Reporting and commentary on the AIG bailout has generally been low on details and all over the map on interpretation. Here’s what I’ve managed to piece together:
- The Fed is giving AIG a credit card with an $85 billion limit, complete with credit-card level interest rates (currently 12%, indexed to market interest rates). AIG will use this to ensure they can continue making payments on their other liabilities in the short term.
- The Fed line of credit is collateralized by AIG’s full assets. This means that if AIG is forced into bankruptcy despite the bailout, the Fed will get paid before AIG’s bondholders.
- The Fed does not own any AIG stock, but has warrants (similar to stock options) on just under 80%, meaning that the Fed not can buy 80% of AIG at a fixed price. I cannot find what that price is.
AIG may or may not be fundamentally solvent. AIG has huge assets and huge liabilities which nobody is quite sure what the correct price for is anymore. They needed the bailout because they have liabilities coming due today which they weren’t able to raise cash to cover. The Fed line of credit lets them pay their current liabilities and gives them time to rearrange their finances in hopes of being able to cover future rounds of liabilities with their assets.
Time will tell whether AIG is fundamentally solvent or not (i.e. are their long-term assets and cash flow from operations enough to cover their long-term liabilities). If they are, the Fed will get paid back with interest and will be in a position to claim 80% of the shareholders’ residual. If they aren’t, they’ll declare bankruptcy and liquidate their assets, the Fed will still get paid back, and AIG’s collapse will happen in a better-understood and more controlled manner which is less likely to destablize other companies than if they’d collapsed today.
AIG’s shareholders are not getting bailed out. At best, they just lost 80% of their assets to the Fed.
AIG bondholders are getting bailed out somewhat, as AIG now has a chance to pay bondholders back in full. But only if AIG is fundamentally solvent. If it isn’t, then bondholders will be taking a bigger haircut than without the bailout because they now have to stand in line behind the Fed.
The real beneficiaries of the bailout are AIG’s counterparties — companies and investors to whom AIG has contractual obligations (most significantly credit default swaps — essentially insurance for bondholders against the possibility that their creditors won’t pay their debts). These are the people we *want* to bail out, because they behaved responsibly by buying insurance for their risky assets from an apparently solid insurer, and because it is the possibility of AIG defaulting on its counterparties which holds the biggest risk of a cascading failure wrecking a big chunk of the financial system.
This seems like an all-around good deal, in that the Fed (and thus taxpayers) seem to be covered no matter what, the risk of a cascading failure is minimized, and moral hazard is limited to the people whom its least reasonable to hold responsible for AIG’s failure (the shareholders, who are most responsible, take an 80-100% loss; while the counterparties, who are least responsible, get paid back in full).
It seems like such a good deal, in fact, that I’m wondering why no private company made it. Granted, $85 billion is a lot of money, but there are a number of companies and institutions with tens of billions of dollars, and for a large enough profit opportunity it should be possible to piece together a conglomerate (for example, Berkshire Hathaway, Microsoft, and General Electric have enough cash on hand between them to offer a similar line of credit). What am I missing?
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Pretty much. Shareholders and, potentially, taxpayers have been put on the hook on behalf of bondholders. As you might expect the shareholders are not amused and the taxpayers haven’t much noticed.
I’d never thought of Uncle Sam as a corporate raider but that might well be how things turnout. Not only with he (we) get LIBOR+5% on whatever amount of the credit line that AIG draws on but AIG’s hard assets might well cover the whole amount plus.
I read that one company did, in fact, offer AIG a bailout of $85 billion, but the terms they were asking were considered too onerous by AIG. AIG thought it could do better with a government loan on the principle that it was ‘too big to fail’.
Perhaps it was too big to fail, but the terms it got from the government were far harsher than the one’s it had rejected.
BTW, the assets of AIG are valued over a trillion dollars, so I think if it comes to a fire sale, the USG will be able to recroup its loan. AIG fell because of a liquidity problem, not a value problem.
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One of the connecting threads in the recent crop of failures is that the CEO’s have preferred going after bailouts or letting their companies fail rather than take responsibility for the terms they’d need to agree to to save their companies. Another piece of evidence supporting the notion that entrepeneurship is dead.
Apparently, AIG signed a 4 year, $100 million sponsorship deal with Manchester United, an English professional soccer team. So, Now the US Government, and all of us as tax payers, are sponsors of Manchester United. Go Team!
"Another piece of evidence supporting the notion that entrepeneurship is dead."
Among the management of trillion-dollar companies? I was never aware that it lived there.
These are the people we *want* to bail out, because they behaved responsibly by buying insurance for their risky assets from an apparently solid insurer, and because it is the possibility of AIG defaulting on its counterparties which holds the biggest risk of a cascading failure wrecking a big chunk of the financial system.
