Why Bail Out AIG's Bondholders?

Much as the prospect of an AIG (AIG) bankrupcy terrifies me, I'm not a fan of an $85 billion government bailout either. Bond investors have already taken enormous mark-to-market losses on their AIG paper; if they realized just a fraction of those losses, that would provide AIG with a huge proportion of its needed capital right there. Instead, it seems that they're being bailed out.

AIG has about $190 billion in debt outstanding, which has a market value of about $65 billion. So conceptually it should be possible for someone to buy that debt for $100 billion, forgive the $75 billion of new capital that AIG needs, and still end up $15 billion ahead. AIG would be solvent again since its liabilities would have shrunk by $75 billion; its bond investors would make a mark-to-market profit of 50% on where their bonds are trading right now; and the white knight with the $100 billion would make a tidy profit to boot, so long as the remaining bonds were worth more than 87 cents on the dollar, which they would be.

Instead, the proposed bailout, far from reducing AIG's liabilities, seems to comprise increasing them by another $85 billion. It also seems to leave all existing bondholders with a haircut of precisely zero -- effectively trebling the value of their bonds overnight.

Why should holdco creditors get back 100 cents on the dollar after making such a dreadful investment? They shouldn't. There's a strong case for bailing out policyholders, or people who bought financial insurance (credit default swaps) from AIG. The case for bailing out those who lent to AIG directly, however, is much weaker.

Comments

[levin70:]

felix, what is it about being the senior secured lender don't you understand? From the text of the fed announcement, the gov't is receiving a senior secured pledge of all the parent assets and the stock in the underlying insurance subs. The loan gets repaid first over the next 24 months and the bondholders will get what's left after that. Not only that but the gov't is getting libor plus 850 - not too shabby

Regards

2008 Sep 16 10:11 PM

[bowonwing:]

Buffet looked into buying AIG and walked away. We all know Buffet would have loved to have bought AIG, right up his alley.
Ergo, there must be some very toxic waste at AIG.
Why was the Fed (excuse me, the U.S. taxpayer) the only entity who would loan AIG the $85B!!
IMO, AIG will follow FNM and FRE to penny land. Sad but true.

My prayers go out to all AIG employees, except executive management, and LEH. Ten of thousands losing their jobs, and perhaps their savings.

2008 Sep 16 10:47 PM

[The-Honest-...:]

Finally lucid comments about the AIG bailout...

Bondholders should have lost their money.

2008 Sep 16 11:58 PM

[sohony:]

paulson's remit is to look after his pals on wall street.

that's fine i guess but is there anyone out there whose remit is to look after the US taxpayer.

i'm not feeling very looked after right now.

paulson is not an elected representative so by US tradition he can look after his own personal interests, bail out his pals and represent the lobbyists who throw money at the republican party.

but where are our elected representatives in all of this?

oops i guess they've been paid off (see the above), isn't that how they raised the funds to get elected in the first place?

just one question: how many trillions will paulson and bernanke be able to give away to their pals on wall street before foreigners loss of confidence in the $, the treasury bond and the US balance sheet creates the huge sucking sound of dollar decline and interest rate expansion.

how rapidly and to what level will US debt be downgraded?

seekingalpha.com/artic...

look out below.

and oh yes, are there enough lobbying $s to pay off china, japan et al and convince them to keep buying our treasuries.....?

or do we have a better idea than bribing government decision makers to keep wall street afloat?

prey tell.....

2008 Sep 16 11:58 PM

[Minawi:]

Does those $85 billion have +interest attached to it or it is The Tax Payer job to pay The Interest?

Yes, sohony, what a Pals. lol a friend in need is a friend indeed.

2008 Sep 17 12:40 AM

[The-Honest-...:]

Bill Gross might have some AIG bonds in his funds lol.

2008 Sep 17 01:47 AM

[Charles Jan...:]

AIG is not just any insurance company. It is a major expansion of US financial might around the globe, especially E. Asia. Plus, it owns the ports facilities of the US that the Dubai firm was forced to sell.

www.usatoday.com/money...

AIG unit to buy Dubai company's U.S. ports
Updated 12/12/2006 12:53 AM ET E-mail | Save | Print | Subscribe to stories like this
DUBAI (Reuters) — State-owned Dubai Ports World said on Monday that it had agreed to sell its U.S. port operations to an American International Group unit after relinquishing control to allay concerns about U.S. national security.

DP World will conclude its deal with AIG Global Investment Group in the first quarter, the Gulf Arab company's chief executive, Mohammad Sharaf, told Reuters. He declined to give a value for the deal.

DP World took over facilities at six major U.S. ports when it acquired Britain's Peninsular & Oriental Steam Navigation for $6.8 billion in February, becoming the world's third-largest container port operator.

"We have reached a deal covering 100% of the U.S. assets," Sharaf said Monday. "It will be a cash deal."

Jamal Majid Bin Thaniah, group chief executive of Dubai Ports and Jebel Ali Free Zone Authority, which includes DP World, in October told U.K. publication Lloyd's List that the company expected the winning bid price to exceed $700 million, or about 10% of the price it paid for P&O.

AIG declined to comment on the price it had agree to pay for P&O's U.S. port business.

Publicly traded U.S. companies are bound to reveal the price of acquisitions if they are deemed material, or significant to the company's capital base.

AIG Global Investment Group, part of American International Group, the world's largest insurer, has more than $635 billion in assets.

AIG would not come under disclosure requirements if the price is about $700 million, as it would for larger purchases.

AIG Global Investment Group has a track record of investments in various infrastructure businesses, including power, waste and water operations, it said.

DP World agreed to sell its P&O facilities in New York, New Jersey, Philadelphia, Baltimore, Miami, Tampa and New Orleans after U.S. lawmakers threatened to block the company, saying they feared giving a state-owned Arab company control of U.S. port terminals would pose a threat to national security.

With a political firestorm threatening to become a diplomatic crisis, DP World announced it would sell P&O's U.S. assets at the behest of Dubai's ruler and hold them separately until a suitable buyer could be found. Those arrangements would remain in place until the deal was completed and cleared by regulators, Sharaf said.

The forced capitulation of a government-controlled company in the United Arab Emirates, a U.S. ally and frequent port of call for American warships, reinforced Arab concerns that their U.S. assets could be targeted for security reasons.

Some Arab investors said at the time the uproar smacked of racism.

U.S. critics of the deal, including Democrats and members of President Bush's Republican Party, note that two of the Sept. 11 hijackers came from the UAE and that the country once recognized the Taliban government in Afghanistan.
Copyright 2006 Reuters Limited. Click for Restrictions.
Posted 12/11/2006 9:51 AM ET

2008 Sep 20 11:16 PM