Why is AIG Being Permitted to Retrade Its Deal With Taxpayers Yet Again?

In case you lost track of this sorry affair, AIG, the biggest ward of the state in human history, continues to get the kid glove treatment. The IMF, doing the dirty work of the Washington Consensus, has repeatedly imposed far more pain on over-indebted countries than US government on the failed insurer.

AIG originally agreed took a deal from the Fed that was on the same terms as a private sector funding that failed to raise enough dough: 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, and management was confident it could do so.

Now this was a dandy solution to a bad situation. And no, I’m not being ironic. The remedy was suitably punitive. No executive would want to get in a AIG type mess and be required to dismantle his company. The interest rate was high, thus keeping pressure on AIG to move expeditiously as well as providing taxpayers with a decent return. And from a systemic risk standpoint, breaking up AIG was a plus, since it would cut a TBTF entity down to size.

But AIG was able to slip the leash. Its cheery assurances that it could divest divisions proved hollow. It came back to Uncle Sam and managed to get both more money and a reduction in interest rate. In deal land, this is called a free concession and is a sign of chumpdom (the Treasury press releases tried to imply that the government got more, but when you already have a senior lien on all the assets, there’s nothing more to get, save maybe throwing out the board, which would have been a good gesture). The argument was that the interest payments would damage AIG, but all that suggested was that the interest payments be deferred, not reduced. Oh, and in case you weren’t paying attention, the financial deal was retraded not once, but three times.

Your diligent Administration also installed three trustees to oversee AIG, and since they were all professional board members, they were the last people you’d expect to rock the boat by asking Elizabeth Warren style tough questions. They were thus easily rolled when new CEO Robert Benmoshe took the reins and retraded the deal yet again, with the imperial announcement that AIG would not seek to repay the loans via divestiture. This was an act of unbelievable intransigence; no private sector majority owner would tolerate such backtalk from a hired hand.

Yet not an official word was said in opposition, since the Administration bought or hid behind the canard that Benmoshe would be hard to replace. And given that AIG has a lot of cross-company exposures (divisions lending to each other) one wonders whether dismembering the company might yield more accounting improprieties, which would mean the divisions were worth even less than thought, which would reveal that the taxpayer loans were unlikely to be repaid in full.

Tonight, the Wall Street Journal reports yet another retrade of the AIG financing: 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.

This latest scheme is being positioned as a way to accelerate repayment, when it’s another version of extend and pretend. Look at the happy talk courtesy the Wall Street Journal:

American International Group Inc. and its government overseers are in talks to speed up an exit plan designed to repay U.S. taxpayers in full while enabling the giant insurer to regain independence, according to people familiar with the matter.

Under the plan, which could commence as early as the first half of 2011, the Treasury Department is likely to convert $49 billion in AIG preferred shares it holds into common shares, a move that could bring the government’s ownership stake in AIG to above 90%, from 79.8% currently, the people familiar said. The common shares would then be gradually sold off to private investors, a move that would reduce U.S. ownership and potentially earn the government a profit if the shares rise in value….

But if it could be pulled off, an exit would be seen as a victory for the government and the company.

Yves here. Notice another sleight of hand at work. All the restructurings have succeeded in lowering the benchmark for success. An investor doesn’t simply want to get his money back; he wants a suitable risk adjusted return. That would have been 11.5% for the first two years of the loan. AIG won’t provide anything resembling either proper compensation or a Bagehot-style penalty rate.

Note that the article later does provide some caveats:

The market value of AIG stock held by investors is currently about $5 billion, down from over $100 billion in early 2008 before the bailout….

There’s risk in moving too fast. If AIG isn’t financially strong and its businesses aren’t stable when the Treasury tries to sell its shares, the company could spiral downward again—an outcome the Treasury is trying to avoid. AIG’s restructuring already has experienced setbacks, such as failed deals to sell major assets in recent months.

The timing of the government’s exit from AIG could also depend on how major credit-rating firms view AIG’s strength as a stand-alone company without federal support, and whether it can maintain a single-A investment-grade rating on its own. Rating agencies recently signaled that absent government support, AIG’s rating would currently be below investment grade, but it could improve if AIG completes key asset sales in coming months.

Funny, isn’t it, how creative and accommodating the Treasury can be when dealing with large distressed firms, and its skill seems to evaporate when contending with underwater homeowners.

