Monday, November 17, 2008

Bailing out AIG's Bailout

Naked Capitalism came out against the recent plan to further stabilize AIG. The plan from WSJ:

The U.S. government was near a deal Sunday night to scrap its original $123 billion bailout of American International Group Inc. and replace it with a new $150 billion package, according to people familiar with the matter.
While the proposed arrangement would considerably ease terms on the faltering insurer, it would give the government an unprecedented role as an actor in financial markets. It could also spark a political backlash, especially from congressional Democrats, because the Treasury, while adding to its AIG obligations, has thus far refused to extend a hand to the struggling Big Three auto makers.

Naked Capitalism's bottom line:
...the worst is that not only was the initial AIG de facto bankruptcy a case of looting, the government has now decided to aid and abet AIG management in further looting. What pro-taxpayer purpose is there in the improvement of terms above? None. As we pointed out, there were only a couple of reasons for easing up on AIG, and they could have been provided for with minor changes that would not leave the taxpayer materially worse off. Instead, major concessions have been made to AIG, all to the detriment of the taxpayer. AIG management now has job security for five years (and AIG top brass is very well paid) and better odds of salvaging something for themselves when the five years are up thanks to the government giving them an unwarranted subsidy.

I say it really is high time to nationalize the entire industry.

On a different note, Fortune ran an almost fawning article about ex-CEO Hank Greenberg. True, he may not have been responsible for the CDO mess (he's sometimes considered an "unindicted co-conspirator" in an attempt (he says is legally pushing the envelope) to inflate loss reserves at AIG. Executives at AIG and General Re were indicted by jury on securities fraud. However, the problem with CDOs arose as follows:

The roots of the troubles lay in a series of insurance-like contracts that AIG had entered into almost as an afterthought from 1998 through 2005. Nearly half the deals were initiated under Greenberg's regime. Here's how it happened:

Starting in 1998, Wall Street's major mortgage-bond underwriters - Merrill Lynch, UBS, Citigroup, and others - approached AIG to insure certain classes of a then-arcane type of security called a collateralized debt obligation. AIG executives liked the fact that the company didn't have to own this illiquid paper. If the credit rating of the CDOs deteriorated, the swap owner could get AIG to pay them the face value of the CDOs no matter where they were valued in the market. There was a risk, of course, but it seemed almost impossibly remote.

Under Greenberg's supervision, AIG wrote credit default swaps on 200 or so CDO deals, charging an average of $750,000 per deal - but only a handful were exposed to subprime mortgages. After Greenberg left the company, Sullivan accelerated the use of those derivatives. Between Greenberg's departure in March 2005 and the end of that year, AIG insured another 200 or so CDO transactions - the majority of which were subprime. In all there were about 420 deals done that brought in between $315 million and $400 million, according to AIG executives and Wall Street brokerage officials. The risk managers started getting the jitters in late summer and decided to stop both the swap insurance business and all subprime mortgage issuance.

But by then, AIG had committed its once-pristine balance sheet to backing about $63 billion in increasingly illiquid CDOs. Sullivan had risen through the brokerage side of the business and wasn't familiar with complex financial instruments. He took office in a period of turmoil at the company, when it was under siege by the government. But he made missteps too. At a time when the company was trying to raise capital, he hiked the dividend, a move that even his supporters say was a horrible mistake.

Then again, shouldn't CEO's bear the price of their failures?

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