Why Would Treasury Cut AIG's Interest Payment?

The WSJ's latest AIG story has set off Joe Wiesenthal's bullshit detector -- and mine, too. It's headlined "U.S. Weighs Options to Ease Strain on AIG", and it seems to be an attempt to jawbone Treasury into reducing the punitive rates at which it's lending to the troubled insurer.

But the stated reasons for Treasury doing such a thing don't make sense:

People close to the insurer complain that the terms of AIG's loans are onerous compared with the 5% interest charged by the government to banks and other financial institutions under the $700 billion Troubled Asset Relief Program.

AIG officials hope these factors will help persuade the government to change its loan terms, since the government would have the most to lose as both AIG's creditor and controlling shareholder.

The idea here is that if Treasury charges AIG a lower interest rate, then AIG will have more money left over for shareholders, and will be less likely to default on its obligations.

But as the sole reason why AIG hasn't gone bust, Treasury has no reason to let AIG's minority shareholders benefit from its largesse. And it doesn't really matter how much Treasury charges on its loans to AIG, since the money's just going around in circles anyway.

The fact is that the US government isn't going to lose anything as AIG's creditor, because the US government isn't going to let AIG default on its obligations. So long as you have an unlimited source of liquidity, you never need to default, no matter how insolvent you might be. So the US has no worries on the creditor front.

And the government is a very special kind of shareholder, because it's effectively getting a monster dividend in the form of high interest payments, which isn't available to AIG's other shareholders. Besides, the cost basis of the US goverment's shareholding is effectively zero, which means it can't lose money there, either.

So I'm having difficulty seeing any upside, as far as Treasury is concerned, in bringing down the interest rate it's charging AIG for its billions. Of course, if AIG can raise that sort of money elsewhere at a lower rate, then it should be able to do so -- but it can't. Treasury holds all the cards, here, so I do wonder why it's at all amenable to this idea.

Comments

[Arohan:]

Ah Felix, you are assuming that the government is interested in holding on to AIG for long! This doesn't make sense. I think they want to make it possible so the government is able to get out of this investment as quickly as possible, with profits, and with a stronger AIG in the wake

2008 Nov 07 02:15 PM

[not_disinte...:]

AIG cannot sell its business units in this market to pay off the loan, as the Fed and AIG expected. And no the Fed does not have an "unlimited source of equity" - all they have is a printing press, which if used in an "unlimited" fashion, can result only in "unlimited" inflation. So the Fed has to change terms or face AIG's bankruptcy, which taxpayers should rightly howl over in indignation

2008 Nov 07 02:52 PM

[AIGGUY:]

Confidence in AIG creates Confidence in the markets. The deal is a redo because the 1st deal thought there was a moral hazard to lending money to these institutions. At this point, there is no discussion of moral hazard, so AIG should have the same deal as the banks.

2008 Nov 07 04:33 PM

[Rigged:]

Lowering the interest rates will make AIG cash flow and financial looks better. This would then may result in some credit upgrades and remove the needs for collateral.

Your assumption that under the current model AIG is less likely to default is not correct. If it was, the credit agencies would not be downgrading AIG and is looking to do more downgrade. The credit agencies only see the terms of the $85B line-of-credit and they are looking the other way regarding your assumption that everything at AIG is backed by the the Govt.

You must agree that this loan at 8.5% + libor for drawn portions and 8.5% for undrawn portion is onerous and not consistent with any other Federal loans in place. Even if you go back to the old Chrysler bailout. Or if you look at FNN or FRE or what is offer under TARP.

If AIG financial and operating cash flows looks better, maybe it can raise capital on the open market (for its remaining 20%) and it will have more leverage in selling off assets to pay the Govt.

Its a win-win for the Fed and AIG shareholder if the $85B loan is under better terms. AIG market cap goes up because its a loan that AIG can realistically pays off. With AIG market cap going up the Govt.'s 80% shares goes up also.

