Wednesday, September 17, 2008

The AIG Deal In Detail

First, please see the article I wrote yesterday on AIG, titled "Is AIG Too Big To Fail?" The short version is, well, yes it is. Let's look at the deal specifics.

The U.S. negotiators drove a hard bargain. Under terms hammered out Tuesday night, the Fed will lend up to $85 billion to AIG, and the U.S. government will effectively get a 79.9% equity stake in the insurer in the form of warrants called equity participation notes. The two-year loan will carry an interest rate of Libor plus 8.5 percentage points. (Libor, the London interbank offered rate, is a common short-term lending benchmark.)

The loan is secured by AIG's assets, including its profitable insurance businesses, giving the Fed some protection even if markets continue to sink. And if AIG rebounds, taxpayers could reap a big profit through the government's equity stake.

"This loan will facilitate a process under which AIG will sell certain of its businesses in an orderly manner, with the least possible disruption to the overall economy," the Fed said in a statement.

It puts the government in control of a private insurer -- a historic development, particularly considering that AIG isn't directly regulated by the federal government. The Fed took the highly unusual step using legal authority granted in the Federal Reserve Act, which allows it to lend to nonbanks under "unusual and exigent" circumstances, something it invoked when Bear Stearns Cos. was rescued in March.

As part of the deal, Treasury Secretary Henry Paulson insisted that AIG's chief executive, Robert Willumstad, step aside. Mr. Paulson personally told Mr. Willumstad the news in a phone call on Tuesday, according to a person familiar with the call.

First, the government is making a loan valued at $85 billion. This is on top of a loan of up to $200 billion for Freddie and Fannie and backstopping the Bear Stearns deal for $30 billion. That's a total of a possible $315 billion the government has put on the line so far. That's 11.54% of the 2007 federal budget. This at a time when the federal government has been bleeding money since 2003:

09/30/2007 $9,007,653,372,262.48
09/30/2006 $8,506,973,899,215.23
09/30/2005 $7,932,709,661,723.50
09/30/2004 $7,379,052,696,330.32
09/30/2003 $6,783,231,062,743.62
09/30/2002 $6,228,235,965,597.16
09/30/2001 $5,807,463,412,200.06
09/30/2000 $5,674,178,209,886.86

The current total is $9,634,090,464,815.55

SO -- the US government which is already run about as incompetently as possible -- is now loaning more money. What's a few more billion when you can pawn off the problems on the US taxpayer.

The government is getting a 79.9% interest -- clearly a majority interest. As Bloomberg noted:

The Federal Reserve will provide a two-year loan, take 79.9 percent of the New York-based company's stock and replace its management because ``a disorderly failure of AIG could add to already significant levels of financial market fragility,'' according to a statement by the central bank late yesterday

In short -- the government is now the owner of an insurance company. Great. They've done such a great job so far with everything else.

AIG is paying a hefty insurance rate:

The government is lending AIG the money at 8.5 percentage points above the three-month London interbank offered rate, or a current rate of about 11.5 percent.

This is probably in line with where AIG should be paying interest rates for a loan. They bottom line is they should be forced into bankruptcy at this point, which is essentially the business plan for the foreseeable future:

The agreement will give the company, which sells insurance in more than 130 countries, time to sell assets ``on an orderly basis,'' AIG said in a statement. Chief Executive Officer Robert Willumstad, 63, will be replaced by former Allstate Corp. CEO Edward Liddy, 62, according to a person familiar with the plans, who declined to be identified because the change hadn't been formally announced

So, to sum up --

1.) The deal makes the US government the owner of an insurance company

2.) The US government has already promised outlays of 11% of the 2007 budget at a time when the government is bleeding money

3.) AIG is at paying a fair interest rate given their condition, and

4.) AIG is essentially in bankruptcy.

AIG made a ton money in the good times and now we're paying for their excesses.