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Fed Considering Lending to AIG (Update: Or Treasury Conservatorship)

I guess someone at the Fed figured that letting the financial system blow up on its watch was not such a hot idea. But as far as the Fed’s purview is concerned, lending to AIG is just about as far afield as lending to General Motors.

What is surprising (at least based on this report) is that the Fed appears to be going solo, AIG is a global firm with considerable operations in Asia. Having other central banks or private firms participate in the package would improve appearances, as well as spread risks more equitably (of course, rounding up enough of the usual suspects to go along is another matter….)

From Bloomberg:

The Federal Reserve is considering extending a “loan package” to American International Group Inc., the insurer facing a cash shortage, according to a person familiar with the negotiations.

The stance by federal regulators is a reversal from a position they held as late as last night, and people with knowledge of the talks are “cautiously optimistic,” said the person, who declined to be identified because negotiations are confidential.

The person gave no timetable for reaching an agreement or estimate on how much money New York-based AIG would need….

“To the extent that a bridge loan or some type of liquidity provision allows AIG time to sell some assets on its balance sheet and time to maintain it’s investment-grade rating at A or higher, I think it’s a good move,” Bill Gross, co-chief investment officer of Newport Beach, California-based Pacific Investment Management Co. said …

“The Fed doesn’t have to necessarily put its own capital at risk,” Gross said. “We’ll see what the plan says, but I think it’s definitely a necessary step.”

Goldman Sachs Group Inc. and JPMorgan Chase & Co. were working with AIG to determine how much the insurer needs, said two people familiar with the talks yesterday. Goldman has helped the Fed appreciate the effects that an AIG collapse would have on financial institutions, the first person said….

Senate Banking Committee Chairman Christopher Dodd warned the Fed and Treasury against a rescue of AIG without checking with him first, expressing anger about past incidents where he was only informed afterwards. He also said he was skeptical that AIG merited aid while Lehman didn’t.

“Tell me why this situation is different from Lehman,” he said today. “I’m willing to listen.”

I was shocked at the lack of Congressional pushback after the Bear bailout. Clearly the mood has changed.

Update 5:10 PM, Bloomberg says conservatorship is under consideration:

The U.S. Treasury is considering taking over American International Group Inc. under a conservatorship as one option to address the insurer’s crisis, according to two people briefed on the discussions.

Executives from AIG, bankers and Treasury and Federal Reserve officials are meeting today on the company’s situation at the New York Fed. A number of options are under being discussed to fill a shortfall of $75 billion to $100 billion in funding, one of the people said. The talks are continuing, he said.

Goldman Sachs Group Inc. and JPMorgan Chase & Co., which have been leading efforts to find a private-sector solution, informed the Fed that such an effort would be difficult, the person said. Under another option, the Fed would extend a loan to New York-based AIG, according to a person informed of the matter.

Treasury Secretary Henry Paulson earlier this month seized Fannie Mae and Freddie Mac and put them into conservatorships, where officials will oversee the firms and aim to protect their assets.

This actually could turn out to be attractive financially. Don’t throw brickbats. If this is indeed a holding company liquidity crisis, there may be considerable value in the subs. I heard second-hand the views from some people who know AIG’s Asian operations (the company started in China) and say is has considerable value.

Bur would the business get run into the ground in a conservatorship? It would be difficult to keep good people in that sort of regime.

Unfortunately, I think whichever route gets chosen will be driven by political considerations rather than what arrangement makes most sense.

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28 comments

  1. a

    “Goldman has helped the Fed appreciate the effects that an AIG collapse would have on financial institutions.”

    Translation: We (Goldman) would go bust.

  2. Anonymous

    Just say it. AIG has a deep root and large impact in China. Maybe Beijing can spare a few bucks on it…

  3. mxq

    Today’s biggest travesty re: aig was the fact that CNBC put Hank Greenberg on for what seemed like hours…the guy rambled and complained the WHOLE time…sorry hank, you can’t do anything…its all out of your hands now.

    He is as crooked as he is irrelevant. And his taint is reflected in the $4 aig price tag.

