Fed Bails Out AIG With $85 Billion Loan

Not to be outdone by Treasury Secretary Hank Paulson's Fannie and Freddie rescue operation, Bernanke stepped up to the plate to try his hand at a takeover of a failing financial institution.  AIG will receive an $85 billion two year loan from the government, who will take a 79.9% equity stake in the company.  The plan is suspiciously similar to the Treasury's promise to inject preferred equity into Fannie and Freddie in return for a 79.9% equity stake announced a little over a week ago.  Here I was hoping for something creative and unfamiliar.  But no, it's the same old government bailout plan.  If you're concerned about your tax payments financing an $85 billion loan to a highly leveraged financial firm that went from only needing $15 billion to desperately pleading for $85 billion in the span of about 3 trading days, fear not.  The taxpayers will be protected, the Fed said, because the loan is backed by the assets of AIG and its subsidiaries.  Correct me if I'm wrong but those assets seem to be underperforming.  Anyone who is amazed at how rapidly the firm kept recalculating the cash necessary to stay afloat just learned a valuable lesson in finance.  The official term used in derivatives trading circles is a "blowout."  Selling volatility seems like a nice easy way to collect premiums and produce a deceptively steady income, until you have a blowout.  That is when an extremely unlikely event causes you to lose all of your capital in one fell swoop.  If you've ever traded on an options trading floor, you'd hear this term used occasionally in the following way:

Trader #1:  Dude, where's Mack today?

Trader #2:  What, you didn't hear?  He blew out.

Trader #1:  No way! On what?

Trader #2:  Sold too many of those Lehman 15 puts at a 500 vol.  He thought they were juicy.

Trader #1  Dude, that's too bad.  I just thought you meant he ate some bad sushi.

AIG just had the mother of all derivatives blowouts.  The Fed thought the blowout was so bad that it would inevitably lead to catastrophic losses in the already battered capital markets if it let AIG fail.  Money from the private sector was not forthcoming so it was either a government bailout or a bankruptcy filing.  So, my fellow taxpayers, thanks to Hank Paulson, we're in the mortgage finance business.  But thanks to Ben Bernanke, we are now all derivatives traders.