Why the world's biggest insurance company is still getting taxpayer funds
AIG is 'too interconnected to fail,' some experts say. Its interconnectedness with other companies, markets and economies is so huge that consequences of its collapse are unforeseeable.
March 09, 2009|Jim Puzzanghera
WASHINGTON - To understand why federal officials keep pumping astronomical sums of money into companies such as insurance giant American International Group Inc., it might help to take a high-altitude view of the situation.
Say from 30,000 feet, up where jet airliners fly.
AIG is not just the largest insurance company in the world, with about 74 million customers -- more than the populations of California, Illinois and Florida combined -- but also owner of a company called International Lease Finance Corp.
Century City-based International Lease Finance is the world's largest aircraft leasing business; it owns about 1,000 commercial jet aircraft, including planes flown by nearly every major airline.
If the once highflying AIG filed for bankruptcy protection, it could pull down International Lease Finance too -- with punishing repercussions for an airline industry already staggering under the weight of other economic problems.
"If somehow it can't be sold or can't be sold in an orderly way, it would send a real chill through the industry," said Richard Aboulafia, an aviation analyst for Teal Group Corp.
When the government ponied up $30 billion more for AIG last week -- on top of $150 billion previously committed -- the rationale was that it was "too big to fail." The same claim is made for other government rescue efforts, notably banking giant Citigroup Inc.
Failure of these companies would indeed hurt millions of ordinary Americans in direct and indirect ways, while sending further shock waves through the global economy. But that hasn't tempered any angry reaction from lawmakers and ordinary Americans alike.
"It effectively has the world financial system by the throat," Sen. Christopher J. Dodd (D-Conn.), chairman of the Senate Banking Committee, complained about AIG.
Yet federal policymakers keep pouring out tax dollars. Why? Because they are concerned about what would happen if the bailouts stopped. And the feared consequences fall into two categories: what officials know would happen, and what they don't know.
Some of the consequences of letting a giant fall can be foreseen, permitting officials to make at least educated guesses about whether they would outweigh the cost of continued aid.
Even more worrying are the consequences that can't be fully understood in advance.
AIG, Citigroup and other companies in their class have grown so large and diverse -- with their fingers in so many pies and their involvement so complex and hard to figure out -- that having one of them melt down could be like having an accident at a nuclear power plant: Bad under any circumstances, but would it be a Three Mile Island or a Chernobyl?
Rolling the dice on possibilities like that is something policymakers and politicians shy from. Bailouts seem like the fail-safe course.
With AIG, one thing that lies in the realm of the fairly predictable is what failure would mean for its healthy subsidiaries. For example, although AIG's life insurance companies remain well-capitalized and capable of paying their obligations, a bankruptcy could lead to a rush of customers seeking to cash out their policies, potentially destabilizing those companies, said Joe Paduda, a principal at insurance consulting firm Health Strategy Associates.
Also, many longtime holders of AIG life insurance policies might find them hard to replace. Age, changes in their health or other factors could make them uninsurable -- or only at sharply higher costs.
AIG is the world's largest property casualty insurer as well, and the largest provider of retirement savings for primary and secondary school teachers and healthcare workers. It has 71 U.S.-based insurance companies and 176 other financial services subsidiaries worldwide.
Having the parent company go down could create problems for all these companies, as well as for their customers.
"When individuals take a step back, they can see if AIG fails, it will in all likelihood impact them and people they know -- and the impact could be significant," said Paduda, a former AIG employee. "Putting the funds into AIG is a really bad option. The only problem is it's the best of the options on the table."
That's what federal officials believed when they stepped in again last week to help steady AIG as it reported a $61.7-billion loss in the last three months of 2008 -- the largest quarterly loss in U.S. corporate history. The goal is to keep the company afloat until it can sell its subsidiaries -- something that has become increasingly difficult as potential buyers struggle to raise cash amid the global recession.
Much the same calculation lay behind the Treasury Department's move Feb. 27 to increase the government's stake in teetering Citigroup.
Even the Fed's normally unflappable chairman, Ben S. Bernanke, said he was angry that AIG had put the nation, and the economy, in a bind.
"We had no choice but to try to stabilize the system because of the implications that the failure would have had for the broad economic system," he told the Senate Budget Committee in testimony that was almost plaintive in its appeal for understanding. "We really had no choice."
Beyond the more or less predictable consequences of letting a company like AIG go down are the murkier possibilities known as "systemic risks" -- most of them arising from AIG's rush in recent decades into all sorts of highly speculative businesses that were a huge departure from the staid world of insurance.
Some experts say what these ventures have done is make an AIG or a Citigroup that's "too interconnected to fail." And it's not just the size that would matter. AIG's interconnectedness with other companies, markets and economies is so huge and convoluted that it's almost impossible to foresee what all the consequences of collapse would be.
The prime example of this problem is about $500 billion in unregulated credit default swaps held by AIG. Those complex financial instruments are essentially insurance policies taken out on mortgage-backed securities and other assets. The swaps were designed to pay out money to buyers who got caught in exactly the type of financial crisis taking place right now.
