AIG's Bailout -- Take Two

AIG’s (NYSE: AIG  ) original $85 billion rescue package (augmented by $37.8 billion) has been scrapped as the giant insurer's condition continues to deteriorate, including the astounding $24.5 billion quarterly loss it announced today. The new package is worth – drumroll, please – a round $150 billion.

The government’s false start
The original package fizzled because of increasing margin calls from AIG’s counterparties (which include Goldman Sachs (NYSE: GS  ) and Morgan Stanley) on credit default swaps. The plan also called for a prompt sale of non-insurance activities; unfortunately, there are few buyers in this market (not at full value, in any case).

The original terms of the government’s loan were punitive -- 8.5% over the interbank rate for funds that AIG drew down, 8.5% for funds available under the facility but not used. It soon became clear that AIG would have a very tough time meeting those hefty interest payments. The interest rate is now set to drop to 3% over the interbank rate. See how AIG’s original bailout compares to large postwar financial bailouts in the table below:

Bailout

Package Details

Result

2008: Fannie Mae, Freddie Mac

Treasury purchases $1 billion in newly issued preferred shares, paying a 10% dividend, and receives warrants to acquire 79.9% of outstanding common shares at essentially no cost.

Ongoing

1984: Continental Illinois Bank (seventh largest bank in the U.S. at the time)

FDIC purchases $1 billion in newly issued preferred shares to re-capitalize bank, as well as $3.5 billion in distressed loans at adjusted book value, $2 billion of which had been reduced by two-thirds from its carrying cost.

$720 million of the preferred shares issued were convertible into 80% of the common stock, giving the FDIC effective control over Continental Illinois.

Original shareholders were wiped out after five years. The bank was re-privatized gradually in public share sales. Acquired by BankAmerica in 1994 (now Bank of America (NYSE: BAC  ) ).

Estimated cost to the taxpayer: $1.1 billion -- 3.25% of the bank’s assets.

1974: Franklin National Bank (20th largest bank in the U.S. at the time)

Borrowed extensively from Fed discount window at below-market rates (ultimately as much as half of the bank’s funding!).

Franklin National never returned to profitability and was eventually sold to a bank with an FDIC guarantee against losses.

The FDIC experienced a “moderate” loss.

AIG and beyond
AIG is an example of one of the risks inherent in a government bailout: becoming bogged down in a money quicksand pit. Just as in its natural counterpart, flailing about to solve a financial crisis will only add to the predicament. Thankfully, version two of AIG’s bailout looks more deliberate than the first -- it gives the insurer more time to sell assets, which should ultimately translate into better prices. Since we taxpayers effectively own 80% of the insurer, we like better prices.

All the same, it’s a warning that the government should only extend its bailout to non-banks such as CIT Group (NYSE: CIT  ) and GE Capital (part of General Electric (NYSE: GE  ) ) -- not to mention automakers Ford (NYSE: F  ) and General Motors (NYSE: GM  ) -- if it can show that there are overwhelming systemic risks involved.

More Foolishness:

What now? The Motley Fool is here to answer your questions about this financial crisis. Send us an email at AsktheFool@fool.com, and check back at Fool.com as we answer your questions and cover the latest on the Panic of 2008.

Alex Dumortier, CFA has no beneficial interest in any of the other companies mentioned in this article. Bank of America is a Motley Fool Income Investor pick. Try any of our Foolish newsletters today, free for 30 days. The Motley Fool has a disclosure policy.


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  • Report this Comment On November 11, 2008, at 10:34 AM, JasonApolloVoss wrote:

    Who could have seen the AIG meltdown coming? Well, interestingly enough there is one tell-tale sign that always underlies these sorts of colossal problems; from Enron, to Tyco, to Worldcom, to AIG. That tell-tale sign is: hubris.

    Hubris is a behavioral disease that leads to extraordinarily bad judgments being made. Hubris is another way of saying that someone is extremely selfish and self-centered. What that means in the context of managing a business is that decisions are not made for the good of the shareholders, or even of the business. No, instead, decisions are made to feed the bottomless pits of very weak egos. The problem is that the holes in these executives’ lives come from within, but they have each decided to try and fill that hole externally. In the short and medium-term that’s a great thing for shareholders because these folks are usually very, very driven. That means that Jeff Skilling, Dennis Kozlowski, Bernie Ebbers and Hank Greenberg all did things to increase the success and, more importantly, grandiosity of their businesses. However, as the disconnection between a hugely successful business and a still deep-seated feeling of personal vacancy grows, the executives of these firms take even bigger chances. That is, they start doing things that are illegal in a desperate need to fill their hole. It’s as if they are ego-addicts and they need ever greater hits to feel good about themselves. [Feets don’t fail me now!]

    In the case of AIG, and the current situation, Hank Greenberg has been gone for 4 years, however he had nearly a half century to create the corporate culture that permeates the structure of AIG. Yikes! And how do I know all of this? I am a retired financial professional whose firm was one of the top 5 largest shareholders of both Tyco and AIG. While my firm was one of the largest shareholders of these two companies, I steered clear of Tyco in my mutual fund because Kozlowski always made me very uncomfortable because of his obvious personal insecurities and massive pay package. I wish that I could say the same thing about AIG, but I blew it for my shareholders there. I am confident that I would no longer make the same mistake, though. Why?

    In our business-culture we love for our executives to have swagger. And there is a fine-line between swagger and hubris. But now I know definitively the difference and the signs that reveal the difference. Those executives possessed of hubris are derisive and insulting to those who question them, whereas those with swagger are not. I distinctly remember being a participant in AIG conference calls and having Hank Greenberg insult, cut down and chastise intelligent, experienced analysts that had asked good questions. This is inexcusable behavior. Also, AIG used to be one of the only firms on all of Wall Street that did not host analyst conference calls. And when, under tremendous shareholder pressure, they finally started hosting calls the firm did not have a Q&A section at the end of the call! Remarkable.

    So as investors we should all be on the lookout for the evidence of hubris: insulting behavior whose intention is to degrade others in an effort to prop up the insultor. In AIG’s case hubris has cost the United States $150 billion! Buyer beware.

    And who am I? I am Jason Voss, the retired Portfolio Manager of the Davis Appreciation & Income Fund. Over the course of my tenure as the Fund’s manager I bested the NASDAQ by 77.0%, the S&P 500 by 49.1%, and the DJIA by 35.9%. I was also a Lipper #1 ranked fund manager and was one of Morningstar’s analyst’s picks. Last month, at the insistence of close friends, family members, and former associates I began my own blog that can be found at http://jasonapollovoss.blogspot.com. In my efforts to increase traffic I humbly ask for a little bit of your time. Please check out the Blog. In addition to discussing hubris, you will see extensive postings about the true underlying causes of this “financial” crisis, as well as when you can expect financial markets to stabilize. Thanks for your attention and have a brilliant day!

    Jason

  • Report this Comment On November 11, 2008, at 6:11 PM, ckgz wrote:

    I'm having a hard time coming up with the $150 B in the bailout numbers. The number should be a good bit less than that if the restructuring is correct. I actually thought that this reduced the amount of capital that they borrowed or "had access to". Also a lot of what they had access to they did not use so that is being returned or restructed into another entity. I think that someone used some "new math" to sensationalize the effect. Am I wrong or does anyone have better information on this?

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