AIG Bailout Second-Guessed by Government Watchdog

A bipartisan Congressional watchdog panel reviewing the government's bailout of American International Group Inc. (NYSE: AIG) has raised doubts about whether U.S. taxpayers "will ever be repaid in full," and concluded that the U.S. Federal Reserve didn't act aggressively enough during the 2008 rescue.

In a lengthy report, the Congressional Oversight Panel also said the bailout had a "poisonous" effect on the U.S. financial system because it demonstrated the government would protect Wall Street firms from their own risk-taking.

The Federal Reserve could have acted earlier to find a privately funded solution for New York-based AIG before deciding on a rescue that transformed banks' financial bets into fully guaranteed government obligations, the panel said.

"The AIG rescue demonstrated that Treasury and the Federal Reserve would commit taxpayers to pay any price and bear any burden to prevent the collapse of America's largest financial institutions and to assure repayment to the creditors doing business with them," said the panel, led by Harvard University law professor Elizabeth Warren.

The Federal Reserve Bank of New York and the Treasury Department have committed up to $182.3 billion to prop up AIG, with roughly $132 billion of those funds already spent. AIG is to repay about $101 billion mainly through asset and stock sales, and the rest is to be raised by liquidating mortgage securities the New York Fed took onto its balance sheet.

While the rescue of AIG helped to keep the financial system afloat, the government "failed to exhaust all options" before committing taxpayer funds to AIG, the report said. The panel argued that the government could have done more to execute the bailout with private-sector funds or concessions from other financial institutions that ended up benefiting from the AIG bailout.

The report criticized the controversial decision by the New York Fed in late 2008 to pay off in full AIG's trading partners, including Goldman Sachs Group Inc. (NYSE: GS), on $62 billion in soured mortgage trades, saying the move "distorted the marketplace" and protected AIG creditors at taxpayers' expense.
"Billions of taxpayer dollars were put at risk, a marketplace was forever changed, and the confidence of the American people was badly shaken," the report said.

The report blames regulators and AIG management for AIG's near-collapse. At the time, the New York Fed was scrambling to come up with a plan to salvage Lehman Brothers Holdings Inc., which failed Sept. 15, 2008, a day before the AIG rescue was announced.

"By the time the Federal Reserve Bank reversed that approach, leaving Lehman to collapse into bankruptcy without help and concluding that AIG posed a greater threat to financial stability, time to explore other options was short," the panel said.

Treasury spokesman Andrew Williams said that the panel's suggested alternatives overlook the fact that "the global economy was on the brink of collapse" at the time and that the Fed had "only hours" to make critical decisions.

A Fed spokesman told The Wall Street Journal that the central bank believes the actions it took to rescue AIG were necessary and disagrees with "the view that there were any better alternatives that were workable in the extreme circumstances of the time. He added that policymakers need "much better tools for dealing with such situations in the future."

Any prospect for recovering the bailout funds depends heavily on the ability of AIG to find buyers for its units and on investors' willingness to purchase shares if the Treasury Department sells its holdings. AIG turned over a stake of almost 80% as part of the bailout and the Treasury holds additional preferred shares from subsequent investments.

"If everything goes gangbusters, we will get paid back," Warren said yesterday (Thursday) in a Bloomberg Television interview. There is still a "lot of risk for the American taxpayer."

British insurer Prudential PLC recently scrubbed its plan to buy AIA Group Ltd., AIG's biggest Asian life insurance business for $35.5 billion, a setback to AIG's efforts to repay taxpayers.

Jim Millstein, the Treasury's chief restructuring officer, told the panel on June 2 that AIG should be able "to realize value equivalent to the $35.5 billion" price by implementing a strategy that could include an initial public offering of the overseas unit.  Millstein also said AIG needs to map out an updated strategy in the coming months to repay the government.

The bailout includes a $60 billion Fed credit line, an investment of as much as $69.8 billion from the Treasury Department and up to $52.5 billion to buy mortgage-linked assets owned or backed by the insurer through swaps or securities lending.

AIG owes about $26.6 billion on the credit line and $49 billion to the Treasury. The company returned to profit in the first quarter, posting net income of $1.45 billion.

"I'm confident you'll get your money, plus a profit," AIG Chief Executive Officer Robert Benmosche told the panel in Washington on May 26. "We are a strong, vibrant company."

News & Related Story Links:

• Bloomberg:
  AIG's Rescue Had 'Poisonous' Effect, U.S. Panel Says
• Wall Street Journal:
  U.S. Faces 'Severe' AIG Losses, Says Panel
• Money Morning:
  Delay in Prudential's Deal for AIG's Insurance Unit Threatens U.S. Debt Repayment
• Money Morning Archives:
  AIG Bailout Category