Feds Up AIG Bailout: 5 Things You Need to Know

The Feds announced Monday that they were boosting the government’s bailout package for AIG to more than $150 billion, significantly greater than the original $85 billion lifeline Uncle Sam tossed the struggling insurance giant in September.

Here’s what you need to know:

1. AIG’s problems are in credit default swaps and securities lending. AIG on Monday reported a third-quarter net loss of nearly $25 billion. But the company’s big headaches haven’t been in its bread-and-butter insurance business, but rather in lesser-known lines. AIG is a big player in credit default swaps--which are essentially insurance contracts that pay out when a company defaults--and is also involved in securities lending. Turmoil in these two businesses have hammered AIG’s balance sheet, causing a severe liquidity crunch.

2. The original bailout was a punishment. Although the Feds stepped in to rescue AIG--while at the same time refusing to bail out Lehman Brothers--it did so in a punitive fashion. The original rescue package came with a painfully high interest rate of LIBOR plus 8.5 percentage points. That put pressure on AIG’s management team to sell assets quickly to pay it back. But such emergency selling--coupled with the chaos in the market at that time--meant that AIG could only command very low prices for the assets.

3. New Bailout is less harsh. The revised bailout package is much more favorable to AIG. First, the interest payments on the loans are cut from LIBOR plus 8.5 percentage points to LIBOR plus 3 percentage points, and the repayment period is extended from two to five years. “The restructured bailout should give AIG the flexibility to sell assets in an orderly manner for closer to their intrinsic values rather than fire-sale prices,” Robert Haines, an analyst at CreditSights, said in a report. At the same time, the government will be putting billions of dollars towards removing assets that had been at the heart of AIG’s troubles from its balance sheet (from its credit default swap and securities lending businesses). The Treasury is also taking a $40 billion equity stake in the company.

4. Actions could make repayment and equity appreciation more likely. The development saddles the government with even more exposure to a deeply-troubled company. But there is a possible upside, Haines says. The restructured bailout increases the chances that AIG will be able to repay the loan and puts the government in position to get a better return on its equity stake in the company. “I believe it ultimately is a better deal for taxpayers,” he says.

5. AIG development adds pressure for a bailout of automakers. The Democrats are already been pushing to expand the bailout to include aid for the nation’s struggling automakers. Look for lawmakers on Capitol Hill to use the government’s expanded bailout of AIG to further their argument that Detroit should get cash as well.