Looking Under The Hood Of The AIG Bailout

Market Commentary | Politics | Stocks

Yesterday, amidst massive political and public opinion pressure, AIG revealed the counterparties they had paid out money to since receiving bailout money from the US government (AIG Press Release).

The payouts are as follows:

$22.4 billion for collateral postings under Credit Default Swaps contracts AIG wrote

$24.6 billion net to buy toxic assets from institutions on which AIG had also sold Credit Default Swaps on those assets to those institutions

$43.7 billion to pay back securities lending counterparties

$12.1 billion to states under guaranteed investment agreements

TOTAL: $102.8 billion

In a front page New York Times article from today (“AIG Lists Which Banks It Paid With US Bailout Funds”), we see that Goldman received about $13 billion, Societe Generale and Deutsche Bank about $12 billion each, about $7 billion to Merrill, $8.5 billion to Barclays, $5 billion to Bank of America and UBS, $2.3 billion to Citi and $1.5 billion to Wachovia.

So now we now where all this government bailout money has gone and the systematic links between AIG and other huge, systemically important financial institutions. 

Let’s review the categories so we understand why the payouts were made in the various instances:

(1) AIG’s Financial Products division, the 377 person unit based in London, that everybody knows wrote these CDSs that torched the entire company, paid out $22.4 billion in collateral to parties it sold these contracts to.  It is required to post this collateral as the value of the securities it insures declines in value and also if it’s own credit rating gets reduced (which it has).  (Anybody who wants to learn more about AIG’s Financial Products division needs to read Gretchen Morgenson’s superb New York Times Profile, “Behind Insurer’s Crisis, Blind Eye to a Web of Risk”, September 28, 2008, A1).

(2) Another $24.6 billion from the Financial Products division’s reckless gambles went to buy up toxic assets from institutions it also wrote insurance (CDS) policies on those assets.  This way AIG just owns the assets and has no liabilities to these counterparties anymore.

(3) Interestingly, the $43.7 billion to securities lending counterparties comes from AIG’s Investment division.  This division manages AIG’s huge investment portfolio which it gets from insurance premiums and then has to be used to pay out future claims. 

To juice returns on the investmen portfolio, AIG lent out securities to financial institutions in exchange for cash which it then invested in mortgage backed securities!  Most insurance companies that do this, invest the cash in very liquid, safe short term vehicles like treasuries and commercial paper to juice returns a bit but conservatively.  As the value of the mortgage backed securities bought collapsed, they couldn’t pay back the money they owed to their securities lending counterparties. 

It is noteworthy that this money isn’t the fault of the Financial Products division but the Investment division which apparently also did some really stupid stuff.  (Anybody who wants to read more about this needs to read The Wall Street Journal’s “An AIG Unit’s Quest to Juice Profit: Securities Lending Business Made Risky Bets. They Backfired On Insurer” (subscription required), February 5, 2009, C1 (e-mail for a link if you want to read it – fascinating reading!))(Hat Tip The Economics of Contempt).

(4) Finally, $12.1 billion went to states who left money raised from bond issuance in AIG’s hands to manage until they needed it.  What AIG did with this money I”m not sure, but I’m thinking something stupid.

So this is very informative and interesting information.  We can kind of see now how exposed other financial institutions were to AIG, though this is still an ongoing and unfolding process, and what kinds of hits they might have had to take had AIG went under.  We can understand why the Fed did what it did. 

Bottom line, however, is that taxpayers are paying out money to all these financial institutions when they would have had to take losses on their AIG exposure had AIG went under.  They could have fought over whatever AIG had in a bankruptcy proceeding based on their claims.  Instead, the taxpayer is making them whole.  Maybe there would have been systemic meltdown, maybe not.  But why not let the financial institutions who have the exposure take the hit?  Why do taxpayers have to bail them out?

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