Out of Control Policy Blog

AIG bailout could have been worse

The Federal Reserve opened a new branch of business last night, and is now one of the nation's top insurance agencies. With American International Group (AIG) on the brink of bankruptcy, the Fed decided to offer an $85 billion loan to keep the insurance giant afloat. AIG had spent the past several days seeking funds to stem is capital needs, but could not put together the loan from private banking.

AIG has been suffering from subprime related losses nearing $20 billion. Compared to some other firms (like Fannie and Freddie's $500 billion in potential loses) it's a smaller number, but still enough to hurt the firm. On Monday, major New York credit rating agencies–such as Standard & Poor's and Moody's Corp–downgraded AIG, forcing it to put up $14.5 billion in collateral or face bankruptcy.

After watching the Dow Jones drop 500 points, the government felt it would be "catastrophic" to see AIG go down and take stocks with it. Though the Dow recovered 140 points yesterday from Monday's fall, it was back down again this morning. The Treasury Department and the Fed are desperate for stability and unwilling to ride out a poor season for the stock market and deal with the short-term pains.

(Ironically, some speculate the bailout is what has driven the Dow down this morning on concerns over other firms. Had the loan been avoided or one mustered from private firms the Dow would probably have continued its surge from yesterday).

Another reason given for the AIG bailout is that, as an insurer, AIG backs many banks and mutual funds. Others are major shareholders in AIG's debt. The insurance giant's collapse would take many of those down with them, and give Wall Street even more of a reason to panic.

So on this reasoning the Fed has come in with a $85 billion, two-year loan. In exchange, the Fed gets an 80% ownership share in AIG, and is, for all practical purposes, it's operator. The first move of the Fed was the firing of AIG's chief executive Robert Willumstad. Treasury Sec. Paulson ordered this, and though the AIG board of directors typically handles such decisions, the firm had little room to negotiate. Edward Liddy, former CEO of All-State Corp. will take over the troubled reigns of AIG.

While this bailout should be condemned as yet another government intervention in the natural order of the free market, there is a positive side. Unlike the Fannie Mae and Freddie Mac bailout, in which the government took the firms completely onto its balance sheets, the Fed is not taking on the debt of AIG. Instead they are offering up a loan and taking operational privileges.

The difference is that only the $85 billion is on the line for US taxpayers, and not an unknown about of potential debt losses. Still, that is $85 billion that shouldn't be on the line. That's nearly $300 per American (and not all of those American's pay taxes). The interest is on the loan is a potential loss, but even still its not nearly the level of risk owning AIG outright would take on. That is the one glimmer of light in the whole debacle--it could have been worse.

If AIG is able to recover the government will reap a healthy financial reward when they sell their ownership shares. Yet, the government shouldn't be seeking to profit off of private enterprise. (The US Postal Service has figured that concept out well, by constantly posting revenue losses.) Its not the role of government to make money.

Thankfully, the risk in this AIG bailout is low. If AIG continues to falter over the two-year period of this loan, then AIG can sell off its assets to pay back the loan (which they have the capacity to do). The reason AIG didn't sell assets to cover the capital it needed was because it didn't have the time–which means it wasn't prepared.

This "bridge loan" will allow an "orderly" dissolution of AIG–if need be to pay back the government–so as to cover debts but not tank the stock market and other firms at the same time. While the thought is commendable, it still is not the role of government and–this is worst part of it all–this continues to encourage irresponsible action on the part of business.

The Lehman Brothers bankruptcy should serve as a warning that the government won't always ignore its Constitutional mandates. But this AIG bailout shows that the Fed and Treasury Dept. aren't quite done yet spending taxpayer money on corporate failures.

Anthony Randazzo is Director of Economic Research


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