Wednesday, November 12, 2008

AIG - Bailing Out the Bailout... Again

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The New York Investing meetup has repeatedly said in its meetings that there is no such thing as one bailout for an insolvent financial company. If Fed Chair Bernanke or Treasury Secretary Paulson belonged to the group they might have realized that Dow stock AIG was likely to turn into the bailout black hole of taxpayer funding that it has become. AIG is now on its third government bailout in less than two months. In mid-September, it had originally requested a loan of $40 billion from the Fed which was turned down. Days later the Fed bought 80% of the company for $85 billion. (see our September 17th blog entry: The People's Republic of the U.S. - the AIG Bailout). The government had to throw in an additional $38 billion in October to keep the company afloat. AIG then reported a $24.5 billion loss, 80% owned by the American taxpayer, for the third quarter in early November and this necessitated the bailout to be totally restructured.

After the initial bailout, the federal government issued assurances that its actions had stabilized AIG - and indeed it did for a whole few weeks (the approximate see ahead time for the visionaries that currently run the U.S. Treasury department and Federal Reserve). Unfortunately, the way the government stabilized AIG helped destabilize the market. This occurred because there seems to have been a high interest attached to AIG's government funding, which was treated as a loan even though it involved the purchase of common stock. While this apparently makes no sense whatsoever, we are dealing with the government here so don't expect the ordinary rules of financial logic to apply. This high interest rate forced AIG to dump a lot of securities on to the market in late September and early October helping to exacerbate the post-Lehman bankruptcy meltdown that took place during that time.

In the $150 billion AIG bailout part 3, the amount of funding from the Fed will be reduced to $60 billion and the interest rate on this loan will be lowered as well. An additional $40 billion will come from TARP, aka the Wall Street welfare bill, for the purchase of preferred shares in AIG. The Treasury for once correctly stated that this would not increase the government's ownership in AIG, although Treasury has previously indicated that preferred stock, which is a perpetual loan, represented ownership rights in a company. Paulson has also indicated that funds from TARP would only go to 'healthy companies', not failing companies such as AIG (this of course begs the question of why a 'healthy company' would need government assistance). The government will also be funding a $20 billion dollar buy back of residential mortgage securities that AIG insures and $30 billion dollars for the purchase of collateralized debt obligations (CDOs) for 5o cents on the dollar. It is CDO exposure that has financially ruined the company.

AIG has taken $100 billion or so in write downs so far. Its exposure to insurance for fixed-income investments fell from $441 billion to $372 billion after the governments first injection of $85 billion. Based on these figures, my guess is the the upper limit for bailing out the company is somewhere around $400 billion. Assuming of course they can cut down on using taxpayer funds for spa treatments for their executives and the one-million dollar a month payments they are making to former management who's decisions helped destroy the company.

NEXT: U.S. Market Tests Low as Global Recession Predicted

Daryl Montgomery
Organizer, New York Investing meetup

This posting is editorial opinion. Like all other postings for this blog, there is no intention to endorse the purchase or sale of any security.

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