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  1. CingRed

    In reference to your last paragraph, I have said it before and will say it again, we are a banana republic in every sense of the phrase. Until the people of this country stand up and say we will accept nothing less than equal treatment under the law as set forth in the Constitution we will continue on this path to ruin. The responsibility of the government and the laws and regulations they pass is to provide a level playing field for ALL participants and to punish those who think they have a different set of rule to play by. Obviously AIG has a different rule book and the Treasury, headed by a tax evader, thinks that it is good that everyone is equal even though some are more equal than others. How many of the persons outraged by this behavior will put an end doing any business whatsoever with AIG? Yeah, just what I thought, no commitment to the principle of fair play!

    1. aet

      AIG is the company which is the basis of “Judge” Kenneth Starr’s (of the Clinton impeachment) family fotune, is it not?

      That explains some things, perhaps.

    2. Eric

      Between this and Yves’ last paragraph I am left wondering what this adds up to. If it is equal treatment under the law, then we need to get tougher with AIG. But if the meaning is that somehow the government should get involved in re-organizing underwater mortgages – and in the final analysis nearly every proposal boils down in some measure to the government heavily subsidizing a principal reduction – then is the proper comparison of equality under the law between underwater borrowers and AIG or those same borrowers and other citizens? I’m not underwater, but my home value has notionally diminished right in line with my more credit-exposed neighbors. If they get $40K, am I going to get $40K? Not to mention what should be done for people who wisely stayed out of the homeownership market entirely. Doing nothing for anyone is the surest way to arrive at equality under the law.

  2. attempter

    This pattern of conduct is strong evidence that although the nominal terms of the original bailout may have been theoretically acceptable as Yves said, they were never intended to be exercised as written but changed to AIG’s advantage over time.

    It would be the same M.O. as the parts of the sham “reform” bills that may sound good on paper but will never be enforced as advertised.

    The AIG bailout was the first thing they did after Lehman. They still felt squeamish about the “optics” of the thing (in Sorkin’s book everyone’s obsessed with the optics, which is strong circumstantial evidence that their lame objections over principle were in fact bogus). So they felt the need to make a big show of how the terms weren’t punitive for the taxpayer. But we’ve seen since then what their real intent was, since as Yves has repeatedly said, there was never any reality-based reason for any of these AIG renegotiations. They were undertaken as part of the premeditated ideology of the Bailout.

  3. Francois T

    Obama and the Congressional Democrats would do themselves an immense favor reading and committing to memory your last paragraph.

    It summarize very well one of the root of their troubles.

  4. RueTheDay

    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.

  5. Bill H

    Yes, the largest legalized swindle in American history continues to plague us. Benmosche is going around acting like a private-sector mogul instead of a steward of public funds (although as Yves points out, he wouldn’t last in the private sector, either). Now that the systemic risk has passed (hasn’t it?), the Treasury Department needs to put a bullet in the head of AIG and get whatever it can. The stockholders who have been profiting from this failed life support strategy can take the bath.

  6. Rodger Malcolm Mitchell

    The entire article is based on one false phrase: ” . . . as well as providing taxpayers with a decent return.”

    The U.S. is a monetarily sovereign nation. In a monetarily sovereign nation:
    1. Federal taxes do not pay for federal spending. The government spends by creating money ad hoc. If all taxes (and borrowing) fell to zero, this would not affect by even one penny, the government’s ability to spend.
    2. Money paid to the federal government does not benefit taxpayers. In fact, money paid by U.S. entities to the federal government hurts U.S. taxpayers by removing money from the U.S. economy.

    Other monetarily sovereign nations include: Canada, Australia, China, Japan.
    Non-monetarily sovereign nations include: Portugal, Italy, Greece, Ireland, Spain
    It’s necessary to understand the difference, in order to understand economics.
    Rodger Malcolm Mitchell

    1. Siggy

      There’s a bit of a problem with your little piece of looney logic. If the government simply creates money to pay for what it buys or pays out as ‘benefits’: then, what ever the medium is that is paid out will have zero purchasing power.

      Now, if the medium that is paid says that it is legal tender for all debts, public and private; then the medium is useful for the paying of same. If, it is desired to use the medium recieved from the sovereign to purchase assets or consumables; i.e. something other than for the payment of a debt or taxes, then that ad hoc piece of medium (think shit) will not have meaningful purchasing power.

