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I have been thinking about the AIG bonuses and the (justifiable) outrage that has boiled over and brought us to the point of reaching critical mass. In the grand scheme of things, the bonuses are small potatoes. After all, what is $165 million when compared to the $170 billion that has been poured into propping up the floundering, mismanaged giant? My husband’s hypothesis on the outpouring of anger is that it is a number we can comprehend and doesn’t make the eyes glaze over, combined with a reward for failure that exceeds what the vast majority of people make for working their asses off in essential jobs. “Yeah, giving those fuckers bonuses is about as offensive as it can get. But the real question is, can AIG repay the bailout loans they have already received?” I thought when he said it that he was likely spot on, but that is not unusual. If he isn’t the smartest person I have ever met, he is damned close.
Yesterday, in testimony before Congress, the director of the GAO’s financial markets division confirmed that his assessment was right. AIG has not been successful in restructuring efforts, even though we, the taxpayers, have given them $170 billion in bailout loans, and according to a new GAO report that was released yesterday, the company will not be able to pay us back.
Federal financial assistance to AIG, both from the Federal Reserve and FRBNY through their authority to lend funds to critical non-bank entities in certain circumstances and from Treasury’s TARP, has focused on preventing the systemic risk that could result from a failure or further rating downgrade at AIG. The goal of the initial assistance and subsequent restructurings was to prevent systemic risk from the failure of AIG by allowing AIG to sell assets and restructure its operations in an orderly manner. The Federal Reserve has been monitoring AIG’s operations since September, and Treasury will more actively monitor AIG’s operations as well. Although the ongoing federal assistance has prevented further downgrades in AIG’s credit rating, AIG has had mixed success in fulfilling its other restructuring plans, such as terminating its securities lending program, selling assets, and unwinding its AIG Financial Products (AIGFP) portfolio. For example, AIG has made efforts at selling certain business units and has begun an overall restructuring, but market and other conditions have prevented significant asset sales, and most restructuring efforts are still under way. AIG faces ongoing challenges from the continued overall economic deterioration and tight credit markets. AIG’s ability to repay its obligations to the federal government has also been impaired by its deteriorating operations, inability to sell its assets and further declines in its assets. All of these issues will continue to adversely impact AIG’s ability to repay its government assistance. Table 1 provides an overview of the total federal investment in AIG of $182.5 billion as of March 2, 2009.
Conversely, state insurance regulators, insurance brokers, and insurance buyers said that while AIG may be pricing somewhat more aggressively than in the past in order to retain business in light of damage to the parent company’s reputation, they did not see indications that this pricing was inadequate or out of line with previous AIG pricing practices. Moreover, some have noted that AIG has lost business because of the problems encountered by the parent company. As we evaluate these issues, we face a number of challenges associated with determining the adequacy of commercial property/casualty premium rates. For example, the terms of the policy are often negotiated, and pricing adequacy is ultimately determined by future losses.
While AIG is commonly thought of as an insurance company, ‘holding company’ is a better description, and the subsidiaries of the company are engaged in the underwriting of insurance policies and insurance-related activities. Those subsidiary companies control a huge swath of the global insurance markets, as well as retirement services, financial services and asset management.
The financial services division is the diseased organ that imperils the entire system. The patient appeared perfectly healthy one minute, but got sick quick and deteriorated rapidly.
From July 2008 to August 2008, ongoing concerns about AIG’s securities lending program and continuing declines in the value of super senior collateralized debt obligations (CDO) protected by AIGFP’s super senior credit default swap (CDS) portfolio, along with ratings downgrades of the CDOs, resulted in AIGFP having to post additional cash collateral, which raised liquidity issues.2 By early September, collateral postings and securities lending requirements were placing increased pressure on the AIG parent company’s liquidity. AIG attempted to raise additional capital in September but was unsuccessful. It was also unable to secure a bridge loan through a syndicated secured lending facility. On September 15, 2008, the rating agencies downgraded AIG’s debt rating three notches, resulting in the need for an additional $20 billion to fund its additional collateral demands and transaction termination payments. As AIG’s share price continued to fall following the credit rating downgrade, counterparties withheld payments and refused to transact with AIG. Also around this time, the insurance regulators no longer allowed AIG’s insurance subsidiaries to lend funds to the parent under a revolving credit facility that AIG maintained and demanded that any outstanding loans be repaid and that the facility be terminated.
