Rowyn (rowyn) wrote,

AIG and the Federal Reserve

Okay, here's what I hate about mainstream financial reporting.

It throws around big numbers with no context. It tosses about terms without defining them and misleads readers, very badly, about what's actually going on.

I'm going to try to explain what happened with AIG. I may even try to do it without ranting. Bear with me.

The AIG deal has been described as a "bailout" which "cost $85 billion". From this, one might conclude that the Federal Reserve gave AIG an $85 billion present with no strings attached. This is ... not true. See, I said I'd try not to rant.

The Fed gave AIG an $85 billion loan at a rate of Prime + 8% (that's currently 13%, and is a rate my bank would be ashamed to offer on unsecured loans). In return for this loan (not an investment, mind you, a loan) the Fed also received a 79.9% equity stake and forced the ousting of AIG's CEO*.

This is the Fed's "bailout" of AIG. It takes control of the company, dilutes AIG's shares, and charges an onerous interest rate. This is not a sweetheart deal. This is not something you want to have happen to your company. The directors' reaction to the offer was not "Praise the Lord! We are saved!" It was "... come to think of it, bankruptcy's not that bad." In fact, AIG's directors almost didn't accept. And yes, their only other alternative at that juncture was bankruptcy. The Fed's offer was so bad that it's just marginally better for AIG's shareholders than a bankruptcy filing, which would wipe them out completely instead of just mostly. It is significantly better for AIG's creditors and customers than a bankruptcy filing, since an AIG which is still in business is much more likely to pay them back in full. This is as it should be: shareholders get most of the benefits when a company does well and accordingly should shoulder most of the burden when it plunges. The deal was not offered for the benefit of AIG or its shareholders. It was extended for the benefit of AIG's creditors, customers, and the broader market. (Whether or not it is good for the broader market is debatable. It's supposed to calm fears but it's questionable whether it actually does, and moreover nationalization under any terms is usually bad for the overall economy).

Now, as a good little libertarian, I don't want my government in the business of selling insurance or leasing airplanes (those two arms of AIG's operations are in fine shape, btw) or engaging in credit default swaps** (which is what killed the company). So as a libertarian, I don't want them to own the company even at fire-sale prices.

That said, as a good little capitalist I gotta say that Mr. Paulson drove one heck of a bargain. I think he's appraised the risk well and that the deal for AIG was not only a reasonable valuation of its worth, but probably undervalues it. In other words, I think the taxpayer is going to make money on this deal in the long run, not lose money. That's not a guarantee of profit: this is a deal made under the capitalist system and this year's lesson is "Capitalism Involves Risk". Just because the odds are 60:40 in your favor doesn't mean you will win on any given bet. This is a bet. It may well lose money.

But what it's not is a gift. It is not an $85 billion Christmas present from Santa Federal Reserve to AIG. It is not an excuse for every other company to whine "but where's my present?"

You want what AIG got? Then bend over and grab your ankles.

And when Detroit automakers come complaining that they deserve a loan too, well, you can tell 'em this from me: if they want to offer an 80% equity stake in return for a loan at 13% interest, I bet they don't need to go to Washington to find a taker.


OK, I didn't manage to do that without ranting. Sorry.

* This last is a shame, actually, because the poor guy had only had the job two months and AIG's collapse was hardly his fault. I think giving him the sack was a political move, part of the Fed's message to other companies in dire straits: "do NOT let this happen to you or you WILL regret it".
** "Credit default swaps" are bets between two companies on whether or not a loan will default. Insitutional investors in loan securities, like those lovely subprime ones you've heard so much about, would buy credit default swaps as protection in the event of a default on their investment. AIG was on the side of the bet that said these wouldn't default. Obviously, this did not turn out to be a winning bet.
Tags: economics, politics, rant
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