This is amazing. As I wrote the other evening, it is as if we are reading financial science fiction.
If the Federal Reserve Bank of New York plans to write an $85 billion check to AIG (NYSE:AIG), then Treasury market participants should duck for cover. They will likely raise the money by selling Treasury debt from the System Open Market Account. I have no idea how they would do that, but it would be the largest such sale of securities since the dawn of human history.
Why does the Federal Reserve not control 100 percent of the company? Capitalism punishes bad risk. These jokers took bad risk in spades, so they should be wiped out. The common shareholders should be left with nothing. If this was a good deal for the taxpayers, this would have been a private transaction. The very fact that the Fed is involved speaks loudly to us that no private company believes that this is a prudent loan.
Preferred shareholders? If the deal calls for making them whole, I ask why. There does not seem to be any reason to bail them out.
Bondholders? They should be forced to take a haircut. This is not FNMA (FNM) or Freddie Mac (FRE) issuing debt for 40 years with a wink from the Treasury Secretary and the implied backing of the Government. This was a completely private enterprise. AIG debt could have been purchased earlier today for cents on the dollar. To reward the holders of that debt truly creates a windfall profit.
The Federal Reserve is careening down a very slippery slope. The risks of that joyride are understandable and worthwhile if they exact a financial pound of flesh from those at AIG who so bungled their mission. On the surface, that does not appear to be the case here.
Update: The term of the loan is 24 months. The interest rate is three month Libor plus 850 basis points. The loan is collateralized by all the assets of AIG and its subsidiaries.
The taxpayers now own 79.9 percent of a gigantic insurance company.