Commentary

Feds Toss More Money Down AIG Hole

American International Group (AIG) made history this week by declaring a $61.7 billion loss for the fourth quarter of 2008. That equates to $22.95 per share, compare that to a stock price of less than a buck, (it was quoted at $0.34 today) and one can see the absurdity of our nation’s current financial situation. The stock market considers AIG to be a penny stock, yet the company is still sucking in billions of taxpayer dollars as it struggles desperately to avoid bankruptcy. A large part of this loss – a whopping $25.9 billion – came from writing down the value of souring assets rotting away on its books. Monday’s confession brings AIG’s 2008 loss to just under $100 billion – nice work, boys. As bad as this sounds, losses at the insurance giant will only get worse because everything they own keeps sinking in value as economic conditions continue to deteriorate.

This staggering quarterly loss increased the possibility of a disastrous credit downgrade, which would make it even harder for AIG to fend off creditors from around the globe. In response to the latest distress call from the former insurance titan, the federal government heaped another $30 billion on this flaming wreck of a company. This marks the fourth attempt to rescue AIG from the jaws of bankruptcy. The latest round of government aid appears to have bought the company some breathing room, because Fitch affirmed AIG’s credit rating this week, avoiding almost certain disaster – for now at least.

I think it is helpful to recap the federal government’s costly efforts to save AIG over the past six months. It all started in September of last year, when the Federal Reserve loaned the company $85 billion to meet its spiraling obligations. In return, AIG issued warrants to the Federal Reserve equal to just under 80 percent of company stock. (80 percent is the magic number, because once this level of ownership is reached, the government would have to put AIG’s toxic assets and its mountain of liabilities on the federal ledgers, meaning that the American public could be responsible for over 70 million potential insurance claims,)

Shockingly, $85 billion was not enough to halt the damage. AIG was burning through their new credit line at warp speed, resulting in huge interest payments to the Federal Reserve. By mid-October it was time for another $38 billion credit facility and access to a brand new commercial paper lifeline, which offered increased financial support at a lower cost to AIG.

Less than a month later, as Americans were preparing for Thanksgiving feasts, AIG continued to starve in the frigid credit markets. The feds stepped in again to restructure loans to AIG, increasing its overall commitment to $150 billion. The bailout loan was reduced to $60 billion, the interest rate demanded by the government was drastically reduced, and the duration of the loan was increased to five years from two – saving AIG even more money and giving it additional time to heal. The government also funneled $40 billion into AIG’s coffers in exchange for interest-bearing preferred shares and paid $50 billion to buy the insurer’s toxic assets.

The latest installment of the AIG financial bailout saga – intended to buy yet more time – involves a commitment of $30 billion in cash from the Troubled Asset Relief Fund (TARP), set up last year to save American finance from a prolonged period of irrational lending during the credit boom.

The government’s newly revised script also calls for the exchange of $40 billion worth of AIG non-voting preferred shares that paid the U.S. Treasury a 10 percent dividend for a new class of preferred shares that pay no dividend at all. In addition to the share swap, the federal government will convert $38 billion of taxpayer money AIG has already spent into equity stakes in two of the company’s Asian subsidiaries – American International Assurance and the American Life Insurance Company. It is important to note that American International Assurance was up for sale in the private market last year, and there were no takers. (This implies that the feds may be paying more than the unit is actually worth, helping AIG at the expense of the taxpayer.) The feds also agreed to pay between $7 billion and $10 billion for a stake in AIG’s U.S. life insurance business.

The latest chapter ends with a reduction in the interest rate the government receives on AIG debt, setting it to equal the London Interbank Offered Rate (Libor). This will shave 3 percentage points off the interest rate AIG pays on federal IOUs, saving the company $1 billion a year.

AIG now has access to $70 billion in TARP funds, meaning that 10 percent of the government’s entire financial bailout arsenal is being directed at curing one company’s desperate ills.

The truly maddening aspect of the AIG story is that it is being played out at Citigroup as well. (I wrote about the former banking star last week, explaining my views on why the government swapped its preferred shares for common equity, and the dangers that would arise due political meddling in the affairs of a once privately held bank.)

As the real estate market and the economy continue in meltdown mode, the losses at AIG and Citigroup grow ever larger. Hundreds of billions in assets owned by both institutions are tied to sinking real estate values and the deteriorating condition of business and consumer balance sheets. Neither the housing market, nor the economy will emerge from this tunnel of gloom to see the light of recovery anytime soon.

This means that deathly ill financial giants like AIG and Citigroup cannot sell subsidiaries to raise cash, and the securities and derivative contracts they hold, based on property values and consumer and business loans, keep dropping in price, forcing them to raise capital (from the U.S. government) and shell out more money for servicing debt.

The Obama administration should focus its efforts on valuing and selling the toxic assets owned by walking dead entities like AIG and Citigroup. The consecutive rounds of expensive financial bailouts orchestrated by the U.S. Treasury and the Federal Reserve are only putting off the inevitable collapse of these crippled financial giants. These bailouts continue to focus on extending lifelines and not on the source of the problem, which is the continuing deterioration of asset prices. Until there is a floor established for all of the troubled assets in the financial system, the government’s efforts, and our money, will continue to be wasted.

Please be aware that I have a much fluffier side. You simply must check out my awesome cartoons in the Splendid Marbles Cartoon Gallery.

I also host a Cartoon Caption Contest on Mondays, and I have brand new original cartoons for you every Wednesday.

While you’re here, sign up for my feed so you can get some of the best in original political cartoons and commentary

© 2009 Splendid Marbles.