Felix Salmon

Exiting AIG

By Felix Salmon
May 9, 2011

Serena Ng has been keeping an eye on AIG’s share price, which is far below where it was trading at the beginning of the year — and below even where it was in October, when Treasury’s Jim Millstein told me that Treasury was going to make a profit of roughly $13 billion on the money it used to bail out AIG. That’s looking increasingly unlikely: Treasury’s break-even price on its AIG stake is about $28.70 per share, and at current prices it’s going to have to accept less than that if it wants to sell $20 billion of stock into the market.

There are three issues at stake here. First, should Treasury have converted its AIG debt into equity just so that it could exit its position more quickly? Second, will Treasury manage to disentangle itself from AIG at a profit? And third, does that matter?

Governments care very much about the 0% return level on their investments in private companies. If they make more than that, the investment/bailout is considered a success; if they make less, it’s a failure. That’s a bit silly, but the psychology is at least easy to understand.

But if Treasury wanted to end up extracting more money from AIG than it put in, the safe and sure way of doing that would have been to keep its investment as debt, rather than converting it to volatile equity. The problem with that strategy is that the stake couldn’t be sold quite as quickly: for reasons I don’t fully understand, it’s easier to sell $20 billion of AIG stock than $20 billion of AIG bonds.

And one thing that the Obama administration shares with its predecessor is a deep disinclination to have any kind of stake — equity, debt, warrants, anything — in private companies. Treasury hates such things so much that it’s willing to take a higher risk of taking a loss, if that means it can extract itself from companies like AIG more quickly.

That’s an intellectually honest position: after all, the 0% return level is mathematically as arbitrary as any other, and shouldn’t drive government policy. A similar philosophy exists at the New York Fed, as well, which turned down AIG’s offer of a guaranteed positive return on its Maiden Lane II assets, in favor of running a slightly riskier auction which was likely to make more money, ultimately, for Treasury. (Interestingly, Treasury, as the owner of AIG, was the one pushing the Fed to just sell the assets to AIG at a modest profit.)

The big question, of course, is whether the government will really have extricated itself from AIG even once it sells all its shares in the company. One thing missing from Dodd-Frank was a proper federal insurance regulator: the insurance industry is still regulated on a state-by-state basis, and the NYT this morning has a rather alarming story of the way in which various states are competing with each other to see who can be the most lax on that front.

Insurance companies in general, and AIG in particular, are still too big to fail: no government is likely to turn around and tell policyholders that they’re simply unlucky that their insurer ran out of money and went bust. So AIG, along with all other insurers, represents a significant contingent liability for the government. Treasury might be trying to get out of its formal stake in the company as fast as possible. But it can’t get out of its informal links.

4 comments so far | RSS Comments RSS

I don’t quite understand why the desire for a 0% return level is a bit silly. Could you go into more details on that?

My initial thoughts are that the investment is made for other reasons than just to turn a profit (e.g., prevent a financial collapse, job losses, GDP declines, etc.), so measuring the success/failure on just the return of the investment, rather than the results across the entire economy, would be the proper way to measure the success/failure. However, this seems difficult to do.

Posted by mickey7410 | Report as abusive

@mickey I think that considering an action a success only if it is a break-even or better proposition is what he’s calling silly. Which is to say that putting up the US$150B or however much it was more than worth the cost even if Treasury doesn’t get back $150B in that it helped prevent the collapse of the world economy. That may be a bit of hyperbole – maybe not – but $150B to save the world seems a good investment, especially when it’s probable you’ll get some/most/all of that back.

Posted by CDN_Rebel | Report as abusive

“Governments care very much about the 0% return level on their investments in private companies. If they make more than that, the investment/bailout is considered a success; if they make less, it’s a failure. That’s a bit silly, but the psychology is at least easy to understand.”

A 0% return on an investment that includes selling warrants (claims for future earnings) from the initial deal is a negative return. We should stop pretending otherwise.

If you saved the world, you would also want to incent others from making the same mistakes. While CDN_Rebel has a point in concept, the reality remains that the buybacks have, to date, only reconfirmed that socializing the risks is perfectly acceptable.

I don’t mind giving platelets on a fairly regular schedule. There would be rather a difference if I were told the system would fail completely unless I gave every four days in perpetuity while the blood bank kept dumping oversupply.

Posted by klhoughton | Report as abusive

There is a giant non-sequitur in the way we look at these bailouts on the order of $20 billion and call them a success if they “break even” while backdoor bailouts in the form of as yet unsanitized monetization of trillions of dollars (Q.E. I and II and Fannie/Freddie losses mainly) are ongoing.

Money being fungible, the enormous backdoor bailouts are flowing in meaningful part into the share prices of AIG and bailed-out institutions. The backdoor bailout is making front door bailouts look good. Using honest accounting of course, AIG has been a huge disaster for taxpayers and the public generally. It necessitated much greater financial suppression than would have been needed otherwise.

Posted by DanHess | Report as abusive

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