The recent Congressional hearings on AIG generated intense heat. But was there any light?
Actually, quite a lot. The scandal over bonuses paid to AIG’s rogue trading unit has obviously dominated news coverage and public attention. But while explaining the bonuses, AIG CEO Ed Liddy and other experts also provided lots of information on the most important question of all: Is the $170 billion AIG bailout working, or not? And what would happen if the government simply pulled the plug? Here’s some of the new information that has emerged:
The unit that brought down AIG was a tiny part of the company. AIG Financial Products Corp., which generated the credit-default swaps and other derivatives that brought AIG down, comprised just 438 people as of last fall. AIG’s total employment at the time was about 116,000, including about 50,000 Americans. In other words, a group representing just 0.4 percent of AIG’s global workforce wrecked the entire company.
AIG is an unwieldy mess. Liddy said that AIG is “too complex, too unwieldy, and too opaque” to be run effectively. A blinding flash of the obvious, perhaps. But still important. With sweeping new regulations on the way, AIG will serve as one model helping policymakers slim down firms that are “too big to fail,” or prevent them from getting too big in the first place. (Citigroup will serve as another model that must be avoided in the future.)
The AIG bailout has helped, so far. Rodney Clark of Standard & Poor’s told Congress that “the government’s continuing actions with respect to AIG have significantly reduced the risk of further rapid deterioration in the company’s creditworthiness.” That, in turn, has forestalled the panic that nearly erupted last fall, when it looked as if AIG might collapse and default on billions of dollars worth of derivatives contracts.
Since the feds effectively took over the company last fall, AIG has reduced its derivatives holdings – the main source of its problems – from $2.7 trillion to $1.6 trillion. The plan, ultimately, is to close its Financial Products division and get out of the derivatives business.
Meanwhile, to pay back the government, AIG’s plan now includes four basic elements. It hopes to sell some of its smaller business units. Some of the larger, more valuable business lines could be spun off as initial public offerings, though probably not until the financial markets are healthier, which will take a few years. At least two of AIG’s valuable foreign-based insurance businesses will be put into a trust as collateral backing the loans from the Federal Reserve. And AIG’s U.S.-based life-insurance companies will be securitized and sold as investment vehicles, which AIG describes as the best way to maximize the value of those companies. That may also take a few years.
[Read about the bonus outrage at Merrill Lynch.]
The bailout is far from over. Selling business units and other assets has turned out to be difficult, because the value of many businesses – including other insurance companies - has been falling, not rising. And with large-scale financing difficult to secure these days, buyers have been scarce. “All of these issues will continue to adversely impact AIG’s ability to repay its government assistance,” according to a study by the Government Accounting Office. That means AIG might require still more taxpayer funds.
Much of the bailout money has already been spent. AIG says about $126 billion in federal money has been disbursed. About $35 billion has been posted as collateral backing derivatives contracts with trading partners like Barclay’s, Deutsche Bank, and Goldman Sachs. Another $49 billion has been used to purchase “toxic assets” like mortgage-backed securities and park them in a couple of holding companies for sale later on. AIG used $21 billion to shore up reserves at its life insurance companies. Another $37 billion or so has gone toward ongoing operations and other expenses. The company supplied further details about who got what in documents submitted to Congress.
Taxpayers may not get all their money back. AIG’s plan to restructure and pay back the government is contingent on a bunch of things you probably wouldn’t want to sell an insurance policy against. The economy and the financial markets have to bounce back. AIG’s insurance businesses need to remain profitable, which is a lot harder now that the antics of the Financial Products division have trashed the company’s name. Aggressive competitors may even capitalize on AIG’s woes and poach customers. “Competitors are actively pursuing AIG’s accounts and key underwriting personnel,” says Clark of S&P. If the money does find its way back to federal coffers, it will take years.
If AIG failed, it would be more damaging than the Lehman Brothers collapse last year. That’s what AIG contends, anyway. In its submission to Congress, AIG paints a doomsday scenario that gives some idea what the Fed and the Treasury Dept. felt they’d be faced with last fall if they stepped aside and let AIG implode. More than 1,500 major corporations, for instance, would lose money on derivatives issued by the Financial Products division. That could generate a commercial-grade bank run by thousands of other companies seeking to redeem contracts and get their money back.
AIG’s insurance, aircraft, and financial-services businesses could create other shock waves if the company failed. The results, according to AIG, could impact 30 million U.S. policyholders, and another 44 million policyholders in other countries. Retirement accounts containing $134 billion might be jeopardized. Boeing and many airlines would take a huge hit, as AIG’s large fleet of commercial aircraft got sold off at steep discounts, bringing down prices for every kind of competing aircraft. The U.S. dollar would fall, the U.S. government’s borrowing costs would rise, and investors worldwide would suddenly question the ability of the United States to support its banking system. If true, all of that makes AIG too big to fail, too complex to succeed, and too dangerous to abandon. Not a good choice among the lot.