FacebookTwitterGoogle+RedditEmail

Paulson’s Folly

The Treasury is injecting another $27 billion into AIG and raising the taxpayers’ investment to $150 billon. Secretary Paulson appears more intent on helping his pals on Wall Street than protecting taxpayer interests.

AIG has solid businesses in industrial, commercial and life insurance, but like a lot of financial firms, was attracted to easy profits writing credit default swaps on mortgage backed bonds—so called collateralized debt obligations (CDOs).

AIG received fees to guarantee repayment of those mortgages, or the funds obtained through foreclosures when homeowners defaulted. Like most on Wall Street, AIG executives believed home prices would rise faster than household incomes forever, so these CDOs really bore little risk.

This credit default swap business was outside AIG’s highly-regulated, solid insurance businesses but was backed by the value of those businesses. Essentially, if the CDOs fell too much in value, AIG pledged the value of those businesses.

If an abnormal number of the mortgages failed, the held to maturity value of the CDOs would fall, and obligations would trigger for AIG to post collateral. When that happened in 2007, AIG deposited cash or other liquid assets with the investors holding the CDOs. With the housing market so depressed by the summer of 2007, AIG could not raise enough cash to meet all its obligations.

On September 16, the Federal Reserve provided $85 billion in loans to AIG in exchange for warrants—the right to buy common stock—equal to 79.9 percent of the company.

AIG was to pay 8.5 percent above Libor for the first $85 billion. AIG was to use the loans to honor obligations to holders of the credit default swaps, and AIG was to sell parts of its insurance businesses to repay the loans to the Federal Reserve. That loan proved inadequate, and the Fed advanced another $38 billion on October 9.

The $123 billon was not enough to finance AIG’s short-term credit default swap obligations, and it cannot sell enough pieces of its good insurance businesses to pay back the Federal Reserve in the current environment.

Now, the Federal Reserve and Treasury are agreeing to restructure $60 billion of the original loan, lowering the interest rate to 3 percent above Libor and invest about another $27 billion AIG.

The interest rates on the loans were lowered, in part, because large shareholders complained about heavy handed government action.

The monies will be used to set up two special funds. The first will seek to buy up some of the CDOs that have declined in value for about 50 cents on the dollar, permitting AIG to recoup its collateral paid in cash. This fund will not buy up the most troubled CDOs, whose values are even lower than 50 cents on the dollar.

The second fund will be used to solve liquidity problems at AIG’s securities lending business. It rents securities to short sellers in the stock markets.

This is all folly.

The government assumes greater risks without getting benefits for the taxpayer. Many firms who purchased the original credit default swaps from AIG have used the collateral posted by AIG on the less risky CDOs for other purposes and may not want to sell AIG their CDOs. Also, many of the swaps have been resold to firms that don’t hold the CDOs, as part of complex derivatives transactions.

The short selling business is a whole new headache, and it should make taxpayers ask, what else is lying around at AIG.

If the deal works out, AIG executives get to keep their jobs; but if the plan fails, the U.S. government may get stuck holding the bag on billions of dollars of false promises to pay from AIG. Its warrants may prove not worth very much as AIG’s obligations overwhelm the value of its businesses.

If AIG can’t make it on the money the taxpayers have already apparently squandered, then the Treasury should simply exercise its warrants, take control of AIG, and sell off AIG’s solid insurance businesses for what they are worth. The Treasury can buy back the CDOs for common shares in the company and reorganize the new AIG with more responsible management.

The executives at AIG certainly have not behaved well since the first bailout. They have enjoyed lavish golf retreats in California and luxurious hunting trips in Britain.

While the American taxpayer make monthly tax payment to Washington, AIG executives bang away at birds on the English countryside.

PETER MORICI is a professor at the University of Maryland School of Business and former Chief Economist at the U.S. International Trade Commission.

 

More articles by:

PETER MORICI is a professor at the Smith School of Business, University of Maryland School, and the former Chief Economist at the U.S. International Trade Commission.

