votes to give it to him now
without a prepayment clause. Out . NOW.
Go to Galveston or Crawford and ride your bike.
This man is THE MOST PATHETIC human being on earth.
Posted by: Robert | Sep 16, 2008 11:29:15 PM
Quote Eclectic, "You've already got the shares. Look in your billfold."
Yeah, but I think I paid too much per share. Let's see, 10 trillion divided by 300 million....
Posted by: Winston Munn | Sep 16, 2008 11:29:37 PM
Direction of the market hmmmmm.....lets see. Well, Wed it will probably go up followed by more down down down. Once again how much is this adding to the debt that we can't pay already? I have a solution....we don't pay.... massive boycott in order. Then we start over.(New Game). Come on greatest generation take one for the team.
Thanks,
Econ 101
Posted by: Economics 101 | Sep 16, 2008 11:32:45 PM
if you want to shoot a politican to blame for this mess look no further than our esteemed chairman of the finance services committee barney frank.
Posted by: Richard | Sep 16, 2008 11:37:36 PM
Per Barringo:
"4) Moral Hazard, successful[ly] avoided in the Lehman Brothers bankruptcy, was mostly put aside" (end quote)
--
I can only agree in a hybrid sense because of two aspects.
Some of Lehman's moral hazard may (may, I said) have transferred to Merrill, if Roubini's intuition is on target. He's speculated about a possible Fed/Treas wink-wink given to the BoA/Merrill deal. I can't find it now but he told it to Blodget on TT recently.
And, too, I doubt the AIG shareholders would consider that they've avoided moral hazard in this, another, conservatorship. They are likely to get their other 20% equity clocked as well, if very many of
AIG's CDSs come home to roost.
--
More/to all:
I've shared in the criticism when appropriate for both Benber N. Anke and Sec Paulson...
...but you all had better be thankful to your Lucky Stars that we have these skillful and articulate men in these times. I'm not excluding Sheila Bair at FDIC from the class either and other leaders in government that don't have blinders on about the reality of a situation that they didn't make.
It's pungently possible that a BK of AIG could've triggered a total commercial paper lock-up. Even though this government action in private markets is distasteful to me personally, such a lock-up would've led to a money market mutual fund "holiday" of at least a whole business day... and possibly as long as a week or more.
That would've been the functional e-q-u-i-v-a-l-e-n-t of the bank run/crash "holiday" of the Great Depression era -- What would that mean?... Well, your credit cards wouldn't clear at the check-out counter. Your payroll checks to employees start to bounce. You can't close on a house in good federal funds (green cash equivalents)... contracts get broken... consumers can't clear checks for groceries, gas, vacations, etc. Even the affluent would be at least temporarily caught short of cash.
It would be an ugly total collapse of our economic payment system that might echo for months and months, even for a decade or more.
Why?... Because we are lucky enough now to have FDIC insured deposits to hold the hinges on the doors at the banks... but, except for pure-blooded U.S. Gov Securities-based money market mutual funds, the great majority of mm mfs aren't insured by anything other than private insurance, if that... and that insurance was never intended to provide protection against a system-wide commercial paper lock-up... and thus mm mfs could've easily suffered emotionally driven "bank runs" in stratospheric proportions.
I'll suffer a little moral hazard leakage if it might prevent such as I've described.
Posted by: Eclectic | Sep 16, 2008 11:39:27 PM
The secret is to get "too big to fail". I was already on that road and my heart almost failed. Could the same thing be happening to our country? Are we losing heart?
Posted by: Bryan B | Sep 16, 2008 11:41:11 PM
If it was only a liquidity issue, then why didn't any of the privates come through with a deal for 11+% loan?
Somebody suspects they have a solvency issue.
Posted by: JP | Sep 16, 2008 11:44:05 PM
I (presume to) understand it was under the banner of pragmatism/necessity that this deal is struck, but finishing off the hat trick begun yesterday - especially after taking the hard line against enabling further moral hazard...or was it? - with this piece of work seems like sheer bravado. How many more corporations will the U.S. government "incidentally" nationalize?
Posted by: Andrewunknown | Sep 16, 2008 11:44:55 PM
the real question is now who is next. Hedge fund guys had figured out a great way to make some profit.
1. short the stock of a big company
2. make the headlines with the company
3. sell it to Paulson
:) very nice
the government also made some good money on this liquidity issue.
They bought 2.152B shares ( 80% of AIG equity) for $85B which is about $39/share.
I think in a couple of years they could easily sell the company for $40-45.
It seems that everyone is happy right now. The only question is who is next? Goldman/Morgan? Citi? WaMu? Wachovia ?
Show must go on !
Posted by: Igor | Sep 16, 2008 11:45:39 PM
