Why AIG Had to Be Nationalized

Chris Kaufman uses the example of AIG as a reason not to nationalize:

If voices of wisdom aren't enough for skeptics, the example of AIG may be. AIG is not a bank, but it faces a lot of the same problems that banks do. And nationalization has done little to help the insurer, which has been losing bailout dollars with dizzying speed, and is seeking more cash from the U.S.

I'm not sure I understand this. The losses exist. They will have to be taken by some combination of bondholders, shareholders, and taxpayers -- plus, conceivably, depositors (in the case of banks) or policyholders (in the case of insurers). It's possible that the efficiencies and strictures of private ownership might, at the margin, reduce the magnitude of the losses -- although the recent history of Wall Street gives us no real reason to believe that to be the case. But even if the losses are reduced, they're still enormous.

There is no doubt that, absent nationalization, AIG would be bankrupt by now. And the systemic consequences of an AIG bankruptcy would have made Lehman look like a walk in the park. For starters, Wall Street would be in much worse shape than it's in right now, since AIG Financial Products insured hundreds of billions of dollars of assets on banks' balance sheets, and has been putting up precious magin as the value of those assets has continued to decline.

On top of that, AIG's bonds would be largely worthless at this point, and the write-downs on those bonds would have caused another few hundred billion dollars in wealth destruction at precisely the financial entities which most need healthy assets.

And most importantly, the failure of AIG would probably have caused what the failure of Lehman brothers didn't -- a catastrophic cascade of counterparty failures in the multi-trillion-dollar CDS market, from which the global financial system might never have been able to recover.

Against all that, we have some very large and painful losses for the US taxpayer, which will never fully recover the money it's put into AIG. But compared to the alternative, we're all much better off.

Comments

[User 363972:]

Come on, don't keep handing us "the nonsense". Are you telling us that AIG's worthless insurance is all that's keeping the banks from failing? If that's the case then the banks have already failed, and should be "gracefully" liquidated. Only the government would waste tax payer dollars investing in bankrupt entities. Even Lenin must be laughing his axx off.

Feb 25 08:09 AM

[Rigged:]

What if AIG proposed the following? Wouldn't this be better than nationalization for tax payers?

- Govt. would buy some of AIG assets at fair market value (non distressed valuation...it could be based on profits/cash flow/revenues, etc.)

- In exchange Govt would reduce the loan that AIG owes to the Govt by the amount that the Govt is paying for the assets. Govt. would realized any appreciation in its share of the assets if and when it can be resold to third parties (via regular sale for IPOs).

- In effect, Govt would be buyer for the assets that AIG is selling and paying it with the existing Govt loan to AIG.

Example, AIA Asset (Asia Life).

- AIG value this at $20B to $40B. Lets say fair valuation (non distresed is $30B).

- AIG sells 49% to Govt. at $15B. The principal of the loan from Govt to AIG would be reduced by this $15B amount.

- Govt. would get 49% of the earnings from AIA moving forward.

- Govt. could sell this 49% stake at a later time if market conditions improve.

- AIG and Govt could decide to IPO AIA and Govt would get its 49% back through the IPO.

How this would help AIG? It would be similar to AIG selling AIAI to a third party at a fair valuation and paying back the Govt.

How this would help Govt? Govt. would now owe 40% of a profitable business with earnings. Govt. gets paid back on the loan. There is potential for appreciation in asset value or at a minimum the asset would still have a positive valuation . Govt's liability would be reduced by $15B (example used for AIA).

Without doing it this way, Govt may never get paid back. At least this way the Govt gets its hand on the profitable assets.

Feb 25 08:20 AM

[User 363986:]

Until they take down AIG the whole insurance market will continue to falter. Let creative destruction heal the Insurance segment by letting the business flow to more the sound companies.

Feb 25 08:24 AM

[I weep for ...:]

Rigged. I think what you stated is the plan.

Feb 25 10:04 AM

[Roger Knights:]

Felix is right--the only alternative to propping up and stabilizing the financial house of cards is letting it tumble down on our heads. But if Bernanke & Co. were to say that (to justify their policies), it WOULD tumble down on our heads. (Imagine what they're saying to one another privately!)

Feb 25 11:22 AM

[Bill Jencks:]

There is a fairly simple reason why AIG had to be saved. China has bought billions of Treasuries from the US - and a large chunk of these were 'insured" and guaranteed by AIG using complex instruments like CDS etc. If AIG had fallen, China would have been hit by the nasty consequences. And since China is propping up America's debt, well I think you get the point.

That's why AIG really had to be saved.

Feb 25 11:45 AM

[henarl:]

When an AIG CDS is more of an insurance for China on their treasuries that the U.S. governments guarantee of repayment, then the financial world has been turned upside down. Why would anyone consider a CDS to be more solid than the underlying asset ??? Aren't treasuries still treasuries even if the CDS "insurance" becomes worthless?

Feb 25 12:19 PM

[Teutonic Kn...:]

With the company's stock trading at ~ 40 cents, the entire equity of the company had already been virtually wiped out - they wouldn't need to pay pricey bankruptcy lawyer fees to go that route.

Was it better just to let it fall last year? No one can tell the outcome otherwise. I suspect if it were let to fall, the ensuing domino hellish financial fire ball would just engulf us all, and around the world.

Feb 25 08:35 PM