We Bought Ourselves an Insurance Company
posted by Dave Hoffman
So many questions, so few details:
The Federal Reserve Board on Tuesday, with the full support of the Treasury Department, authorized the Federal Reserve Bank of New York to lend up to $85 billion to the American International Group (AIG) under section 13(3) of the Federal Reserve Act. The secured loan has terms and conditions designed to protect the interests of the U.S. government and taxpayers.The Board determined that, in current circumstances, a disorderly failure of AIG could add to already significant levels of financial market fragility and lead to substantially higher borrowing costs, reduced household wealth, and materially weaker economic performance.
The purpose of this liquidity facility is to assist AIG in meeting its obligations as they come due. This loan will facilitate a process under which AIG will sell certain of its businesses in an orderly manner, with the least possible disruption to the overall economy.
The AIG facility has a 24-month term. Interest will accrue on the outstanding balance at a rate of three-month Libor plus 850 basis points. AIG will be permitted to draw up to $85 billion under the facility.
The interests of taxpayers are protected by key terms of the loan. The loan is collateralized by all the assets of AIG, and of its primary non-regulated subsidiaries. These assets include the stock of substantially all of the regulated subsidiaries. The loan is expected to be repaid from the proceeds of the sale of the firm’s assets. The U.S. government will receive a 79.9 percent equity interest in AIG and has the right to veto the payment of dividends to common and preferred shareholders.
What do you think, Nate: Should “Berneke and Paulson [have] looked on in stony indifference” here too? Either way, the Feds options looked bleak. And, just to be clear, the Country just bought itself an enormous reinsurance company, with assets of unknown toxicity, and our security is the ability to sell it off in a wildly unsettled market in the next 24 months. I think we might want to start rooting for the price of gas to increase, so the Saudis have enough money to buy our bad debt.
[Update: Thinking about this more, and prompted by a colleague's email, I confess I'm completely stumped as to how to characterize this transaction. What is a "loan" in return for a "79.9 percent equity stake"? Is it a stock purchase agreement? A secured line of credit - i.e., we own the company until such time as it pays off the debt, taking interest payments along the way? Is this the Fed's way of avoiding the more drastic nationalization procedures that Zaring spelled out earlier tonight?]
September 16, 2008 at 10:02 pm
Posted in: Corporate Law
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Responses (4)
Frank - September 17, 2008 at 12:03 am
Here’s some support for Nate’s skepticism on bailouts:
http://www.nytimes.com/2008/09/17/business/17leonhardt.html?hp=&pagewanted=print
“Barry Ritholtz — who runs an equity research firm in New York and writes The Big Picture, one of the best-read economics blogs — is going to publish a book soon making the case that the bailout [of Chrysler] actually helped cause the decline [of Detroit generally]. The book is called, “Bailout Nation.” In it, Mr. Ritholtz sketches out an intriguing alternative history of Chrysler and Detroit.
“If Chrysler had collapsed, he argues, vulture investors might have swooped in and reconstituted the company as a smaller automaker less tied to the failed strategies of Detroit’s Big Three and their unions. “If Chrysler goes belly up,” he says, “it also might have forced some deep introspection at Ford and G.M. and might have changed their attitude toward fuel efficiency and manufacturing quality.” Some of the bailout’s opponents — from free-market conservatives to Senator Gary Hart, then a rising Democrat — were making similar arguments three decades ago.”
Kaimi - September 17, 2008 at 12:15 am
Dave asks, “What is a “loan” in return for a “79.9 percent equity stake”? Is it a stock purchase agreement? A secured line of credit – i.e., we own the company until such time as it pays off the debt, taking interest payments along the way? ”
According to the NYT:
“Under the plan, the Fed will make a two-year loan to A.I.G. of up to $85 billion and, in return, will receive warrants that can be converted into common stock giving the government nearly 80 percent ownership of the insurer, if the existing shareholders approve. All of the company’s assets are being pledged to secure the loan. Existing stockholders have already seen the value of their stock drop more than 90 percent in the last year. Now they will suffer even more, although they will not be totally wiped out. The Fed was advised by Morgan Stanley, and A.I.G. by the Blackstone Group.”
See http://www.nytimes.com/2008/09/17/business/17insure.html
Michael Guttentag - September 17, 2008 at 1:41 pm
I’m curious, for teaching purposes among other reasons, how does corporate governance work when you have a lender with a warrant for 80% of the equity. Is Bernanke effectively the acting Chairman of the Board of AIG now? If so, how does the FED manage AIG?
And what about shareholder approval of the warrants: Are shareholder approvals already executed? Does AIG have to return the $85 billion if they don’t approve the warrants?
Kaimi - September 17, 2008 at 4:00 pm
Good question, Michael.
I heard it characterized on NPR as that the government now has effective veto power over asset sales that it doesn’t approve of. That sounds reasonable enough (though I don’t know how the details work in this case).
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