On March 2, 2009, the U.S. Treasury Department and the Federal Reserve provided insurance and financial giant American International Group (AIG) with its fourth bailout—up to $30 billion in capital over a five-year term by issuing non-cumulative preferred stock to the U.S. Treasury. The cash comes from the Troubled Asset Relief Program (also known as TARP funding). The deal also improved the terms on prior capital injections and preferred stock investment in AIG by the U.S. Treasury. Estimates differ, but the bailout monies delivered to AIG now total $140 to $150 billion. Recent news reports also indicated that U.K. fraud investigators and U.S. regulators were looking through the books of AIG Financial Products Group, the Mayfair, England-based subsidiary blamed for the company's speculative trading activities. For the fourth quarter of 2008, AIG reported a net loss of $61.7 billion.
The latest bailout move is meant to boost the company's sagging capital structure and support it after significant losses attributed to the company's speculative credit default swaps business (basically bond insurance) written on collateralized debt obligations (CDOs)—all done by the tiny England-based subsidiary and serving to financially cripple the global insurance company. AIG has paid untold amounts to U.S. and foreign banks and investment firms after the value of these CDOs (bundled subprime real estate debt) tanked.
In a breaking news story reported on March 6, 2009 in The Wall Street Journal, Goldman Sachs, Deutsche Bank, Merrill Lynch, Barclays, Bank of America, in addition to a number of other U.S.-based and foreign bank and investment firms, were described as the true beneficiaries of the bailout cash sent to AIG and then immediately paid out as credit default swap money. Critics argue that government officials maintained the “too big to fail” excuse as the real reason for the bailout efforts, while basically using the bailout of AIG to prop up other lagging banks and investment firms. As taxpayers tire of the old to big too fail argument and wonder about the transparency in this process, the AIG story provides a bit of a twist. The U.S. federal government now sits on 79 percent of AIG stock, making it the largest shareholder in the company.
AIG isn't new to criticism. In 2004, former AIG CEO Hank Greenberg faced down then New York State Attorney General Eliot Spitzer over a sweeping antitrust suit, with Greenberg eventually stepping down from the company's helm in 2005. Greenberg is now pressing a claim against his former employer, alleging securities fraud at AIG. He is listed as the largest individual shareholder in AIG, but far behind the U.S. government's ownership in the company.
According to Greg Waymire , a chaired professor of accounting at Emory University's Goizueta Business School , the ownership of AIG, basically the nationalization of the company, is unprecedented. However, he does question whether or not the U.S. government can effectively manage such a large and complicated business. Waymire also notes that the ability of AIG to repay the debt owned to the U.S. Treasury is difficult to assess, but that the company's suggestion that it may be in need of additional bailout funds does not bode well for the taxpayer.
While many financial experts look to place some of the blame on mark-to-market accounting for the woes at AIG, Citigroup, Bank of America, and other banking institutions and investment firms, Waymire takes a different perspective. “Mark-to- market accounting may have exacerbated the financial problems, but it certainly didn't cause this mess,” says Waymire. Mark-to-market accounting merely made financial institutions show the fluctuating and shrinking value of risky and less liquid investments, he notes.
Instead, Waymire points to the years of artificially low interest rates set by the Federal Reserve during Alan Greenspan's tenure. The relatively free money sent financial institutions into a lending and investing frenzy, he says, spurring banks and S&L's to give mortgages to people who couldn't afford the debt. He notes that it was the “perfect storm” for creating financial crisis—a combination of bad loans with considerable defaults, exotic and speculative financial instruments or derivatives based on this bundled real estate debt, the downturn in the economy, and minimal capital reserves at financial institutions to cover potential losses.
What's Driving the Bailout?
Raymond Hill , assistant professor in the practice of finance at Goizueta, believes that the U.S. Treasury and Federal Reserve's fear of the unknown did play into the bailouts, given the financial contracts that the insurance behemoth writes for companies and other financial institutions across the globe. Now that the taxpayer basically owns the company, Hill does not see bankruptcy as an attractive alternative. Instead, he says, it would be better for the U.S. government to continue to support AIG in an orderly restructuring to realize the highest value for the American taxpayer.
That appears to be the next step for the company. On March 2, AIG announced its intention to create an insurance holding company to be known as AIU Holdings, which would comprise its commercial insurance group, foreign general unit, and other property and casualty operations. The establishment of AIU Holdings will assist AIG in preparing for the potential sale of a minority stake in the business, which ultimately may include a public offering of shares, depending on market conditions.
AIG also announced the possibility of a combination of its domestic life and retirement businesses—the more profitable and attractive pieces of the company. In a press release dated March 2, 2009, Edward M. Liddy, chairman and CEO for AIG, noted, “The ultimate success of our restructuring plan centers on ensuring that the unique businesses that make up AIG can thrive on their own. While this process may take up to several years to complete, we will ultimately create stronger, sounder businesses worthy of investor, customer, and regulatory confidence.”
Subsidiary companies ALICO and American International Assurance may also be divested through a public offering of common shares of stock. But the Federal Reserve Bank of New York, which previously lent some $85 billion to AIG in October 2008 under the direction of the U.S. Treasury, will receive preferred interests in these two companies as repayment of a portion of the previous bailout funds.
Kevin M. Crowley , adjunct lecturer of finance, admits that the AIG debacle is an ugly and complicated affair. And while few would deny that AIG's speculative activities are the undoing of the firm, the importance of this global insurance player, he notes, does mean that the company needs to be rescued. However, Crowley adds that it remains difficult to objectively assess what the government should and shouldn't have done in the given situation. “Certainly, much of the previous negotiations with AIG were handled behind closed doors and the public wasn't privy to the details,” he says. “It's the lack of transparency that is probably more problematic than the actual bailout moves. The government can argue that AIG is too large and too important to go under, but it's hard to get people to agree with the statement without knowing the exposures involved.”