We cannot say we’re shocked that the Federal Reserve and the Treasury swooped in to take over the
American International Group US Department of Insurance. We began reporting that a takeover was under consideration shortly before two in the afternoon. But to say we expected this takeover is not to say we understand it.
We’re told that this was necessary because the failure of AIG posed a systemic threat to the financial system. This gives rise to a riddle, however. If the financial system was threatened, why wouldn’t the financial firms who were presumably staring into the abyss agree to build the bridge loan? Surely they would have had the most to lose from the collapse of AIG.
We know that the Federal Reserve and the Treasury Department worked hard to find a market based solution to AIG’s problems. Morgan Stanley was hired as an adviser. JP Morgan and Goldman Sachs were asked to organize a lending syndicate. Government officials attempted to signal that they would allow AIG to go the way of Lehman Brothers unless private funding for AIG was found. None of this worked.
It looks as if the heads of our banks and Wall Street firms called the bluff of their comrades in the government’s bank. Perhaps they never for a moment believed that the government would allow AIG to sink. Perhaps they knew that they could get New York’s public officials and foreign governments frightened enough to pressure the government to act.
Or maybe, just maybe, they understood that the dynamics of government are very different from the dynamics of business. Executives in private-sector banks (to the extent such things continue to exist) stand to make or gain an enormous amount of money when the institutions under their care profit. Incentive pay, options grants, restricted stock have somewhat aligned their interests with those of their shareholders and the profitability of their firms, reducing what the economists like to call “agency costs.”
No such incentive alignment has been undertaken with respect to taxpayers and government officials. If the money lent out to AIG is not paid back, Hank Paulson and Ben Bernanke will not suffer financially. If you ever wanted to see an agency cost roaring, the AIG takeover is your dream come true. What’s more, the deal allows government officials the rare thrill of feeling that they are not only very, very relevant, they are now the masters of the universe, the warrior kings of Wall Street.
From the perspective of, say, Jamie Dimon, it must have been obvious that the government would bail out AIG. Everything he knows about human behavior would have told him this. The bailout was overdetermined. If he was surprised, it was no doubt by the brevity of the resolve of the Treasury and the Fed not to offer up money. Remember, we reported that a takeover was in the works before 2 in the afternoon. At that point, it had been under discussion for hours.
So maybe we do understand this thing after all. One one woman recently said to us: “The only difference between Wall Street and the Titanic is that the Titanic had a band.” It’s an old joke but still clever. The Titanic might have been billed as an unsinkable ship. But it turned out it could sink. Wall Street simply believes that, while it may lose a few compartments every couple decades, it is unsinkable.
We cannot say we’re shocked that the Federal Reserve and the Treasury swooped in to take over the
Bloomberg is reporting that the US is considering a conservatorship for AIG. Their story will follow. If you’re in a rush to get the news, however, you can read our version from three hours ago.
UPDATE: Bloomberg’s story is now up.
UPDATE: CNBC is reporting that there are doubts at Treasury about the legal authority of placing AIG into a conservatorship, as we reported in our original story.
(Image via Barry.)
Rather than invoking the “WTF” call, Bank of America Securities has announced that it is dropping coverage of AIG. Sayeth BoAS:
The situation at this stage is binary and dependent on more political will than analyzable facts. While we see the value of the insurance operations being well excess of the parents liabilities, solving the liquidity issues have now entered the political realm. If the company gets into liquidation or bankruptcy the value could be significantly less than estimated. We acknowledge that the government and Fed could come up with a financing and if the situation gets clarified and lends itself again to fundamental analysis we would reconsider picking up coverage at that stage.
Bloomberg is reporting that the Federal Reserve appears to be cracking in its resolve not to bailout AIG. The Fed is considering extending a “loan package” according to a person familiar with the negotiations.
A government backstop may be available for a private financing of a bridge loan for AIG, according to a senior banker at a large international bank who is familiar with the situation. It was unclear whether the source of the bridge loan backstop would be the Treasury or the Federal Reserve, the source said.