  4. Anonymous

    “Senate Banking Committee Chairman Christopher Dodd warned the Fed and Treasury against a rescue of AIG without checking with him first, expressing anger about past incidents where he was only informed afterwards.”

    What does Dodd think this IS — a republic? A democracy?

    Poor deluded soul — he’s veered off-message.

  5. gaius marius

    AIG is already down 55% from today’s close — looks like treasury is considering a conservatorship on the FNM/FRE model, which would of course wipe the equity.

  6. Marcf

    It seems that most of the FED actions these days are aimed at controlling the rate of delevering. Clearly an AIG dumping some of its assets on a wobbly market would just risk a spiral, where the cash raised is offset by further deterioration of assets. They are buying time so the rate of delevering isn’t too steep. Makes complete sense. I do not completely understand why the moral hazard complaining, this isn’t socialization of losses, one would hope the “bridge loan” is made good on. I think this is more akin to extending a lending facility access to the largest insurer in the world.

  7. gaius marius

    ms smith — i love your selected quote from senator dodd. he’s apparently missed how the crisis has cut the legislative branch out of the appropriations business every bit as effectively as truman’s “police action” in korea ended their real authority over the armed forces.

    good luck getting that authority back, senator.

  8. MATT DUBUQUE

    MATT DUBUQUE

    Any sort of a lifeline to AIG seems unlikely. Remember, Rogoff’s warning. He speaks for mainstream Fed thinking.

    In retrospect, this is PRECISELY the situation Rogoff was warning about a short while ago. I’d be hard pressed to name any economist cited more widely in Fed economic research papers.

    Some of the biggest bombshells are in the offshore AIG operations, as near as I can tell.

    MATT DUBUQUE

  9. Steve

    If there’s a conservatorship, the legal authority invoked will be interesting (Executive Order?). And what form of conservatorship? The FDIC kind that wipes debt and equity, or the new GSE kind that protects bondholders?

  10. Anonymous

    Many are invoking the “too big to fail” argument again to defend AIG. I bought that with BearStearns. But this is six months later and several government interventions later. When do you say enough is enough? What other financial entities will need rescue in the future? You can bet AIg will not be the last. Finally, does the the US Treasury have any limit in its resources? If this savior complex remains unchecked, the US itself will be in the same predicament as AIG is today.

  11. Carlomagno

    I’d like to know what authority the Feds would invoke to place AIG under conservatorship. Insurance regulation is a State prerogative. HELLO?!

  12. Anonymous

    Conservatorship is out. It would trigger credit default swaps just like Fannie and Freddie only a lot worse. There really might not be a deal.

  13. Anonymous

    AIG should be allowed to fail. Let its profitable insurance operations succeed on their own without the albatross of a hedge fund that made some very bad bets.

    Hopefully someone will investigate to determine why regulators allowed the “highest rated” insurance company to become a speculative vehicle in the derivatives market.

  14. Walt Pohl

    The issue is other banks’ exposures to AIG. If other banks were using AIG’s credit default swaps as risk management tools, then if those swaps suddenly go bad, you could suddenly have any number of banks in trouble.

  15. Cash Mundy

    Dealbook says:

    Updated: The Federal Reserve plans to offer an $85 billion bridge loan to the American International Group in return for control of the ailing insurance giant, people briefed on the matter said Tuesday night.

  16. Cash Mundy

    Reuters:


    Breaking News
    Bernanke, Paulson meeting now with Congress leaders on AIG: source

    Fed to give AIG $85 billion loan and take 80 percent stake: NYT 7:25pm EDT

  17. kvnc

    Bur would the business get run into the ground in a conservatorship? It would be difficult to keep good people in that sort of regime.

    “keep good people?” give me a break! the good people that ran the business into the ground in the first place? cause it’s pretty close to six feet down in the ground right now. greedy, extremely short-sighted people who were ideologically pre-disposed to overlook the most massive housing bubble in history, which appears to be most of wall street, are not good people to have running a business.

  18. Anonymous

    This is just wonderful, I’m a forced partner in real estate and now I’m going to be an unwilling partner in the insurance industry.

    Signed,

    Taxpayer

  19. Alan von Altendorf

    Aw, c’mon. The Federal Reserve is going to acquire 80% of AIG — and do what? I’m sure Ford and GM are for sale, too. Jeez.

