Treasury’s AIG pump and dump
The nonpartisan Congressional Budget Office has released new projections that the Troubled Asset Relief Program will cost the federal government $23 billion in 2012, $20 billion more than originally anticipated. This comes after Treasury actually made $38 billion on its TARP “investments” in 2011 and more than $100 billion in 2010. That’s quite a reversal.
The cause of TARP’s deteriorating condition, nearly four years after it first was put into place, is the declines in share prices at General Motors and American International Group. For AIG, in particular, this is truly a “chickens come home to roost” moment, as the series of profoundly bad decisions that followed the company’s initial $85 billion bailout in September 2008 (it later would grow to roughly $192 billion in loans, credit lines and guarantees, before all was said and done) are coming back to bite the bailout’s crafters – notably then-New York Fed Chairman, and current Treasury Secretary, Timothy Geithner.
One can debate the merits of saving AIG at all, and there are reasonable positions going either way. But what’s been crystal clear since virtually day one is that, IF one were committed to government intervention at AIG as a means of avoiding a broader meltdown in the financial markets, Geithner and Co. picked absolutely the worst possible way to do it.
To start, there was the decision not to “resolve” AIG, as the FDIC would do with a failing bank, but instead to extend the company an enormous line of credit, which initially was supposed to expire within two years. (We are now going on 40 months since the bailout.) The credit came from the New York Fed, while Treasury took equity collateral in the form of warrants equal to 79.9% of the company’s stock. Why not 80%? Because that was the threshold at which government accounting rules would dictate recognizing the reality that AIG’s obligations must be counted as obligations of the federal government.
Preserving the fiction that AIG had neither failed nor been nationalized would come back to haunt the Fed when the first of many restructurings of the bailout was arranged not quite two months later. AIG’s primary problems, the reason it needed the bailout in the first place, is that it faced enormous collateral calls in two areas of the company’s business: on credit default swaps the company’s AIG Financial Products division wrote on collateralized debt obligations, and on residential mortgage-backed securities the company purchased with cash collateral it received through its life insurance subsidiaries’ securities lending business.
The collateral calls were prompted by rating agency downgrades of the AIG corporate parent. Under its contracts, AIG’s counterparties were entitled to demand collateral on these transactions in the event of a deterioration in the value of the securities (both CDOs and RMBS were then in the toilet) or in the event of a credit downgrade. Indeed, some $52 billion already had been extended to CDO counterparties under these terms over the first nine months of 2008.
But the nature of a collateral call is also temporary; if, for instance, AIG was later upgraded, or the value of the CDOs it was insuring improved, or if the instruments performed as expected, the call could be reversed and the money returned to the company. Although AIG had business assets that were worth far more than what it owed, what AIG didn’t have was enough in liquid assets on hand to keep making its collateral calls. And so it turned to the federal government to give it the liquidity to survive the collateral call storm.
Now, had AIG been nationalized, the company’s credit rating would have been replaced with the then-AAA rating of the U.S. government. Not only would there be no further credit-related collateral calls, but much of what the company had already ponied up could conceivably have been returned. And should there have been interest in capping the company’s potential liabilities, the federal government certainly would have been in a great bargaining position to demand counterparties take haircuts on what they would have been owed. After all, should AIG have gone into bankruptcy, those holding AIG CDS would not necessarily have topped the list of creditors.
Instead, Geithner and Co. created two facilities – the $19.5 billion Maiden Lane II and $24.3 billion Maiden Lane III – that used loans from the Fed to buy out, at 100 cents on the dollar, both the RMBS that AIG was holding in its securities lending business and the CDOs that it insured with credit default swaps. This was an unfathomably stupid decision. Imagine a homeowners insurer that decides, instead of paying out the claims on roofs that had been damaged in a recent hailstorm, it would just buy up the value of all the properties in the neighborhood at full listing price. That’s essentially what the Fed did.
The whys and wherefores of that decision have never been answered to most anyone’s satisfaction, but it bears noting that the largest beneficiaries included not only the likes of fellow TARP recipients like Goldman Sachs, Bank of America and Citigroup, but also foreign banks like Societe Generale, DeutscheBank and Barclays, each of whom received billions in backdoor bailouts from the New York Fed.
So here we are, and after roughly half-a-dozen further “restructurings” of AIG’s bailout, the Treasury STILL holds a 77% stake in the company as of February 2012. Let’s remember what the stated purpose of the AIG bailout was in the first place. AIG was recognized to have large, valuable assets, but it couldn’t immediately tap those assets to meet its collateral requirements because they were mostly regulated insurance companies whose reserves and other resources were (as they should have been) dedicated to policyholders. The idea was, instead, to sell off AIG’s assets over a two-year period to raise the funds to pay back the credit facility.
There have, indeed, been some significant sales of former AIG assets. The Japanese life insurer ALICO was sold to MetLife. Auto insurer 21st Century was sold to Farmers/Zurich. Commercial property insurer Hartford Steam Boiler was sold to Munich Re. The Hong Kong-based AIA went through an initial public offering, although AIG still holds about 20% of its stock.
What AIG has left is a reasonably large U.S. life insurance business, an enormous global property and casualty insurance business, a large (but financially insecure) aircraft leasing business, and various and sundry other subsidiaries, including a major mortgage insurer. But rather than sell off these pieces one-by-one to the highest bidders, Treasury and AIG management are betting they can “capitalize” the remaining government stake with one enormous stock sale.
The current operating plan is to capitalize that stake by selling off 1.455 billion AIG shares to the general public. To raise the roughly $41.8 billion that would be needed to break even on the bailout, those shares would have to hit the market at a price of $28.73.
The only problem? As of this morning, the shares are trading at about $26.
And that’s leaving aside the actual physical dynamics of ginning up market interest to purchase 1.455 billion new shares of a company whose earnings track record over the past couple years has been erratic, to say the least. Indeed, the plan has been placed on hold, as the first attempts to bring the offering to market have seen shares plummet. At this point, Treasury’s best odds to break even with its current strategy would seem to be successfully pulling off the greatest pump-and-dump scam in history.
Not that that’s stopped AIG CEO Robert Benmosche from dreaming big. Even though his company still hasn’t righted its earnings ship and remains more than $40 billion in hock to American taxpayers, he’s given every indication of plans to try to reassemble the empire that AIG lost, talking about buying BACK its stake in AIA and even bidding to purchase the toxic assets that got it into trouble in the first place. Talk about chutzpah.
Perhaps it is time someone remind Mr. Benmosche and Mr. Geithner that there would be no AIG today without the generosity of the American taxpayers, that there are thousands of other insurance companies who compete with AIG in hundreds of markets every day who don’t have the Treasury as a sugar daddy and lender-of-last resort, and that it’s long, long past time to put this miserable failure out of its misery. That should start by spinning off or selling off AIG’s operations to those who could make better use of them, and using those proceeds to repay every penny of taxpayer support the company has received.
If pursuing such a path ultimately falls short of recouping all of the money laid out on AIG, that would be unfortunate, but it would also be the end result of some spectacularly bad decisions made long ago. What is not acceptable is continuing this farce that keeping the corporate entity we call “AIG” intact should ever have been a goal in the first place.