by John Darer CLU ChFC CSSC RSP CLTC
Much has been written about the AIG bailout and some of it has unfortunately been misinterpreted. This post attempts to help educate our readers.
Under the American International Group, Inc. ("AIG") rescue plan, the Federal Reserve will make available an $85 billion revolving credit line to AIG. In return, it will receive warrants (a form of warrants called equity participation notes) that, upon exercise, would give the government a 79.9% common stock interest in the company, if AIG shareholders approve. No evidence appears to exist that such a vote has taken place at the time of this writing. According to Bloomberg and Wall Street Journal, there is speculation that shareholders, including former CEO Hank Greenberg, Sovereign wealth funds and other investors, may try to derail a government takeover by helping to repay the federal loan. The New York Post reports that former AIG CEO Hank Greenberg's attorney David Boies indicated in an interview that his client may try to end government involvement in the company "as prompt as possible"
Sources: AIG Form 8K filed with the SEC on September 18, 2008 Wall Street Journal, New York Times, Huffington Post, Deal Book blog, New York Post, Bloomberg
According to London's Financial Times "the issuance of the equity participation note to the government is designed to prevent existing shareholders from profiting from a rescue of the company, which has been hobbled by the losses on complex securities backed by mortgages and other assets". As AIG begins to sell off assets the taxpayers will have their loan repaid. Assuming the financial health of the company improves, the government's warrants will increase in value.
Quoting anonymous Federal Reserve staffers, Bloomberg reported on September 17, 2008 that "the Fed's loan doesn't require asset sales or the company's liquidation, though these are the most likely ways AIG will repay the Fed".
On Bloomberg.com David Havens, a credit analyst at UBS AG in Stamford, Connecticut, expressed enormous relief, referring to AIG as "the biggest commercial insurance business in the U.S" and "the best Asian insurance franchise in life and general insurance of any Western company''. According to RBC Capital Markets an AIG meltdown would have cost the financial industry $180B because AIG provided insurance on more than $441B of fixed income investments tied to the world's biggest institutions, including $57.8B tied to sub prime mortgages. See definition of systemic risk below
The National Association of Insurance Commissioners ("NAIC") has a wealth of useful information for insurance consumers on its website and stresses that the AIG "conversation should stay focused on the facts". NAIC has a consumer information resource that enables you to check on the financial status, licensing and complaints of any insurance company licensed to do business in your state
As an interesting side observation to all of this, while I was "making the rounds" this week reaching out and speaking to attorneys and fielding calls from a few concerned annuitants there was a disproportionate interest in "whether it was a good time to buy AIG stock?". A number indicated they already had made such purchases.
Revolving Credit With revolving credit, the lender (the bank, or in this case the Federal Reserve) allows the debtor (in this case AIG) to continuously borrow money up to a certain credit limit (in this case $85B!). Every time you buy something on credit, that amount is subtracted from your total credit limit. And every time you pay off your balance, your credit limit goes back up. Credit cards are the perfect example of revolving credit.
Stock Warrant A type of security issued by a corporation that gives the holder the right to purchase a certain amount of common stock at a stated price "as a sweetener" to give the creditor something to claim in case you default on the loan obligation.
Common Stock Each share of common stock represents a single undivided unit of ownership in a corporation. Common stock owners generally have the right to vote to elect the corporation's board of directors.
Systemic Risk A form of financial risk that affects an entire financial market or "system". May also be called systematic risk. It is not possible to avoid systemic risk through diversification. The AIG rescue plan was a defensive measure to counter what was perceived as massive systemic risk that would result from its demise.