The second half of that I agree with, in the sense that we think "have to" bail them out to avoid economic catastrophe. The first half I couldn’t disagree with more.
They didn’t behave responsibly, and this is why we now have disastrous consequences from a housing downtown that we’ve experienced before in this country without such calamity. The CDS phenomenon obscured the risk inherent in these investments, and induced the markets to collectively ignore the risks.
Risk is one of the "natural" regulators of markets. Without that being operative, governmental regulation is needed. Â
If we could figure out a way to allow the CDS buyers and sellers to fail without causing a depression, that would be the best outcome.
To the contrary, if CDS were priced appropriately, they would reflect the risks in the bonds insured. A CDS buyer thus would pay the average cost of default every time, rather than the full cost of default if and when it happens. That thus makes the default risk explicit in every single income statement. It’s like how people with bad driving records pay higher car insurance rates.
The problem is that AIG didn’t price CDSs appropriately (they vastly underestimated the risk of a downturn in housing prices), and (without the ability to borrow against its assets) finds itself unable to pay the insurance policies it sold.
In principle, the counterparties do bear some blame for not realizing the CDSs were underpriced and AIG was at risk of not being able to pay as agreed in a situation like this one. But they bear far less blame than AIG’s shareholders (who hired the management that underpriced the CDSs) and thus the cost should fall first on the shareholders.
To the contrary, if CDS were priced appropriately,
And of course, if Pigs had Wings. . .
I don’t have any problem with the counterparties getting what they can from AIG, but you said "These are the people <b>we</b> *want* to bail out". Sorry, these are speculators willingly incurring risks, and they need to eat it if AIG is insolvent.
Now there is apparently talk of the govt taking over tons of bad debt from companies that are still in business. What happened to all the free market cheerleaders? Are they vactioning this month?If the govt can do this, I’m not sure what can possibly be off the table in terms of govt involvement in the market and economy.Â
And folks who wanted to privatize Social Security can take a break for the next 50 years or so. Times like these are exactly why SS is a govt program.
If I was a conservative opposed to some sort of socialized medicine, I think I would be in despair about now. Most of the arguments about govt screwing things up just lost their sting.
The counterparties are beneficiaries of an insurance policy. They took specific reasonable steps to *avoid* risk. That’s the opposite of being speculators willingly incurring risks.
If AIG clearly didn’t have enough assets to cover the counterparties, you’d have a point that the counterparties should have seen it coming. But all appearences are that with the bailout package to smooth out AIG’s dissolution, there will be plenty of money for the counterparties and for the Fed. Most or all of the bondholders will get paid back, too, and there may even be money left over for the shareholders (of which the Fed will take an additional pound of flesh, to punish AIG for not accepting an earlier bailout package offered by private firms).
As for the trial balloon about the government taking over bad debts on a large scale, I’m not familiar with the details, but I’m pretty sure I’m against it.
How does this take Social Security privatization off the table for the next 50 years? I just checked my 401(k), and it seems to be doing fine, despite me owning AIG stock (indirectly, through an S&P 500 index fund).
The counterparties are beneficiaries of an insurance policy. They took specific reasonable steps to *avoid* risk. That’s the opposite of being speculators willingly incurring risks.
The steps were hardly "reasonable" if they wanted to avoid risk. That’s why we have a global financial panic going on. That’s why no group of private corporations wanted to put up $85 billion. These weren’t "insurance policies" as the term is conventionally used.Â
We tell every Tom, Dick and Harry that if it sounds too good to be true, it probably is. I feel comfortable applying that same logic to finacial firms as well.
If the assets are really there in AIG, then letting it fail was the free market answer. But the financial markets clearly don’t think that is the case, and why they feared cascading writedowns, and bankruptcies. Now, it is possible the assets are there. But it is hard to know, because the whole CDS matter is unregulated, and not transparent. Nobody really knows. Another reason the counterparties actions were not responsible efforts to avoid risk.
To call the govt’s plans a "trial balloon" is to understate what is going on. It is pretty much a done deal, with about the only thing to be decided is what other goodies are gonna be in the legislative package. This is a pretty comprehensive plan to bail out large investors from their risky investments.Â
As for SS, how long did it take from the Great Depression for there to be a sufficient number of voters to seriously consider privatization? Your 401K may be doing fine, but where would it be it the govt hadn’t involved itself in this mess? The claim being made by Paulson, Bernanke et al was the probability of a Depression like global financial meltdown.Â
The voters are hearing that. People don’t oppose 401K’s and IRA’s. But fear is a more powerful motivator than greed (see the current behavior of global markets) and they want that SS floor underneath their other financial plans.  Â
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