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The Fall of AIG

Boy, who would have ever thought the last-minute bailout of Bear Stearns back in March would end up being one of the more minor financial interventions we'd see this year?

In just the past 11 days, the government was forced to take over or seal the fate of:

  • The two largest mortgage companies in the world.
  • The fourth-largest independent investment bank in America.
  • One of the largest insurance companies in the world.

AIG (NYSE: AIG  ) -- facing an inevitable collapse without a huge cash injection -- finally got the gift it needed late Tuesday night after the Federal Reserve agreed to provide an $85 billion credit facility that'll prevent what would have been by far the largest bankruptcy in history, sending the markets into unimaginable panic.

Terms of the deal are very similar to the recent bailout of Freddie Mac (NYSE: FRE  ) and Fannie Mae (NYSE: FNM  ) -- I'm willing to bet they just used the same paperwork. In return for the loan, the government will get warrants to purchase 79.9% of the company's common stock, diluting existing investors into oblivion. CEO Robert Willumstad will be replaced by former Allstate (NYSE: ALL  ) CEO Edward Liddy.

Geesh … another bailout?
Shocked? You should be. Until late Tuesday afternoon, Treasury Secretary Hank Paulson was adamant that he had no intention of using taxpayer money to bail out the struggling insurance company. The original plan was to facilitate a credit line through Goldman Sachs (NYSE: GS  ) and JPMorgan Chase (NYSE: JPM  ) , but both firms appeared to have scoffed at the idea. Option two, as most predicted, was bankruptcy.

Why the sudden change of heart? I have a few thoughts. First, while this is certainly a bailout by any measure, let's not get too carried away with what that implies: There's a good chance taxpayers will get paid back every penny they put into this deal, and then some. With the government's warrants on nearly 80% of the company, there's actually a good chance taxpayers will turn a handsome profit on the deal.

The reason is that AIG isn't insolvent, it's illiquid. The difference: Someone with $1,000 in debt and $100 in the bank is insolvent; someone with $1,000 in debt and a farm worth $100,000 that'll take six months to sell is illiquid. With the Fed's credit facility, AIG will now have the liquidity to start selling assets at a non-fire-sale pace, with the proceeds going first and foremost toward paying off the government's loan. Knowing that taxpayers' downside is largely protected surely made Fed Chairman Ben Bernanke and Paulson's decision a little easier.

Second, we need to realize how catastrophic an AIG bankruptcy would have been. Not only is it hundreds of billions of dollars larger than Lehman Brothers (NYSE: LEH  ) , but AIG has its financial tentacles in nearly every corner of the globe. With everyone already hot and bothered by Lehman's collapse, AIG's failure would have tested the global financial market's flexibility past the breaking point. You can whine and moan all you want about "yet another government bailout" -- and you're absolutely right -- but Paulson and Bernanke really had no choice on this one.

What a week
Let's just hope AIG's bailout marks the final chapter of the recent financial meltdown. Of course, we'll keep you updated throughout the week on these incredible stories. For more on this week's events, check out "The Biggest Financial Story in 50 Years" for a collection of Motley Fool articles surveying these crazy times.   

For related Foolishness:

Fool contributor Morgan Housel doesn't own shares in any of the companies mentioned in this article. JPMorgan Chase is a Motley Fool Income Investor recommendation. The Fool has a disclosure policy.

Read/Post Comments (9) | Recommend This Article (23)

Comments from our Foolish Readers

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  • Report this Comment On September 17, 2008, at 2:26 PM, farmerellis wrote:

    "Boy, who would have ever thought the last-minute bailout of Bear Stearns back in March would end up being one of the more minor financial interventions we'd see this year?"

    Peter Schiff

    Doug Casey

    John Mauldin

    Nouriel Roubini

    And there are several others.

  • Report this Comment On September 17, 2008, at 2:38 PM, TMFCop wrote:

    Morgan, I love you, man, but I gotta disagree that seizing control over AIG was the only option Treasury had.

    In fact, there were a number of alternatives readily available: Hank Greenberg had made overtures to buy the company while others may have been willing to take on various portions of the business. There was also the Lehman option: let it fail.

    Would there have been pain involved in letting it go bankrupt? Sure, but that's because others have been feasting at the trough like pigs themselves.

    The fact that taxpayers may make a buck on the takeover isn't an argument in favor of the seizure, but rather against it! That shows there was still a lot of value that other private interests, not the taxpayers, would have been willing to take on.

    And since AIG was not insolvent, but just illiquid, then what we've done is open a Pandora's box for other ailing (though not terminal) industries considered "too big to fail" to begin lining up for their handouts. In fact, the line is already getting long.

