Monday, November 10, 2008

AIG Government Bailout Take Two

Apparently, AIG needed more than just a temporary $85-$125 billion loan to dispose of some assets, raise some cash, and go about its merry way organizing motivational corporate retreats for all of its "high performers."  The severity of the insurer's dire straits was revealed this morning when it posted a record loss of $24.5 billion or $9.05 a share, thus stealing the title of King-of-largest-quarterly-loss-ever from Wachovia.  These losses should not have been a surprise to anyone who was wondering why the hell a perfectly solvent institution  would require over $100 billion in loans to remain in business.       

AIG's earnings announcement came with the assurance of a new and improved government bailout.  The old bailout will be replaced with an extremely complicated rescue package valued at $150 billion.  The more complicated the better, as it allows the government to buy some time by claiming that this time the rescue package is going to work and nobody will be any wiser until the next bailout package is introduced.  The new package reduces the $85 billion loan from the Fed to $60 billion, injects $40 billion into the company in return for preferred shares, and purchases $52.5 billion of mortgage securities.  This package is certainly better, for AIG, not the government, as it removes risk from AIG and transfers it directly to the taxpayer.  However, if you had already figured out that AIG was toast and the government was going to wind up owning all the crappy collateral anyway, then really this is just a reshuffling and reclassification of the money.  The $40 billion in preferred and $52.5 billion in purchases are now "investments" and not just "loans secured by collateral."  The press release states that $40 billion of the TARP is being utilized for the preferred investment, but I believe that is actually misleading.  The $52.5 billion used to purchase mortgage securities is what, exactly?  Where is that money coming from if not the TARP?  The Bloomberg story quotes a boob analyst with: "This gives AIG much more breathing room.  Now they have the time and flexibility to sell assets to closer to the intrinsic value rather than at fire-sale prices."  Here we go again with the "fire-sale prices" rhetoric.  What if the truth is that AIG had completely mispriced all of its assets at artificially high prices and that today's asset prices are the real deal? 

The earnings report has a few interesting tidbits indicating where all the money has gone.  The insurer booked $7.5 billion in writedowns on CDS and marked other holdings down by $18.3 billion.  AIG's securities lending program accounted for $11.7 billion of the $18.3 billion in impaired investments.  The credit default swap issues are widely known and have been the main focus of the media reports of AIG's problems.  However, the fact that AIG lost $11.7 billion in its securities lending business is, frankly, astonishing.  Securities lending is not based on some sort of fancy derivatives scheme.  It is a really simple business that requires borrowing and lending money and making a small spread on the difference in interest rates.  AIG apparently became greedy and used the money raised from lending out securities to purchase highly illiquid MBS to make a couple extra basis points and wound up losing $11.7 billion in one quarter.  This is a disastrous number that confirms that this company had absolutely no risk management department.  Furthermore, I have to wonder how many other insurers were engaged in the same business of securities lending that are suffering similar losses.  Is enough money left in the TARP to save them all?    


Anonymous said...

All this good money thrown after bad is pretty outrageous. I wonder if it will ever end?

Jason said...

The AIG bailout means nothing to the Fed. The Fed is transparent in that it is subject to the oversight of
Congress. Is twice a year not fast enough? The intent of Congress in shaping the Federal Reserve Act was to keep politics out of monetary policy. Legislation requires that the Federal Reserve reports annually on its activities to the Speaker of the House of Representatives.