Tuesday, September 23, 2008

Bernanke on AIG

In the case of AIG, the Federal Reserve, with the support of the Treasury, provided an emergency credit line to facilitate an orderly resolution. The Federal Reserve took this action because it judged that, in light of the prevailing market conditions and the size and composition of AIG's obligations, a disorderly failure of AIG would have severely threatened global financial stability and, consequently, the performance of the U.S. economy. To mitigate concerns that this action would exacerbate moral hazard and encourage inappropriate risk-taking in the future, the Federal Reserve ensured that the terms of the credit extended to AIG imposed significant costs and constraints on the firm's owners, managers, and creditors. The chief executive officer has been replaced. The collateral for the loan is the company itself, together with its subsidiaries.1 (Insurance policyholders and holders of AIG investment products are, however, fully protected.) Interest will accrue on the outstanding balance of the loan at a rate of three-month Libor plus 850 basis points, implying a current interest rate over 11 percent. In addition, the U.S. government will receive equity participation rights corresponding to a 79.9 percent equity interest in AIG and has the right to veto the payment of dividends to common and preferred shareholders, among other things.

Now that Bernanke has touted the AIG plan, does that mean it is in jeopardy? According to the NY Times:

Major shareholders of American International Group were scrambling on Monday to see if a better deal was possible than the anticipated restructuring of A.I.G. under the Federal Reserve, which they feared would all but wipe out the value of their stakes.

If the shareholders are unable to redirect the Fed’s restructuring plans, they have shown interest in buying some of A.I.G.’s operating subsidiaries. The subsidiaries are mostly insurance companies with solid books of business, as well as other profitable businesses like aircraft leasing.

The shareholders are being represented by Michael Kantor, the former commerce secretary and United States trade representative during the Clinton administration.

He issued a statement at the end of a meeting with the shareholders group on Monday, saying they represented “millions of people who invested their savings, pensions and retirement funds” in A.I.G.

Mr. Kantor said he believed that both the shareholders and the taxpayers would be better off if a new restructuring plan could be devised. The meeting ended without a clear plan of action, but Mr. Kantor said the discussions would continue.

Many hurdles, including money, stand in the way of the shareholders getting an increased role. The Fed stepped in with an $85 billion emergency loan for A.I.G. only after the company’s efforts to raise money from the private sector failed.

Nor is it clear yet whether the shareholders group has the legal authority to force a change of course from the board, which has already agreed to work with the Fed and has drawn down some of the loan.

The loan has a high interest rate, and all borrowings must be paid back in two years. That has raised fears that the Fed will rapidly dismantle the global insurance company to raise the money to make good on the loan.

A.I.G. also promised the Fed a warrant giving it the right to own 80 percent of the company. But the terms of that agreement have come into question after the company filed conflicting references with the Securities and Exchange Commission.

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