Federal Government Grants AIG a New Bailout Package

By William Patalon III
Executive Editor
Money Morning/The Money Map Report

American International Group Inc. (AIG) got a $150 billion government rescue package – almost double the initial bailout deal of less than two months ago and the largest ever granted to a private U.S. company – as the ailing insurer continues to burn through its cash at an accelerating rate.

The New York-based AIG will get $40 billion of new capital from the U.S. Treasury Department’s $700 billion bailout package, to help offset the damage wreaked by four consecutive quarterly losses, including a third-quarter deficit of $24.5 billion that the company announced yesterday (Monday), Bloomberg News reported. The U.S. Federal Reserve also is slashing an $85 billion loan to $60 billion, and is replacing a separate $37.8 billion loan to the insurance company with $52.5 billion in aid.

These actions were taken by the Treasury Department and the Fed after it became clear that the original deal would never save the foundering insurer. In total, AIG is receiving more than $150 billion in aid, the most ever provided to a private-sector company in the United States. Even so, Fed officials said they believed that taxpayers would be repaid.

The reason: The government is buying preferred shares of AIG stock, giving taxpayers an ownership stake in the company. In turn, restrictions will be placed on executive compensation at the firm, Forbes.com said.

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U.S. taxpayers are assuming the additional risk in order to provide new AIG Chief Executive Officer Edward M. Liddy more time to salvage AIG. The insurer, which turned to the government in lieu of the bankruptcy courts in September, had planned to repay the original $85 billion loan package by selling some of its business units. But that plan stalled as the financial crisis hacked away at the value of these businesses, even as it hamstrung potential suitors by causing the credit markets to freeze up.

As AIG leaders looked for a way around that problem, the company continued to lose money. AIG’s third-quarter loss equaled $9.05 a share and compared with profit of $3.09 billion, or $1.19, a year earlier, AIG said in a statement. Losses in the past year erased profit from 14 previous quarters dating back to 2004, Bloomberg reported.

“It was obvious to me from Day One that the terms of that arrangement were really quite punitive in terms of the interest rate and the commitment fee and the shortness of it,” Liddy said in a Bloomberg Television interview yesterday. “I started really about a week after I got here trying to renegotiate.”

Although most media reports attribute AIG’s predicament to the collapse of portions of the U.S. mortgage market, Money Morning Contributing Editor Shah Gilani – a national expert on the credit crisis – wrote in a recent investigative series that what really imploded the venerable insurance giant was an accumulation of misplaced bets on so-called “credit default swaps.”

And in the current economic environment, that problem will only get worse, Gilani said in an interview over the weekend, as reports circulated that a new deal was coming.

“AIG’s continuing problems are nothing short of extensive losses on mark-to-mark accounting of its ill-conceived foray into credit default swaps,” Gilani said. And that situation “will only get exponentially and catastrophically worse as the economy falters and reference companies it wrote swap insurance contracts on actually default, turning AIG’s unrealized losses, the subject of its margin calls, into realized losses for the full amount of its liabilities.”

Gilani isn’t surprised that the government had to restructure the AIG bailout package. Nor is he surprised that no real suitors emerged for AIG business units, several of which are actually superb businesses.

“The pieces of AIG that are desirable, and there are several very profitable divisions, are not getting serious consideration because potential acquirers’ stock prices are in the tank and there’s no inherent value in [the potential suitors’] stock prices as equity capital,” Gilani said. “There’s no one riding to the rescue because the horses are in the barn and the barn is burning.”

The U.S. reversed its opposition to an AIG bailout when the Fed realized that the potential ripple effects of a complete collapse could cause other firms to collapse, as well. The original $85 billion loan was disclosed on Sept. 16, a day after investment bank Lehman Brothers Holdings Inc. (OTC: LEHMQ) was permitted to collapse. AIG got an additional $37.8 billion credit line to shore up its securities-lending program on Oct. 8, and on Oct. 30 received an additional $20.9 billion as part of the central bank’s commercial paper program, which was designed to unfreeze the short-term debt markets.

[Editor’s Note: Money Morning Contributing Editor R. Shah Gilani has toiled in the trading pits in Chicago, run trading desks in New York, operated as a broker/dealer and managed everything from hedge funds to currency accounts. In his recent investigation of the U.S. credit crisis, Gilani was able to provide insider insights that no other financial writer or commentator could hope to match. He drew upon the experiences and network of contacts that he developed through the years to provide Money Morning readers with the "real story" of the credit crisis - and to propose an alternate plan of action. It’s a perspective on the near-financial meltdown that more than a quarter-million readers have read in Money Morning alone - to say nothing of the hundreds of other Internet outlets worldwide that have picked up and published Gilani’s unique insights. Watch for Gilani’s next column – an exploration of “brokered deposits” – which is scheduled to appear in Money Morning in the near future.]

News and Related Story Links:

• Forbes.com:
  AIG’s Plan D.

• Money Morning Credit Crisis Investigative Series:
  The Inside Story of the Collapse of AIG.

• WSJ.com:
  Government, AIG Near a Pact To Scrap Original Rescue Deal.

• Bloomberg News:
  AIG Gets Expanded Bailout, Posts $24.5 Billion Loss.

• Forbes.com:
  Government Provides Record Aid Package to AIG.

• Wikipedia:
  Credit Default Swaps.

• Money Morning Investigative Report:
  By Relaxing “Mark-to-Market” Rules, Has the U.S. Switched Off its Financial Crisis Early Warning System?