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:


Package Details


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.


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.

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