The aid poured into AIG has been focused on preventing the systemic risk that a potential AIG failure could precipitate, but because restructuring efforts have been unsuccessful, AIG is unlikely to be able to repay the loans it received from the taxpayers.
Officials with both Treasury and the Federal Reserve have said that further downgrades of AIG’s credit worthiness and additional collateral calls would result in liquidity concerns cascading throughout the financial markets. A chaotic dissolution of AIG would undermine confidence in and uncertainty about the viability of other financial institutions, and that would ripple all the way through the economy, which would in turn constrict the availability of credit to households and businesses, and as a result the recession we are in would deepen – and take longer to pull out of. If the ultimate goal is avoiding the failure of AIG, the Federal Reserve and Treasury have achieved that goal in the short-term. However, maintaining solvency has required federal assistance beyond that provided in September and November 2008, and rating companies have stated that their current ratings are contingent on continued federal support for AIG. AIG and federal regulators acknowledge that there may be a need for further assistance given the significant challenges AIG continues to face. Therefore, more time is required to determine if the goal will be fully achieved in the long-term.
CDS portfolio, (2) terminating its securities lending program, and (3) selling assets. Federal assistance was targeted to the first two areas that posed a significant risk to AIG’s solvency-AIGFP’s CDS portfolio and the securities lending program-and the risks from both activities appear to have been reduced, but some risks remain. One arrangement, Maiden Lane III-the FRBNY facility created to purchase CDOs-has purchased approximately $24.3 billion in multi-sector CDOs (with a par value of approximately $62 billion), which were the assets underlying the CDS protection that AIG sold. Concurrent with the purchase of the underlying CDOs, AIGFP counterparties agreed to cancel the CDS written on the CDOs, thus unwinding significant portions of AIGFP’s CDS portfolio.
According to AIG, some arrangements did not qualify for sale to the facility, genera
lly either because the counterparties did not own the instruments on which CDS were written or because they were indenominations other than U.S. dollars. As of February 18, 2009, approximately $12.2 billion in notional amounts of CDS remained with AIG. According to AIG, these remaining CDS continue to present a risk to AIG, as further losses from these assets could require additional funding. A second FRBNY facility-Maiden Lane II-purchased approximately $19.5 billion in RMBS and other assets related to the securities lending program. Both the Maiden Lane II and Maiden Lane III facilities allow AIG to participate in the residual proceeds after the FRBNY loan has been repaid. However, AIG faces other potential losses from other investments.The federal assistance has allowed AIG to undertake restructuring efforts, which continue. As of September 2008, AIG was to wind down the operations of AIGFP and sell certain businesses. In October 2008, the company announced plans to sell some of its life insurance operations and other businesses. AIG is continuing to wind down AIGFP but expects the process to take at least several years in order to avoid further losses given the current market conditions. AIG has been unable to sell its insurance assets for prices it deems acceptable given the general state of the global economy. As a result, the plan has been modified, and the federal government will now assume an ownership interest in some of AIG’s life insurance companies. The federal government’s ownership stake will be apercentage of the fair market value of these companies based on valuations acceptable to the Federal Reserve. In addition, AIG plans to consolidate its commercial property/casualty insurance operations in a free-standing entity and potentially offer an equity interest in part of this new entity to public investors.
Liquidating assets has been a steep challenge, not only because lending has all but stopped, limiting the ability of buyers to obtain the capital needed to purchase assets. In addition, the timely sale of CDOs and RMBS held by the Federal Reserve facilities will be challenging, not only because it may be difficult to value those assets, but because many are tied to home values, which have been in decline. This all comes together to make it very difficult for AIG to meet it’s obligations and repay the loans it has received to date. AIG’s ability to repay the federal government hinges on it remaining solvent and effectively restructuring the organization, including the sale of subsidiaries.
*****
Now as I have said repeatedly in the past, Econ is far, far, far out of my wheelhouse. I know just enough to make me dangerous. When I was a college student nearly thirty years ago, I took the two Econ classes that everyone who wanted to graduate had to take, and promptly forgot what I had learned as soon as I turned in my final exam.
But even still, I should hope that it is obvious by now that we don’t need less regulation of banking and markets, but instead we need a hell of a lot more. And no company that wants to retain claim to the mantle ‘private entity’ should ever be allowed to become “too big to fail.”
The free-for-all of the last 28 years have brought us to the brink of disaster, and now we are all on the hook if we want to continue any semblance of the lifestyle we have come to expect we are entitled to.
Did we learn out lesson this time?