Weekend Edition
September 21, 2018
Friday - Sunday
Paul Street
Laquan McDonald is Being Tried for His Own Racist Murder
Brad Evans
What Does It Mean to Celebrate International Peace Day?
Alexandra Isfahani-Hammond
Hurricane Florence and 9.7 Million Pigs
Nick Pemberton
With or Without Kavanaugh, The United States Is Anti-Choice
Andrew Levine
Israel’s Anti-Semitism Smear Campaign
Jim Kavanagh
“Taxpayer Money” Threatens Medicare-for-All (And Every Other Social Program)
Jonathan Cook
Palestine: The Testbed for Trump’s Plan to Tear up the Rules-Based International Order
Jeffrey St. Clair
Roaming Charges: the Chickenhawks Have Finally Come Back Home to Roost!
David Rosen
As the Capitalist World Turns: From Empire to Imperialism to Globalization?
Jonah Raskin
Green Capitalism Rears Its Head at Global Climate Action Summit
James Munson
On Climate, the Centrists are the Deplorables
Robert Hunziker
Is Paris 2015 Already Underwater?
Arshad Khan
Will Their Ever be Justice for Rohingya Muslims?
Jill Richardson
Why Women Don’t Report Sexual Assault
Dave Clennon
A Victory for Historical Accuracy and the Peace Movement: Not One Emmy for Ken Burns and “The Vietnam War”
W. T. Whitney
US Harasses Cuba Amid Mysterious Circumstances
Nathan Kalman-Lamb
Things That Make Sports Fans Uncomfortable
George Capaccio
Iran: “Snapping Back” Sanctions and the Threat of War
Kenneth Surin
Brexit is Coming, But Which Will It Be?
Louis Proyect
Moore’s “Fahrenheit 11/9”: Entertaining Film, Crappy Politics
Ramzy Baroud
Why Israel Demolishes: Khan Al-Ahmar as Representation of Greater Genocide
Ben Dangl
The Zapatistas’ Dignified Rage: Revolutionary Theories and Anticapitalist Dreams of Subcommandante Marcos
Ron Jacobs
Faith, Madness, or Death
Bill Glahn
Crime Comes Knocking
Terry Heaton
Pat Robertson’s Hurricane “Miracle”
Dave Lindorff
In Montgomery County PA, It’s Often a Jury of White People
Louis Yako
From Citizens to Customers: the Corporate Customer Service Culture in America 
William Boardman
The Shame of Dianne Feinstein, the Courage of Christine Blasey Ford 
Ernie Niemi
Logging and Climate Change: Oregon is Appalachia and Timber is Our Coal
Jessicah Pierre
Nike Says “Believe in Something,” But Can It Sacrifice Something, Too?
Paul Fitzgerald - Elizabeth Gould
Weaponized Dreams? The Curious Case of Robert Moss
Olivia Alperstein
An Environmental 9/11: the EPA’s Gutting of Methane Regulations
Ted Rall
Why Christine Ford vs. Brett Kavanaugh is a Train Wreck You Can’t Look Away From
Lauren Regan
The Day the Valves Turned: Defending the Pipeline Protesters
Ralph Nader
Questions, Questions Where are the Answers?
Binoy Kampmark
Deplatforming Germaine Greer
Raouf Halaby
It Should Not Be A He Said She Said Verdict
Robert Koehler
The Accusation That Wouldn’t Go Away
Jim Hightower
Amazon is Making Workers Tweet About How Great It is to Work There
Robby Sherwin
Rabbi, Rabbi, Where For Art Thou Rabbi?
Vern Loomis
Has Something Evil This Way Come?
Steve Baggarly
Disarm Trident Walk Ends in Georgia
Graham Peebles
Priorities of the Time: Peace
Michael Doliner
The Department of Demonization
David Yearsley
Bollocks to Brexit: the Plumber Sings
FacebookTwitterGoogle+RedditEmail