Fed To Rescue AIG - Inviting Non-Political Discussion

[jyl]

Here is a thread to discuss this evolving event. Let's not get it moved over to the political/religious subforum. There's already an AIG thread "over there", in this thread let's stick to the economic and political implications, please.

Here is a quick background.
- AIG is a large insurer, some say the largest.
- Its insurance business is very profitable, I think EBIT around $20BN/yr excluding asset impairments.
- Like most insurers, it has a big balance sheet. Appx $1TR of assets and similar liabilities.
- Among those assets and liabilities are various assets that are declining, and various liabilities that are increasing.
- The former include RMBS, CDOs, etc backed by a variety of prime, Alt-A, and subprime mortgages. Apparently if AIG were to mark this debt down as far as, say, MER or GS have done, it would have eliminated another $20-30BN of capital.
- The latter include CDS written by AIG, which require increasing deposits of collateral as the spreads widen and as AIG's own credit rating deteriorates, supposedly AIG was looking at a $10-12BN collateral demand this quarter alone. Also AIG had some $40BN of debt that matures in the coming year and must be rolled over.
- AIG raised something like $20BN of capital last quarter, but apparently that is already been consumed by deterioration in its balance sheet. In the past few weeks the ratings agencies signaled that they would downgrade AIG's debt and now they have done so. The stock has plunged to almost nothing. This made it impossible for AIG to raise more capital on terms that seemed acceptable.
- The Fed tried to pressure MS and GS to commit $70BN to a rescue of AIG. MS and GS declined. Other private entities also could not or would not step in.
- The Fed does not regulate insurance companies, so it was reluctant to step in.
- Now the Fed and/or Treasury have decided to commit $80BN in the form of a loan, to prevent AIG from going BK. In return the govt will have priority security interests on AIG's assets and take warrants that will largely wipe out AIG's shareholders. Depending on the outcome, the govt could make a healthy profit on this investment, or could lose it all, or anything between.
- Presumably the govt concluded that the impact of an AIG failure on the financial system would be too severe to permit. The govt is clearly not averse to letting firms fail - they are standing aside and allowing LEH to go under. They apparently saw something different with AIG.
- The above is a gross over-simplification - I spent 1 hour reading reports on AIG yesterday and still don't have a clear picture of what they own and owe, and what sort of systemic risk an AIG failure would have been to the financial system. And the details of the deal are not known and perhaps not finalized.

So, that is what I know, and it isn't much. The insurance industry is not my area of expertise, to say the least. (In fact I wrote a post on AIG in another thread, then deleted it when I realized how much I did not know.)

Any thoughts or information, please post. If I learn more, I will post also. But I'm kind of busy right now . . .

[kstar]

Basically, it's an $85B Fed loan for 80% equity in AIG; the company will be, more or less, nationalized as far as ownership.

Let's hope hope it turns out to be a good investment for the taxpayers!

[Mo_Gearhead]

"Let's hope hope it turns out to be a good investment for the taxpayers!"

___________

And those of us who bought the stock this A.M.

[turbo6bar]

The market cap of AIG is $10B. Why didn't the government just buy the company, put executives in the electric chair, and part out the remainder of the company? The stench of moral hazard is getting really old. If honest Americans are expected to foot the bill, then Americans and not shareholders should be taking all future profits.

[jyl]

Originally Posted by turbo6bar

The market cap of AIG is $10B. Why didn't the government just buy the company, put executives in the electric chair, and part out the remainder of the company? The stench of moral hazard is getting really old. If honest Americans are expected to foot the bill, then Americans and not shareholders should be taking all future profits.

To follow on, it seems undesirable for one insurance company to have govt backing and thus a lower cost of debt than other insurers. While AIG is a large insurer, there are other insurers who can step in and do the business. Perhaps insurance premiums will rise, but perhaps they need to rise so that insurers can make their profits from premiums rather than from investing.

That would be an argument in favor of seizing AIG and in effect shutting it down, then liquidating its assets in an orderly manner.

Now, I am not sure if the Fed and Treasury actually have the legal power to seize and close down AIG quickly and smoothly enough to avoid major damage to the financial system. In that case, maybe this loan plus warrants is a back-door way to do just that.

Just speculating, I guess we need to see the details first. I think Paulson and Bernanke are quite aware of moral hazard and have no desire to have the govt running insurers and banks any more than absolutely necessary. But I think they are trying to avert immediate disaster.

[Noah930]

Originally Posted by jyl

Perhaps insurance premiums will rise, but perhaps they need to rise so that insurers can make their profits from premiums rather than from investing.

?!

In principle, I strongly disagree with that statement. Insurance companies already hold all the cards when it comes to the balance sheet of income versus liabilities/payout. I don't think they need encouragement to increase premiums.

[Nine17]

Originally Posted by jyl

But I think they are trying to avert immediate disaster.

Until after the election...