  20. Anonymous

    if a properly functioning financial system is the desired end, crisis management measures must end–allowing aig to fail would be a good start.

  21. Anonymous

    Neither the Fed nor Treasury had the power to impose a conservatorship. The Fed does, however, have the power to make collateralized loans.

    That said, anyone who is clever should have realized (or is probably starting to realize) that a limitation to making “only” collateralized loans is not much of a limitation at all.

    For example, a good lawyer can write what is basically an “equity” investment with loan documents (like a participating subordinated loan or a thinly collateralized loan with warrants like what the Fed is doing). In much the same way, a lawyer can also write what is basically a “debt” investment with equity documents (a joint venture agreement where the money provider gets all its “equity” back plus a preferred return prior to any other distributions (and you could also include a guarantee)).

    My point is that this smells very much like a senior preferred equity investment. And this shows how saying the Fed can “only” make collateralized loans is really meaningless. The Fed can make any investment it wants and just slap a “loan” label on it.

  22. Anonymous

    they better damn well better impose the same terms on AIG they did on FNM/FRE. use the preferred and common shareholders to protect the taxpayer, and demand most of the upside.

    if hank greenberg gets a better deal than the average joes invested in the mutual funds that owned FNM/FRE common & preferred because he happens to be a card carrying member of AEI (and hence is close to the neocons who are running our government) then it will be a sad, sad day for america. it will be another data point which supports the notion that non-elected bureaucrats are deciding which institutions survive and which institutions fail (or are confiscated, in the case of FNM/FRE) based on ideological views and personal relationships.

    disgusting.

  23. Anonymous

    anon 7:59pm

    ***
    My point is that this smells very much like a senior preferred equity investment. And this shows how saying the Fed can “only” make collateralized loans is really meaningless. The Fed can make any investment it wants and just slap a “loan” label on it.
    ***

    Not really. The loan is required to be debt in substance and form. If the Fed makes advances for an instrument that is equity in substance, someone might have standing to sue the Fed for damages or injunctive relief. Maybe a hedge fund who would benefit by scuttling the Fed’s plans. Maybe a citizen with Ron Paul’s politics.

  24. Yves Smith

    I know no one wants to hear this, but AIG is actually considered to have the best people in the insurance industry (Buffett’s insurance ops under Ajit Jain actually requires very few high caliber people. So Buffett does have good people, but comparatively few).

    The trouble came largely from AIG’s foray into financial services. I don’t know enough about that operation, but that was clearly mismanaged. But a lot of insurers have gotten their heads handed to them with similar initiatives (Swiss Re, for instance).

    The big problem at AIG was that Greenberg ran it like the French court. He made tons of detailed decisions personally. I have been told by people who know Greenberg personally that he thinks he is immortal. No succession planning, in fact Greenberg may have subconsciously set things up so they were so dependent on him that they would go awry when he was no longer on the scene.

    I have a friend who is a very senior executive who joined right before Greenberg got the heave-ho. He said no one knew how to make an important decision, all roads lead to Greenberg.

    So AIG apparently functions very well on an operational/tactical level, but has been left in a mess strategically and in its top level organization. And the financial services guys appear to have taken ground in a power vacuum.

  25. Minh

    http://www.bbc.co.uk/blogs/thereporters/robertpeston/2008/09/how_banks_depend_on_aig.html

    AIG is saying here that it has insured $307bn of corporate loans and prime residential mortgages that are on the balance sheets of banks, mostly European banks.

    The banks have bought this insurance to protect themselves against the risk that these loans would go bad, that borrowers would default.

    Their motive for doing so was to reassure their respective regulators – such as the FSA for UK banks – that these loans are of minimal risk.

    And the benefit of doing that was that they could lend considerably more relative to their capital resources.

    But if AIG is in trouble, then doubts arise about whether it would be able to honour the financial commitments it has made through these insurance contracts (which, for those of you who like to learn the lingo, are called super senior credit default swaps).

    In fact, in a wholly mechanistic way, the downgrades of AIG’s credit rating that we saw last night automatically increased the perceived riskiness of loans made by banks that have insured credit with AIG.

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