AIG, the walking-dead insurance giant, is reported to have gone through $81 bn or so of the $122.5bn worth of financial facilities provided by the Fed since September 2008, first through an expensive (850 basis points over 3-month Libor) 2-year $85 bn facility and soon after through a rather cheaper (as far as I can tell) $37.5 supplementary facility. Not only is AIG seeking additional Federal assistance. It is also arguing that the original $85 bn facility is unfairly expensive, compared to the 5 percent plus some warrants charged by the US Treasury for its capital injection into nine large US commercial banks.
AIG is correct in noting and complaining about the inexplicable discrepancy between the cost of official funds charged to the nine banks and that charged to AIG. The unfairness, indeed the outrage, however, lies in the US Treasury injecting equity into the nine US commercial banks on sweetheart terms, way below what these banks ought to have paid for the money, and way below what it would have cost them to raise the money in the markets, whether from Warren Buffett or from Qatar.
AIG’s current modus operandi and business model is obviously not sustainable. Indeed it is not viable even in the short run. What if the US authorities reduce the cost of the existing facilities and dole out a further $200 billion or so to see them through to Thanksgiving? AIG will no doubt be back for another $200bn when the turkeys have been digested, to see them through to Christmas. This is getting very silly indeed.
There are two viable options. The first is to put AIG into receivership immediately. It has quite a lot of viable businesses (anything that did not touch CDS and complex structured products). The currently commercially viable bits could be sold off severally or jointly or re-launched as going concerns. The rest could either be liquididated or taken into public ownership and operated that way until a decision can be made about the private commercial viability of the publicly owned bits when order returns to global financial markets, in a year or two.
(snip)
The second viable option is to take AIG completely into public ownership. The government already has 79.9 percent of the equity. I believe that any increase in that government ownership share would trigger a technical default on some of the outstanding CDS taken out against an AIG default. It such is the case, so be it. It may seem that, with the government already owning almost 80 percent of the equity, the orginal $85 bn facility is largely the US Federal Reserve making an expensive loan to the US Treasury. That, however, is incorrect.
By keeping AIG technically solvent, the bond holders and other senior unsecured creditors of AIG are kept current on interest and principal. AIG’s debt sells at a steep discount relative to US Treasury bills and bonds, reflecting the market’s perception of its fragile solvency. If the government were to nationalise AIG now, while it is still technically solvent and a going concern, the senior unsecured creditors would all be made whole - AIG’s debt would effectively become US Treasury debt. Saving AIG’s unsecured debt holders and other unsecured creditors would be unfair. It would also be a terrible distortion of future incentives, by encouraging reckless lending to large financial institutions - institutions deemed to large, to interconnected or too politically well-connected to fail. It would be the mother of all moral hazard.
http://blogs.ft.com/maverecon/2008/11/time-to-pull-the-plug-on-aig/
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