Letter from Washington: Good news, bad news at AIG

by R.J. Lehmann on March 6, 2012

The glacial pace of unwinding American International Group’s mammoth $182 billion federal bailout inched along ever-so-slightly faster this past month. While this is good news, there remain some significant causes for alarm.

Most recently, AIG announced March 5 it had sold 1.72 billion shares of its remaining stake in AIA Group Ltd., the large Hong Kong-based life insurer it spun off in 2010. The $6 billion in proceeds from the sale go toward paying down most of the remaining debt on a $25 billion special purpose vehicle set up by the U.S. Treasury in early 2010, collateralized by AIG’s holdings of both AIA and the Japanese life insurer American Life Insurance Co., or ALICO.

The SPV initially included $16 billion for AIG’s AIA holdings and $9 billion for its ALICO holdings. The ALICO portion was paid down with that company’s sale to MetLife Inc.  Sales of AIA shares have now paid down all but $2.4 billion of the remainder of the SPV. AIG still owns roughly 19% of AIA, a company that currently has estimated embedded value of $27 billion overall, with its shares having risen 47% since early October 2011.

The sale was the latest in what Bloomberg estimates has amounted to $50 billion in asset sales by AIG since its September 2008 rescue by the Treasury and the Federal Reserve Bank of New York. Just last Friday, the company also reportedly sold its entire $500 million stake in private equity giant Blackstone Group LP, which it had owned since before Blackstone’s 2007 initial public offering.

Perhaps most encouragingly, the Federal Reserve Bank of New York last week sold the remaining assets it held in Maiden Lane II, another special purpose vehicle established in late 2008 to hold residential mortgage-backed securities that had been held by AIG life insurers’ securities lending business. Ordinarily a very safe business, AIG steered its securities lending off a cliff by reinvesting the cash collateral it received for shares of stock it lent out to short sellers, not into safe assets like T-Bills or commercial paper, but into illiquid RMBS.

To handle the mounting collateral calls from AIG’s securities lending counterparties, the New York Fed lent the company $19.5 billion to satisfy those collateral calls, and held onto the RMBS in this SPV. With the most recent sale of $6 billion of RMBS to Credit Suisse Securities (USA), the government recovered the entire loan with an additional $2.8 billion gain for taxpayers. AIG, which has bid to buy the entire portfolio for $15.7 billion in mid-2011, also got to keep one-sixth of the proceeds, but must use those to repay its debts.

(A separate SPV, Maiden Lane III, holds collateralized debt obligations on which AIG wrote credit default swap protection. Rather than continuing to pay collateral calls to AIG’s swap counterparties, the New York Fed lent $24.3 billion to the facility to buy out the CDOs at face value. As of Feb. 29, the Fed was still owed $9.3 billion for loans to that facility.)

Yet, despite all this apparent progress, the U.S. Treasury still owns 1.455 billion shares of AIG, or roughly 77% of the company. That’s better than the 92% it owned as of early 2010, but only a shade less than the 79.9% stake it took when AIG was granted its original $85 billion line of credit. That initial credit injection was only supposed to last two years. We’re now 3 ½ years into the AIG bailout era, and two years out from a restructuring plan that was supposed to see federal ownership of AIG sold off immediately.

The problem remains that, to raise the $41.8 billion that would allow the government to break even on the AIG deal, the company’s shares would have to be valued at $28.73 or higher. AIG has mostly traded below that target in recent months. At mid-day March 6, it was trading a bit above the mark, at $29.23 per share.

And there are signs that, in order to help goose its stock price, the feds are giving the company special treatment. AIG posted a $19.8 billion profit for the fourth quarter of 2011, but an eye-popping $17.7 billion of that total was attributed to “tax benefits” AIG was permitted to record to offset net operating losses it suffered in the depths of the economic crisis.

Counting tax benefits as assets isn’t unusual in securities filings, and it’s routine for property and casualty insurers, whose results can swing wildly from year-to-year based on the level of catastrophes. But what is unusual is that such benefits are ordinarily rendered void once a company is taken over. This is to avoid a situation where a profitable company can avoid any tax liabilities simply by agreeing to buy failing companies with huge past losses.

Yet, even though AIG was 92% controlled by the federal government, and remains 77% government-owned, Treasury has granted the company an exemption that allows it to treat the federal bailout as something other than a takeover. The result is, even if it does exceptionally well going forward, AIG might not have to pay taxes potentially for as long as a decade. As Andrew Ross Sorkin reported in the New York Times:

The tax break for A.I.G. also perversely benefits employees who are paid based on the company’s performance and usually in stock, which is being lifted by this backdoor handout. The biggest beneficiary is Robert H. Benmosche, A.I.G.’s chief executive since 2009, who has been granted tens of thousands of shares.

In the meantime, the government — desperate to increase revenues — is missing an easy stream of guaranteed taxes from a company that taxpayers bailed out. Sure, the tax bill might hurt the price of A.I.G.’s stock price in the short term, but if Mr. Benmosche does his job right, the company won’t have to post fantasy profits.

As I’ve written before, this just contributes to what has amounted to a massive pump-and-dump scheme on the part of the federal govermment. Tim Geithner wants desperately to deliver to his boss the news that the AIG bailout turned a “profit.” This is nonsense. Even if it happens, simply returning more money than was lent out, without regard to opportunity costs or the risk that was borne in the interim, will not magically make the whole thing worthwhile.

AIG was saved to avoid a catastrophic failure of the financial system, because it was believed to be “too big to fail.” If it ever was, it certainly no longer is. With systemic risk no longer an issue there is no justification whatsoever for the federal government continuing to own a majority stake in a major insurance company, particularly one that continues to compete in the open market with private entities who cannot claim government backing.

The sell-off of AIG should have started years ago, and there is no excuse not to begin it immediately.

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