Bailout Datapoint of the Day, AIG Edition

Remember the $85 billion loan that the US government extended to AIG? It turns out the insurer really needed that much money after all:

The firm tapped about $61 billion of the federal credit line after saying Sept. 16 it would give the U.S. a 79.9 percent stake in exchange for the loan.

$61 billion is an enormous amount of money to borrow in the space of a couple of weeks, especially when it's being extended at highly punitive rates: Libor +850bp works out at 12.83%, given today's Libor fix at 4.33%. (Your daily TED update: an awe-inspiring 381bp.)

I have to admit I'm a bit unclear on what exactly they need the $61 billion for: I thought the CDS written by AIG Financial Products were the sort of instruments where you only needed to pay out in the event of a default. Did AIG write a lot of protection on WaMu? But maybe there were separate margin/collateral agreements too.

In any event, AIG has decided to reinvent itself as a property-and-casualty shop, selling off almost all its other businesses. The world will probably never see its like again.

Comments

[Research123:]

I though ther terms of the bail out required AIG to pay interest on the $85B even if they didn't draw it down. Thsu they woudl be stupid not to draw it an invest it to try to at least break even.

2008 Oct 03 01:29 PM

[jmorace:]

How's AIG debt lookin? Afterall, they have that credit line and the gov has 80 percent of the stock, plus they are too big to fail..... (Ahem...) I wonder if the distressed senior debt is okay.... any ideas?

JMorace

2008 Oct 04 11:49 AM

[rogerk2:]

Part of the problem is that none of the insurance companies were prepared for the 100-year storm. They could handle one Katrina, but not six in the same year.

That's how the financial system collapse hit AIG and others insuring counterparty risks. If one company fails, the insurance reserves are sufficient to pay off counterparties who took out insurance. If 100 companies fail at the same time, there's not enough reserves available to cover all the counterparties' policies simultaneously.

If you owned a house in Florida and Katrina destroyed it, you're still on the hook for the morgage. You probably had mortgage insurance to cover such a loss. But if your insurance company also insured thousands of other homes that got destroyed, overrunning it's financial capabilities and causing it to go belly up, your insurance is worthless. And you're still on the hook for the mortgage, on a now non-existant house.

Insurance is a necessary evil to protect against unforseen events, but no company carries enough reserves to cover really major catastrophies...6 Katrinas in a year, a major earthquake along the San Andreas fault in California, a nuclear war, a meteor impact, etc. We all know these events are going to happen sooner or later, but we're not willing to pay the upfront cost to build a reserve large enough to insure against them.

2008 Oct 04 03:30 PM

[ddavid:]

What I learned today its not the fact that AIG is has to cover the actual value of the underlying CDS, but that hedge funds tripled the insurance protection against the CDS in case of failure. That like insuring your house 3 times its replacement cost.
Just a note to pass on, if true ?

2008 Oct 16 07:31 PM