Another source familiar with discussions say a possible takeover of the company by private firms is under consideration, possibly with a combined private and government backstop to certain risks from derivatives. No details were available.
There has not been an agreement on any plan, according to the sources. They are described as alternatives under discussion. Both sources urged a cautionary approach to their stories, saying the situation was very fluid. We’ll add that each of these versions comes from just one person who is familiar although not directly involved with the negotiations. Don’t go all crazy with this.
Update: Bloomberg is reporting that former AIG CEO Hank Greenberg is leading a group of investors who are considering taking control through a proxy fight or buyout. They may also buy the subsidiaries or lend to the company. They’ve retained Perella Weinberg to advise them.
After the jump, Greenberg’s filing with the SEC.
The news that AIG had asked the Federal Reserve to provide a bridge loan worth tens of billions set teeth gnashing everywhere across the universe of market watchers. The now time worn phrase moral hazard was trotted out. Weren’t we supposed to be clawing our way out of this bailout business?
Our first reaction to the news that the insurance titan had gone hat in hand to the House of Bernanke was to ask: can they do that? We had fallen under the impression that the Federal Reserve lent money to banks, and more recently to investment banks. But we didn’t think the Fed was in the business of bailing out insurance companies.
It turns out we were wrong. The Fed is authorized by Depression era amendments to the Federal Reserve Act to lend to pretty much anyone, as David Zaring at the Conglomerate points out. So long as the circumstance are “unusual or exigent” the Federal Reserve may open the discount window to any individual, partnership, or corporation.
Lately we’ve been feeling that our own finances are a bit unusual and exigent but somehow we doubt that the Fed is going to allow us to borrow from the discount window. Maybe AIG will have better luck.
Who Can Access the Fed’s Discount Window? [Conglomerate]
AIG, which is looking to raise capital after ratings agencies threatened downgrades, will be permitted to access up to $20 billion locked up in its insurance subsidiaries, according to Reuters. As part of an agreement reach with New York Governor David Paterson, insurance regulator Eric Dinallo and other state officials, AIG will be able to shift the funds up to its parent company.
AIG’s shares have begun to recover from their worst prices of the day, and are now down just 45 percent. Reuters adds that Dinallo is appealing to the federal government on AIG’s behalf to provide it additional access to capital.
AIG gets New York’s help in accessing $20 billion [Reuters]
In the midst of the carnage of Lehman Brothers, and the semi carnage of Merrill Lynch, something scary seems to have gotten little press. What happens to annuity holders if a large insurer like AIG goes under? They aren’t covered by the usual moral hazard suspects (FDIC, SIPC), and as insurers are generally regulated by state oversight, that leaves the state guarantee funds and the larger umbrella (more of a cozy club than a formal master fund, however) of the National Organization of Life and Health Insurance Guaranty Associations (NOLHIGA). (Forgive me, but all I can think of when I see that acronym is some strange combination of NAMBLA and my University’s Lesbian and Gay Alumni group).
In a very weak attempt to prevent moral hazard, most states forbid insurers from advertising the protection of the state guaranty association when marketing annuities. (That sort of brilliance must have its origins somewhere in the Carter Administration, I think). Moreover, most states limit recovery for annuity holders to a present value of $100,000. It doesn’t take much calculating to see that 20 years of payouts on $100,000 isn’t a lot of money. Considering how aggressively annuities have been marketed from the private wealth management groups of large banks, I think some people are going to be very unhappy. In addition, most states limit total recoveries for all insurance products to $100,000 per person. Just hope you don’t have lots of insurance and an annuity with the same carrier, I suppose. Or that your carrier supplements with private insurance. Or that… something.
Of course, each insurance insolvency is different, and states tend to handle them on a case-by-case basis. Often, troubled insurers will end up pawning off their book to a stronger group, but in the case of a large failure, or several medium sized failures, I suspect states will find themselves rather overwhelmed, and buyers of assets will be rather thin. Say what you like, but at least investment bank failures have looked mostly orderly so far.
UPDATE: A certain DealBreaker executive is quaking in their shoes as AIG insures their condo. Look for minute by minute AIG coverage as a result.