How many companies (insurance and otherwise) have been leveraging themselves uneconomically with the cheap credit fostered by the Fed and by inflows of capital from emerging markets who trusted their savings to our banking system? GM management has just about squandered the capital amassed by that industrial giant over the past 100 years. Who is going to bail them out when they need to borrow to keep the production lines moving? We're talking about massive unemployment if the credit markets have collapsed due to bad loans and a huge implosion of consumer spending and tax revenue. Potentially a nuclear winter.

For the NEXT administration...

[jyl]

Originally Posted by Noah930

?!

In principle, I strongly disagree with that statement. Insurance companies already hold all the cards when it comes to the balance sheet of income versus liabilities/payout. I don't think they need encouragement to increase premiums.

The insurance industry, like any industry, needs to earn a reasonable and sufficient return on its invested capital, to remain healthy in the long-term. Otherwise investors will not provide the industry with capital.

My understanding is that insurers get their earnings from two sources: premiums received, and investing those accumulated premiums.

For decades to come, insurers will be taking less risk and thus earning less from their investments. At least, that seems very likely, after the industry has seen AIG implode.

If the resulting lower investment earnings are "too" low, then what are their options to earn the necessary return on capital?

The general options I can think of are (1) charge higher premiums, (2) reduce expenses and payouts, (3) exit less profitable lines of insurance. But (3) really means (1), since when there are fewer insurers remaining in those lines, they will charge higher premiums.

[Noah930]

Originally Posted by jyl

My understanding is that insurers get their earnings from two sources: premiums received, and investing those accumulated premiums.

If insurance companies made a killing from the latter half of that income avenue (investing), do you think they would lower premiums such that their payouts would exceed the premiums? You know, pass their good fortune onto the customer base?

[Tobra]

Noah, you slay me

[DanielDudley]

In the big picture, this company takes up only a small quadrant. That has me somewhat concerned.

How many companys can we bail out in an attempt to stave off an economic crisis ? I expect that there are a slew more out there in similar situations.

[Aerkuld]

I was wondering about this earlier this morning. Am I wrong in thinking that the crux of the problem, and the reason that the Fed felt the need to bail out AIG, was that they had simply got too big and were involved in too many other companies and industries for the whole company to just collapse without serious repercussions?
If that is the case then wouldn't it make sense for the federal government to break the company up into smaller independent divisions?
What would be the pros and cons of such an action?

[tabs]

Where does Hank Greenburg fit into the equation..He was trying his damdest to get back in the door. What are his political affliations? However AIG mamagment and the FED didn't want him back in any capacity.

My guess is that he had private investors lined up and once back in the door would make a proposal.

His comment was that his stake in AIG was "virtually worthless, it being roughly only a 100M $." Down from how many Billions.

[onewhippedpuppy]

Originally Posted by DanielDudley

In the big picture, this company takes up only a small quadrant. That has me somewhat concerned.

How many companys can we bail out in an attempt to stave off an economic crisis ? I expect that there are a slew more out there in similar situations.

That's what concerns me. And how is it fair that the govt seems to pick and choose?

[legion]

Originally Posted by Noah930

If insurance companies made a killing from the latter half of that income avenue (investing), do you think they would lower premiums such that their payouts would exceed the premiums? You know, pass their good fortune onto the customer base?

I can tell you first hand: YES.

During the late 90's, most auto insurers were charging less than it cost them to service claims (taking an underwriting loss) and making up the difference in investement income. That practice effectively ended on 9/11/01 as the stock market took a prolonged beating. Up until 2005 (with Katrina and Rita), this was SOP for homeowners insurance--up until then, I can guarantee you never paid a premium on homeowners insurance that matched the risk you presented.

The problem with this model is a regulatory one. State insurance regulators won't let insurers raise rates rapidly when claims go up or investment income goes down, so they have learned that they need to keep premiums relatively high so that they have the money when they need it. Insurance and oil are the only two industries where politicians routinely utter the phrase "excess profits".

[legion]

Oh and....

One thing you will notice is that some insurers won't be asking for bailouts. Some did the proper thing and kept very conservative investments that aren't as likely to wildly fluctuate.

[Porsche-O-Phile]

This defies logic. If the risk outweighs the return, why are so many companies constantly jumping into the game? Seems like every week there's some new player in this... Also, isn't insurance revenue a huge portion of Berkshire Hathaway's revenue stream?

[legion]

But...if you can subsidize the price of your product, wouldn't you do so to gain market share?

This especially makes sense for mutual companies--who are owned by their policyholders.

[Rot 911]

Originally Posted by Mo_Gearhead

"Let's hope hope it turns out to be a good investment for the taxpayers!"
__________
And those of us who bought the stock this A.M.

Closed at $3.75, I bought this morning at $2.70. Now down to $2.55.

[The Gaijin]

Originally Posted by legion

Oh and....

One thing you will notice is that some insurers won't be asking for bailouts. Some did the proper thing and kept very conservative investments that aren't as likely to wildly fluctuate.

Indeed.

And all the while competing against the likes of AIG with their funny money investments.

My company fought long and hard to earn an A+ rating. But AIG is now backed by Uncle Sam. How do you compete with that?

Private profit and public risk? Something is very, very wrong with what is going on.