AIG: Hardly a 'Bailout', Absolutely Necessary

There was a lot of uproar back in March when the Fed arranged the deal for JPMorgan (JPM) to buy troubled investment bank Bear Sterns. The deal, which pissed off a lot of taxpayers, put up 30 billion taxpayer dollars to cover Bear’s risky investments losses.

More recently the Fed moved to bail out mortgage purchaser and guarantors Fannie Mae (FNM) and Freddie Mac (FRE) – yet let the fourth largest investment bank in the country, Lehman Brothers (LEH), fail. Now the Fed has arranged a two year, 85 billion dollar loan (of taxpayer money) to American International Group (AIG).

My opinion: This loan was absolutely necessary and anyone who wants to complain about how the government is “privatizing gains and socializing losses” should first look at the terms of the deal and then look at what would have happened if AIG went bust.

The Terms of the Deal - Hardly a Bailout

AIG will receive up to $85 billion from the Federal Reserve Bank of New York. The funds are being lent at LIBOR plus 850 basis points (not very favorable loan terms from the viewpoint of the borrower). The Fed is also getting a controlling 79.9 percent of AIG’s equity interest, and will have the right to veto the payment of dividends to common and preferred shareholders. The deal will give AIG time to sell some assets, while still remaining solvent.

If AIG Had Gone Bust

I am certain there would be international financial bedlam. AIG is the world’s largest insurer by far, and has a very integral CDS (credit default swap) business. Without AIG we would see the credit markets seizing up worse than Caesar in Act I scene ii. With that tightening credit would have come a wave of investment bank defaults. Eventually the mayhem on Wall Street would have spilled over to Main Street and who knows where the trouble would end. If AIG had failed, I don’t think it is unreasonable to think that the US and perhaps even the world, could have entered into a multi-year long economic downturn.

In conclusion, I am more than satisfied with the bailout; the terms were reasonable, and the steps taken were necessary.

Disclosure: Long AIG

Comments

[eternitus:]

Reasonable? If not for a Bear Raid, there would have been no downgrades and no capital needs. The company has $80 billion in equity and generates $8 billion a quarter in cash flow. It would have to have an $8 billion loss 10 more times to get to the same position of insolvency that FNM and FRE had. The government is expropriating long-term value from the shareholders and solidifying a hatchet-job by shorts.

Lender of last resort? Try Mobster of last resort. This is a Tony Soprano deal... the government will make $100 billion on this.

2008 Sep 17 09:15 AM

[Dan Hartzell:]

Bailouts can be good. With a controling interest, maybe the government can push management to make some tough decisions. If so, AIG will survive and not at the cost of the taxpayers.

2008 Sep 17 09:21 AM

[Carl Spackler:]

Satisfied with the bailout? What a joke. An astonishing $85B of our tax dollars is going to help prop up a financial company that does 65% of its business overseas. In addition, 65% of those worthless CDS's AIG wrote are in the hands of overseas banks and governments. So our money is being used to make sure some Chinese or European D**khead gets his money. It sucks - plain and simple! We should have let this one go down, but the Fed is so cozy with the Chinese. No, we cannot have them mad at us, so lets reassure them that we will cover the bill. It reaks!

2008 Sep 17 09:24 AM

[venividivici:]

I agree with you entirely. I think these terms are very tough and necessary to protect America's reputation overseas. America needs, what is it, $2 to $3 billion dollars of foreign money every day of the year just to get by. If you want that flow of money to continue, boy oh boy, you better protect their interests when things go pear shaped. And you better get used to it because that's what happens when you are hopelessly in debt.

2008 Sep 17 10:39 AM

[Amerlafrance:]

I agree with eternitus; this is a taking by the government; Chapter 11 could have deferred the short term capital needs and allowed a restructuring that allowed the shareholders to receive the value of the equity. The printing presses are being used to steal the shareholders' equity; whay a warrant with an oversecured loan (accoring to the fed guy) that is paying north of 11%. Why should the government be allowed to bypass the normal resolution for cash flow issues and extort value from the shareholders? I guess we can all now get discounted health insurance once Congress starts dictating the business that AIG will write in the future.

2008 Sep 17 11:24 AM

[RK:]

AIG did not have to accept the government's term if it had an alternative, one would think. Given the high interest rate AIG accepted, the deal was the last resort. What I don't understand was why AIG did not choose chapter 11. Did the company not do it because of the greater good? Hard to imagine.

2008 Sep 17 08:03 PM