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February 3, 2010

The AIG Screw Up


I have been following the AIG crisis since day one, when Lehman Brothers fell, and I never expected this bailout to be going this bad this soon. However, once again, the federal government has exemplified why it should not cross the boundary into corporate financing and ownership. While the administration is touting that the banks paid back TARP (enough to punish them with a tax), they are hoping to overlook the error of AIG which will cost the taxpayer 10-fold to any TARP profits.


In case you fell asleep in August 2008 and just woke up, here is a brief history of the AIG crisis.

AIG made billions on credit default swaps, which basically was insurance against investments. An investor who bought stocks, bonds, or another type of assets could “insure” those investments so that if they failed, the investor could get some of his/her money back. In Sept 2008, Fannie, Freddie, and Lehman collapsed in less than two weeks throwing hundreds of billions into default. Investors who were wiped out began clamoring on the door of AIG for their insurance payouts. AIG, which itself lost money from the collapses of the institutions, found itself short on cash with $30, $45, $60, then $80 billion in immediate liabilities and growing by the hour.

As I recall, AIG was originally bailed out for $85 billion. Somehow, this number ended up swelling to close to $200 billion as more defaults on mortgage-backed securities and more investors came to AIG looking to cash their insurance policies. Analysts and others have argued that had AIG not been bailed out, a wave of bankruptcies would have swallowed the global financial markets.

A Long Line of Errors

First, the government bailed out AIG without any concessions from the struggling insurer. No bonuses were eliminated, no timelines or deadlines were set, no individuals were designated as accountable for certain tasks, and what’s worse- the bailout money was not earmarked, meaning that it could be used for anything.

Next, along the lines from above, AIG paid out it’s creditors at 100 cents on the dollar or 100% of what was owed. There were no negotiations with these creditors, no analysis, assessments, nothing. AIG just asked for X amount of dollars from the feds, got it, and paid off its debt in full. Why? I believe it is because it is easier to spend other peoples’ money. I tried to find another case where such a debt was settled at 100 cents on the dollar and could not find one.

It gets worse.

According to this Wall Street Journal article, $50 billion of the $180 billion went to European debtors. So now, US taxpayers are bailing out European firms as well as American firms? Why wasn’t any of this researched or disclosed PRIOR to the bailout? Reports suggest that as much as $90 Billion may have went overseas from the AIG bailout. Why don’t we have exact numbers? To add insult to injury, regulators will not disclose who AIG’s counterparties (party to the contract) are.

So, what would have happened if rational-minded individuals would have taken a step back to determine whether AIG should have been bailed out?

1) $50 to $90 billion would have been taken off the bill, since it was owed to foreign entities. Let European Central Banks bail out their own, we have enough problems here and we surely would not have expected another country’s central bank to come to our aid.

2) An additional $20 Billion could have been cut off the bill as New York’s governor allowed AIG subsidiaries to lend to AIG right before the bailout. Research on the matter of whether or not this money was lent have found no results including this statement from the Federal Reserve Vice Chairman which mentions “subsidiaries” multiple times but no disclosure of lending outside of that of the federal government. In fact, the report hints that AIG used bailout money to pay off its debts to its subsidiaries, something that was not necessary.

3) Assets in Exchange for Debts. AIG could have directly transferred performing assets over to their creditors in exchange for a debt write-down. Although highly unusual, such a transfer could have been backed with the threat of bankruptcy had the counter-parties not agreed. In the midst of the crisis, the Wall Street Journal reported:

“AIG's millions of insurance policyholders appear to be considerably less at risk. That's because of how the company is structured and regulated. Its insurance policies are issued by separate subsidiaries of AIG, highly regulated units that have assets available to pay claims. In the U.S., those assets can't be shifted out of the subsidiaries without regulatory approval, and insurance is also regulated strictly abroad.

Tuesday afternoon, after the market closed, AIG put out a statement saying its basic insurance and retirement services businesses are "fully capable of meeting their obligations to policyholders." AIG said it was trying to "increase short-term liquidity in the parent company," but said that didn't "include any effort to reduce the capital of any of its subsidiaries or to tap into Asian operations for liquidity." Asia is one of AIG's largest markets.”

So if we take $70 billion off the government bailout plus add the assets for debt forgiveness program (at LESS than 100 cents on the dollar), maybe we buy a good amount of time where the company would have the opportunity to fix itself, and buy time for the government to develop a lending plan. I’m not advocating that nothing be done, but as Rick Santelli stated, “just because we can’t do nothing doesn’t mean we had to do everything.”

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