More taxpayer bucks to bail out AIG, $61 billion loser
American International Group (NYSE: AIG) just got $30 billion more of our money over the weekend. There were no pesky Congress members debating whether to give it our billions -- just a feverish weekend of negotiations among unnamed government officials and AIG executives.
How did these folks settle on $30 billion? Why not just let AIG fail? How much more will we need to spend before we start getting our money back? The answers to the first and third questions are: "I don't know" and to the second, I'd say, "Systemically costly derivatives contracts."
Meanwhile, AIG set an impressive record -- losing more in a quarter than any company in history -- $61.7 billion (just $1.7 billion more than had been rumored last week). For the year, AIG lost $99.3 billion, which seems like quite a bit of money to lose. And thanks to free market principles, which allow executives to keep the profits in good times and share their losses with taxpayers, the U.S. has so far given AIG a $60 billion loan, a $40 billion purchase of preferred shares and $50 billion to soak up AIG's toxic assets. Due to that record loss, we'll kick in another $30 billion to bring the total to $180 billion.
Here's where the systemically expensive derivatives contracts come in: This loss put credit rating agencies in the mood for downgrading AIG. That downgrade would be a violation of AIG's debt contracts and AIG would respond by defaulting on its debt. This default would trigger derivatives contracts held by banks who would ask AIG to pay them collateral as part of the terms of those contracts. But AIG doesn't have enough cash to meet these collateral demands. So the banks holding those contracts would not get their money. And the U.S. believes that that this failure to collect would damage the entire financial system.
As it turns out, AIG's loss put the U.S. over a barrel in keeping the ratings agencies from downgrading AIG's debt and creating this systemic problem. In addition to putting $30 billion in TARP into paying AIG if it needs the money, here are some other government gifts to AIG:
- Dividend cut. AIG will get a break on its previous deal with the U.S. It will exchange $40 billion in preferred nonvoting shares, which paid a 10% dividend, for new preferred shares with no dividend -- saving AIG $4 billion a year.
- Debt for equity swap. Instead of paying back $38 billion in cash with interest that it has used from a federal credit line, the U.S. will get equity in two of AIG's profitable subsidiaries in Asia -- American International Assurance and the American Life Insurance Company.
- Below market borrowing rates. The U.S. will cut by 3 percentage points the rate it charges AIG on government loans to the London Interbank Offered Rate (Libor).
And now the ratings agencies will refrain from downgrading AIG's debt. It is ironic that the ratings agencies are now trying to do their job after it's too late. During the bubble blow up phase, the ratings agencies put AAA ratings on anything as long as they got their fees from investment banks. Now it takes taxpayer money to keep the ratings agencies from putting the appropriate rating on debt.
The lesson here is timeless, if you owe the bank $1,000 and can't pay it back, that's your problem. If you owe the bank $1 trillion and can't repay, it's the bank's problem.
Peter Cohan is president of Peter S. Cohan & Associates. He also teaches management at Babson College and is the author of You Can't Order Change: Lessons from Jim McNerney's Turnaround at Boeing. He owns AIG shares.