For those of you old enough to remember the Vietnam War, one of its aspects was an effort at what would now be called spin management. When Richard Nixon, who had promised in his 1968 Presidential campaign to exit the conflict but instead escalated it (the movie Patton had a bad effect on his decision process), finally conceded to the will of the American people, he had to come up with a way to present this reversal of course as a victory of sorts. Hence the dubious formulation, “peace with honor,” was born.
Team Obama is trying to present its shameful exodus from what it deems to be a hopeless losing cause, AIG, as a similar victory of sorts. The Journal tells us the US is going to “pare its stake” in the troubled insurer; the New York Times’ formula is “sever ties“; the Financial Times calls it an “exit plan“. But these sanitized phrases deliberately mask what the Administration is so keen to hide: that it has been badly overmastered, whether by incompetence or design, by the world’s biggest deadbeat. And the government’s eagerness to distance itself from a $182 billion sinkhole means it is yet again giving more unwarranted financial concessions.
Recall how we got here: AIG came in desperation to the Fed for a rescue when it somehow noticed it was about to burst aneurysms in its credit default swaps and securities lending operations, and a private sector rescue couldn’t come up with a big enough money transfusion. The Fed provided an $85 billion loan on the same terms as the failed private sector funding: effectively 11.5%, secured by all the subsidiaries of the company. The plan, which management agreed to, was that the divisions would be sold and the proceeds would repay the borrowings.
This would have been a good outcome: the high interest rate was a suitable reward for the risk taken, and the process sufficiently punitive so as to deter future bailouts. No tear should be shed at the prospect of dismembering a poorly run company. Andrew Ross Sorkin’s Too Big to Fail revealed that the company had remarkably poor financial controls; the fact that it also held the investments in many of its subs in physical certificates at head office is another red flag.
But the deal has been retraded a full four times, each time with the Uncle Sam putting up more dough and worsening its footing, through a combination of lowering its interest rate and taking a less senior position. A private sector creditor would do the reverse: more credit would be extended only on more, not less, stringent terms. But the government bought the AIG malarkey that it could not afford the interest rate it had agreed to. The only concession that should have been permitted was to allow interest payments to be deferred rather than lowered, and that should have been accompanied by far more oversight (board seats, more frequent operating reports, etc). And as we have chronicled at length, the government has tolerated the intransigence of the new CEO, Robert Benmosche, who has refused to execute the government program of sale of divisions until the financing is repaid, arguing that AIG is worth more intact. To him and the board members that back him, that is clearly the case.
Admittedly, AIG has hived off some operations. But no one has scrutinized why AIG is not able to dispose of more divisions. Some of the AIG subs have been reportedly been reinsuring each other and there may be other less than savory intra-corporate dealings that if unwound might make some of the divisions less attractive than outsiders believe them to be. So Benmoshe’s theatrics may serve as useful cover for some aggressive accounting.
The latest retrade, announced roughly two weeks ago, is that the government is going to convert its preferred shares to common, and seek to sell its stake over time. But why should the government swap out of preferred, which pays a dividend (well, is supposed to pay a dividend when and if earned) for common when the equity sales are not imminent? This is simply yet another sop to AIG. As reader RueTheDay noted:
Swapping preferred shares for common is LUNACY unless they plan on liquidating their entire holding all at once (which apparently they do not). The Treasury gives up their dividend and their place in line amongst creditors. By then trying to divest the common over a period of time, they expose themselves to market risk.
Here is a sketch of the current state of play, courtesy the Wall Street Journal:
The exit plan would involve the Treasury converting some $49 billion in AIG preferred shares it currently holds into AIG common shares that can be distributed or sold to private investors over time…
The conversion, which could take place at about $35 an AIG share, is likely to occur in the first half of 2011 and is expected to happen after AIG repays its secured debt to the New York Fed, the people added. The move would likely raise government ownership in AIG to more than 90% before it is reduced gradually.
The exact price at which the Treasury converts its preferred shares to common shares would determine how much of AIG the government would own as a result, a person familiar with the matter said.
The calculus in settling on a price involves weighing what the Treasury can reap for taxpayers against the desire to keep enough value for private investors so they will be incentivized to hold or buy AIG shares.
Yves here. Note that a recent example of the Treasury coming up with a way to balance the interest of banks versus other constituencies (in this case mortgage borrowers) in the HAMP resulted in a formula that explicitly gave banks license to game the program (they were encouraged to modify deeply underwater mortgages; the one with equity were evidently understood to be attractive foreclosure material). Do we have any reason to think Treasury will do better this time?
The New York Times adds some cautionary notes:
A rapid exit by the government could also lead to a credit downgrade, which would hurt the company’s ability to sell insurance…..
“This market can’t support” a flood of shares, said Christopher Whalen, managing director of Institutional Risk Analytics. “The reality is that the government has become a long-term stakeholder.”
He and others pointed out that while A.I.G. had made progress in its revamping, it had yet to pass certain milestones that would show it was ready to operate without government support. It is still working on two crucial transactions that must close before it can repay the Fed — roughly $46 billion, $25.7 billion of it in preferred stock that must be redeemed, and $19.7 billion of rescue loans.
Analysts said it was hard to see how the insurer would generate that much cash by the end of this year, which parties to the negotiations said was the Fed’s deadline.
Yves again. One has to wonder about the year end deadline. Does it relate to the Fed not wanting to issue another annual report on the Maiden Lane II and III vehicles, entities created by the Fed to fund lending against AIG mortgage and CDO exposures? The Fed had insisted these loans were money good; our analysis of Maiden Lane III suggested otherwise, and another detailed release might make it hard for the Fed to continue to take that position. Audit the Fed is around the corner, so the AIG bailout will be under renewed scrutiny.
Let’s not kid ourselves: all this fancy financial footwork is to divert public attention from the fact that AIG will deliver big losses to the taxpayer. The latest Congressional Oversight Panel report contained estimates of losses on the AIG financing, with estimates from separate government sources ranging form $36 to $50 billion. Do you see this acknowledged ANYWHERE in the New York Times, Bloomberg, or Wall Street Journal? (To its credit, the FT does pick this up). No, which means this propagandizing, sadly, is proving to be quite effective.
In The Three Burials of Melquiades Estrada, Tommy Lee Jones hauls a fragrant corpse across Texas and into Mexico to honor a commitment made to his dead ranch hand. True to Western hero form, Jones carries out his unpleasant duty manfully. The Obama Administration, by contrast, is ditching the dead body and hoping no one will notice.