      Consider our recent experience with house prices. How ever could it be that house prices in many locales ran up so rapidly? Could it be that because the purchase price of house is substantially funded by credit money, a loan? Now recall that the initiation the house price bubble is proximate to the elimination of creditworthiness evaluations and concurrent with a significant increase in the quantity of credit money that the banking system and its shadow breatheren created out of the intoxicating vapors of securitization and CDOs. And to that securitization, derivatives stew a little fraud for flavor and you have the essence of our current distress.

      The analyses present by Yves are painfully correct. The bailout of AIG is the most aggregious fraud since Teapot Dome.

      Rodger, methinks thou protest too much. Do you own AIG stock? Do you have an AIG funded annuity? Do you work for AIG? Your objection is pointless if not malevolent.

    2. Yves Smith Post author


      I am well aware of the difference, this blog has provided more posts on MMT than any blog not written by an MMT specialist. And this is most decidedly not a false premise.

      1. The Bagehot rule, which is generally accepted among central bankers as a sound basis for lending to illiquid companies, calls for lending at a penalty rate against good collateral. It thus uses the idea of a risk adjusted return as its standard because it provides proper incentives to the borrower. The whole point is to avoid moral hazard.

      2. Both the Bush and Obama administrations have spoken about earning a return on taxpayer investment; thus they have used this notion as the standard by which the TARP and other financial firm rescue ops are to be measured

      3. Even if the US government is not operationally constrained in its sending, it is POLITICALLY constrained. Moreover, my conversations with MMT types suggest that only a very small percent of people at the Fed understand the operational realities of a floating rate regime. For instance, Scott Fulwiler noted by e-mail:

      This statement, while absolutely true (provided one allows that it is spending OR loans from the Fed that come first), should not be interpreted as “MMT’ers think the Treasury can currently obtain overdrafts at the Fed and so there is no legal obligation to have balances in its account before spending.” Further, as I also noted, both “spending comes first” and “Treasury must obtain credits to its account before it can legally spend” can be and are true–they are not mutually exclusive. My quote from that earlier email I think puts the point quite succinctly: “the govt can and currently does require itself to obtain credits from bank reserve accounts that were created via previous spending or CB lending before it spends again.”

      4. Given political constraints on spending, return considerations become relevant.

    3. Ming

      Rodger, your assertions about MMT theory seem correct but your focus on the issue at hand is wrong. The key issue at hand, is the erosion of the
      culture of meritocracy and rule of law, where companies survive or die based on merit of their goods and services sold to the marketplace( in competition against those of their competitors) and on the sound conduct of their operations, vs the rising culture of kleptocracy where political and financial elites manipulate the government to serve it’s interest.

  7. koshem Bos

    To join Francois T’s comment, the reason the coming midterm elections will be a blood bath for Democrats is the total support of Obama of the Banks and other big debtors.

    The average Joe will have to ask himself, “who does Obama work for?” The answer is not Joe, it’s Goldman Sacks.

    1. Glen

      Yes, they do seem to be enamoured with saving the very same banks/companies/people that caused the economic crisis.

      Rational people cannot support that.

  8. Don in GA

    This is similar to the U.S. government swapping Citigroup preferred for common at a conversion price well above where the common was trading at the time. Would any competent investor in an arms length transaction agree to move down the capital structure on favorable terms with a company that had no viable alternatives? It is a transfer of wealth, pure and simple. The government just handed money from taxpayers to AIG investors as they did to Citi investors.

    Won’t the U.S. government have to consolidate AIG on its balance sheet if the ownership stake goes above 80%? My understanding is that’s what is behind the sham of Freddie and Fannie having worthless common stock trading publicly, that the U.S. government wanted to keep its ownership stake just under 80% so it wouldn’t have to include their operating losses in the deficit or include Fannie and Freddie debt as federal government debt.

    But then again, as the government has been willing to hand unearned gifts to the shareholders of Citi and AIG, maybe Fannie and Freddie stocks aren’t really worthless, there is some option value associated with a potential future giveaway.

  9. PQS

    “Funny, isn’t it, how creative and accommodating the Treasury can be when dealing with large distressed firms, and its skill seems to evaporate when contending with underwater homeowners.”

    Or, as Elizabeth Warren has noted, “The American Middle Class knows they’re not Too Big To Fail.”

  10. Frank Gifford

    Perhaps without all the continuing assistance to Citi, AIG, et. al. the whole system comes down. With this knowledge, what would you do if you were in the Obama Administration’s position?

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