    Can we allow the vestiges of the once vaunted U.S. auto industry go under? Will our economy still move if the planes can't fly? What if newspapers, considered by no one less than Thomas Jefferson as the hallmark of a free society, can no longer make it (in fact, the venerable Star-Ledger in NJ may end up going under very soon)?

    The fact is, no one should be too big to fail. I understand there is fear that AIG's collapse would have brought about greater calamities, but then again, forcing the sale of Bear Stearns, seizing Fannie & Freddie, and letting Lehman unwind itself were all supposed to forestall further implosions.

    Apparently that's not happening and it doesn't look so good that seizing AIG is going to stop it either. Instead, it simply looks like taxpayers are going to continue to be put on the hook for billions and billions of dollars as the ripples continue to spread.

    There were other choices; Paulson just chose not to take them.


  • Report this Comment On September 17, 2008, at 3:09 PM, TMFTomGardner wrote:

    Rich, I think your comment presupposes that Greenberg et al could have brought funds together AND arrived at a satisfactory deal quickly enough to save AIG from its illiquidity.

    Greenberg's history (cf. SEC investigation) along with his posturing over the past week (cf. "AIG is a national treasure whose equity value should be preserved) sealed his fate.

    Why would Paulson or anyone else at AIG negotiate in good faith with someone who was likely to demonstrate rampant self-interest. . .at a time when so many counter parties relied on AIG?

    I give the regulator guys an A+ on their performance to date. I think the reward for using taxpayer money to stave off a total collapse of AIG should be upside for the taxpayer.

    As you say, Rich, there IS value in AIG. I just don't think private interests could've gotten the financing and structured a deal quickly enough to warrant waiting. Paulson did what had to be done. . . while doing so in a best-faith effort to protect the taxpayer.

    Which is all my way of saying that I think Morgan hit the nail on the head with this article. Fool on. - TomG

  • Report this Comment On September 17, 2008, at 3:10 PM, cmfhousel wrote:


    I hear ya man, there's nothing pretty about another bailout. I think most people who read my stuff know this stuff makes me sick. But I'm gonna have to disagree with you on the "other options." AIG needed cash quickly before facing bankruptcy. Hank Greenberg wanted to buy the company … where's he going to get $85 billion in a 24-hour period? He himself said on CNBC yesterday that what AIG needs is a loan and time. Could it have sold parts of itself, like aircraft leasing, and raised money? Yes, but not in a matter of hours. There were three options on the table last night, 1) Loan from GS & JPM, 2) Bridge loan from the Fed, or 3) Bankruptcy.

    I also agree, no one *should* be too big to fail, but the fact is they are. Using taxpayer money to bail these guys out is ugly, but is it the lesser of two evils? I firmly believe it is.

    Passing the baton,

    Morgan Housel

  • Report this Comment On September 17, 2008, at 3:15 PM, CIOLLI wrote:

    What does this mean to stock holders if the government gets warrants to purchase 79.9% of the stock?

  • Report this Comment On September 17, 2008, at 3:36 PM, Tshamz wrote:

    I'm curious if now would be a good time to buy into AIG, what with the stock price so low and their big bail out they just secured. (Assuming someone who bought right now would be willing to wait 3,5,10, N number of years for AIG to return to its regular form, and its stock price to recover) Is this a somewhat plausable scenario or is that just a somewhat bad idea, and why?

  • Report this Comment On September 17, 2008, at 4:02 PM, Rdn933 wrote:

    Five hundred million shares traded hands today so far. There are as many buyers (investors, speculators) willing to see a bright future eventually as there are sellers running for their financial lives. This mess too shall pass.

  • Report this Comment On September 17, 2008, at 7:53 PM, EScroogeJr wrote:

    What they did was absolutely abominable. If it were not for their interference, I would buy DJIA at 7000. Now thanks to Bennie and Hankie I will have to keep buying the same stocks at a 50% premium. This means that for the same money, I will get less shares. Twenty years from now, when the shares I couldn't buy today will be worth several times more, this will translate into many thousands of dollars I could have earned but did not thanks to these corporate welfare types. The free market was ready to give me this money, but Bennie and Hankie decided to rescue their business buddies at my expense. To call things by their proper names, they simply picked my pocket. And it is amazing that a service for people looking to buy, rather than sell, stocks, should defend socialist policies designed to increase our cost basis.

  • Report this Comment On September 17, 2008, at 10:59 PM, dividendgrowth wrote:

    The rate AIG pays for that government loan is about as high as a credit card, and it costs 80% of the company.

    US government (and tax payers) really got a pretty good deal.

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