AIG - Bailing Out the Bailout... Again

The 'Helicopter Economics Investing Guide' is meant to help educate people on how to make profitable investing choices in the current economic environment. In addition to the term helicopter economics, we have also coined the term, helicopternomics, to describe the current monetary and fiscal policies of the U.S. government and to update the old-fashioned term wheelbarrow economics.

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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
http://investing.meetup.com/21

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.

When the Lender of Last Resort Becomes the Only Resort

The 'Helicopter Economics Investing Guide' is meant to help educate people on how to make profitable investing choices in the current economic environment. In addition to the term helicopter economics, we have also coined the term, helicopternomics, to describe the current monetary and fiscal policies of the U.S. government and to update the old-fashioned term wheelbarrow economics.

Our Video Related to this Blog:

In the current credit crisis, central banks and governments in the U.S. and Europe are making the transition from supporting the financial system to becoming the financial system. There seems to be no ruined financial company that governments won't bail out (at least if its large enough or if the impact of its failure would have some significance), nor any limit to the amount of money that central banks will lend. The complete dependency relationship on governments that now exists among financial institutions is the ultimate outcome of Moral Hazard - banks have repeatedly been bailed out in the past, so they take on greater and greater risks until a total systemic failure takes place requiring a government takeover.

The latest bank bailouts include UBS last week and ING this weekend. After UBS declared a surprise profit, the Swiss government announced it would be injecting up to $60 billion into the bank and would get a 9% stake in return (apparently the Swiss government doesn't even believe their accounting figures). The UBS bailout was predicted long ago by the New York Investing meetup. The Dutch government today announced it would be giving ING Groep NV $13.4 billion in exchange for non-voting preferred stock, but would nevertheless be getting two seats on the board. Yesterday, the Korean government announced a blanket $100 billion backing for its bank's foreign currency debts.

As for cash injections into the financial system, these hit a record last week in the U.S. with banks and dealers direct borrowing from the Fed reaching $438 billion per day. This was up from the $420 billion per day the week before. The only Fed program that had less lending last week was the one that allows banks to purchase asset backed securities ($123 billion versus $139 billion the previous week). The U.S. Treasury sold $499 billion in T-bills for the Fed's Supplementary Finance Account to support all of this lending. Meanwhile, the Bank of England started implementing a new framework to provide emergency funds to banks. The new facility cuts the penalty for banks borrowing funds directly from it overnight. Why go elsewhere under those conditions? Ditto in the U.S. where funds from the Fed are plentiful and cheaper than can be gotten elsewhere.

If only one government was engaging in increased lending, a case could be made that it could borrow the money from other more financially sound countries. However, in the current crisis, all the developed countries are increasing available funds substantially. They do so by selling bonds. But if everyone is selling more bonds, who's left to buy them? Only an increase in the supply of the world's major currencies can make this possible, which means they are all being devalued in this crisis. By how much, only time will tell.

NEXT: The Fed Should Be Careful What It Wishes For

Daryl Montgomery

Organizer, New York Investing meetup

http://investing.meetup.com/21

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.