2008 Nov 07 04:45 PM

[Duude:]

There is an inconsistency with the terms offered AIG versus Bear Stearns, versus Lehman Brothers versus the remaining banking institutions. I think I understand how the Treasury settled on the various terms, but the reasoning had more about timing than the health of the company. Additionally, Congress has already agreed to make loans to the Automobile industry at very favorable terms. How can we compare AIG's deal to that offered the automobile industry? Its conceivable AIG may survive with terms such as offered the automobile industry. But it isn't likely the automobile industry will survive without a continuous stream of cash infusions for as far as the eye can see. Their business model is broken and unlikely to be repaired as union members have an ally in the Congress, and the next administration.

2008 Nov 07 04:47 PM

[Rigged:]

In addition to my post above, I think that when the FED did the $85B line-of-credit, they wanted to look "tough" since they have just let Lehman go and everyone thought that their would be no more bailouts. After seeing the true effect of Lehman's bankruptcy and the FED deciced that they need to bail out AIG....but they need to show the public and taxpapers that its not really a bailout for AIG's as a company or for shareholders....hence the "tough" stance.

All that should be changed now since now the FED is bailing out everybody.

2008 Nov 07 04:59 PM

[Steven Hansen:]

the deal with AIG was brokered under duress and in hours. sit back now and analyze what has happened since. AIG is a healthy company apart from a bad business decision. they should be given better terms than the auto industry simply from a risk point of view.

what ignites my fire is the usury rates on credit cards. we are very close to a situation where a monopoly exists. try to get better credit cards terms - none exists now that BAC purchased MBNA.

2008 Nov 07 10:24 PM

[Tom Armistead:]

The series of decisions and actions on Bear Stearns, Lehman, AIG etc were not self consistent. The AIG deal was bad, the usurious loan and then the confiscatoin of 80% of the company. It destabilized the economy since it created a lot of fear and uncertainty about governments role.

I saw an interview today with Hank Greenberg, he makes a wonderful case for AIG being given the same terms as the banks. As a fellow shareholder, I think Hank has it right.

2008 Nov 07 10:48 PM

[Luis filipe:]

First, the terms of the loan aren't fair when compared with the big banks that only pay an interest of 5% to the FED. 8,5% plus Libor rate on $85 billion is close to $10 billion a year of payments to the FED, about 50% of the full year revenue.

If the FED doesn't change the terms of the loan or doesn't agree other kind of bail out, I suggest AIG to quickly pay every dollar to the FED, fill for bankrupcy and help destroy the financial system, then we will see if the terms of the FED change or don't, then we will see if the FED has all the interest in helping AIG.

2008 Nov 08 08:42 AM

[MichaelZZ:]

Felix,

Your thought processes are contaminated by the concept of greed.

Can you figure that one out???

LOL

2008 Nov 08 10:14 AM

[Loan Shark:]

Taking 80% of a publicly traded company without shareholder approval is illegal in the State of Delaware where AIG is Incorporated. There are at least 2 lawsuits that have just been fast tracked by Delaware Judges to deal with the issue. The entire AIG deal was a backroom GS deal because GS had the largest counterparty risk to AIG. AIG would have been better off going into BK..that would have given them time and protected them from the collateral calls.. But that could not be allowed since it would have crippled the global financial services system ..so a deal was agreed to.....but lets be honest the terms have changed at least 2 times since it was originally anounced so why not a 3rd time and make it fair.

The people really being hurt by the loss in share value of AIG are not the Wall Street fat cats...they made their money when the deals where being done...it is the poor average joes that had AIG in their 401k plan or their pension plan... the State of NY pension plan lost roughly $1.2 BILLION ... why should the deal with AIG be any different than that with the bank. AIG issue was a liquidity problem...if they would have been allowed to go to the Fed window they could have just borrowed the money that way. The original deal will not stand up in a court of law nor will does it pass the smell test of fairness....

2008 Nov 08 11:18 AM

[Rigged:]

If the deal (bailout) is restructured and AIG's stock price goes up to $10 per share (from $2s today). That means that Wall street likes the deal. AIG is more attractive to investors. With the FED still owing a large stake in AIG (TBD based on the restructured deal), how is this bad for the FED and tax papers?

2008 Nov 08 12:21 PM

[BerkeleyBob:]

I would not characterize AIG as a criminal enterprise from top to bottom, but by the same token, if Hank Greenberg has taken a hit on his large position in his shares, I have zero sympathy. He has zero credibility and is a thief, no better than the former head of Enron.

2008 Nov 08 04:58 PM