In essence, AIG was committed to insuring hundreds of billions, if not trillions, of dollars in investments. When the housing market crashed and the economy nose-dived, those investments tanked as well. And AIG was liable for the losses -- a liability so large that it is now overwhelming the rest of the company, including the still-profitable parts.
What's worse, because credit default swaps were unregulated and the layers of transactions so arcane that they are difficult to understand clearly, the true cost is essentially impossible to measure with certainty. Once the dominoes began to fall, no one knew where the process would end.
"People don't know the exposure, so as a result there's a huge premium on fear and the unknown," said Kent Smetters, associate professor of insurance and risk management at the University of Pennsylvania's Wharton School.
Such fear is contagious and has the potential to sow panic in parts of the economy entirely unconnected to AIG.
Many analysts see an example of what can happen in Lehman Bros. Holdings Inc., the big Wall Street financial house that was allowed to crash in September. Lehman's bankruptcy triggered a severe market downturn as the ramifications of the collapse of the company's huge and diversified portfolio rippled through the financial system.
Many analysts think that Lehman's failure set off the severe financial crisis and credit crunch now plaguing the global economy. After seeing that effect, government officials didn't feel like taking a chance with AIG and Citigroup.
"AIG is a huge, complex, global insurance company, attached to a very complicated investment bank hedge fund . . . that was allowed to build up without any adult supervision, with inadequate capital against the risks they were taking, putting your government in a terribly difficult position," Treasury Secretary Timothy F. Geithner said.
Geithner was involved in the decision to launch the government rescue in September, and said the worsening financial crisis meant an AIG failure now "would cause enormous damage" to the economy.
The Lehman experience weighs heavily in that calculation.
Lehman was the largest underwriter of bonds backed by home mortgages, and the effect of its collapse went well beyond Wall Street. In California, for example, the $500-million construction of the Ritz-Carlton Rancho Mirage hotel was halted because Lehman was the major lender for the project. And San Mateo County lost $150 million because Lehman debt was part of its investment pool.
The Dow Jones industrial average fell 504 points on news of Lehman's bankruptcy. A day later, a large money market mutual fund dropped below the standard $1 a share because of Lehman's losses.
When AIG was teetering two days after Lehman's collapse, Bush administration officials feared a chain reaction. The Federal Reserve stepped in with $85 billion in loans to finance AIG's liquidation in exchange for 80% of the company, the first of four infusions of government money.
Lehman was much smaller than AIG, which has more than four times as many employees and had nearly twice as much in total assets -- $1.1 trillion -- at the end of 2007. AIG operates in more than 130 countries.
AIG also is more connected to other companies throughout the economy.
"If you had an institution and you had protection against credit default from AIG, your bank gave you credit for that," said Russell Walker, a risk management professor at Northwestern University. "When that's gone, the banks would pull back."
The failure of AIG could cause a series of defaults at other financial institutions, he said. In a way, AIG was like a master valve in the system with its credit default insurance, Walker said. Taking away that valve could cause chaos.
It is this fear of chaos, even more than concern over the measurable costs of an AIG going under, that has kept the government from halting the bailout.
"The biggest effects and the most troubling effects -- like what you saw in Lehman, but I think they would have been bigger in this case -- would have been on broader confidence in the financial system," Geithner told the Senate Finance Committee last week.
"The world has gotten dramatically worse since September of 2008. . . . And therefore the consequences of allowing a disorderly failure of AIG would be at least as damaging today."
Taxpayers unlikely to be fully repaid in AIG mess
By Kathryn Kroll, The Plain Dealer on March 16, 2009 at 6:26 PM, updated March 16, 2009 at 6:29 PM
Pressure is mounting on the government to revise its bailout of AIG to ensure that taxpayers are repaid as much as possible of the $170 billion lent to the troubled insurer.
Experts warn we shouldn't expect to get much back.
The problem stems from AIG's obligations to its trading partners. So far, the hobbled insurance giant has honored in full its contracts with U.S. and foreign banks. It's paid out more than $90 billion in taxpayer money to keep some of the biggest names in finance from losing money on bad bets linked to subprime mortgages and other risky assets.
As the cost of the rescue swells, experts says it's becoming harder to envision a scenario in which the government could recoup its full investment. Even though the AIG payouts to major banks have angered critics of the bailout, it might be legally impossible to claw back any of the billions already doled out.
"A contract is a contract," said Russell Walker, a risk management professor at Northwestern University. "That money all went to people who bought protection from AIG."
The government agreed to uphold those contracts when it seized control of American International Group in September. It argued that failing to repay the debts of the globally interconnected company could cause catastrophic losses at big international banks, potentially toppling the financial system.
Scrutiny of AIG's dealings with its trading partners comes after revelations over the weekend that the insurer plans to pay out tens of millions in executive bonuses. President Barack Obama on Monday accused AIG of "recklessness and greed." He pledged to try to block it from handing out the bonuses, which AIG insists it's contractually obligated to pay.
Obama's aggressive stance toward the AIG bonuses raises the question of whether the government could also pursue the billions paid to AIG's trading partners. Under growing scrutiny from Congress, AIG on Sunday finally identified those trading partners that indirectly benefited the most from its bailout.
Among the largest recipients, Goldman Sachs received $12.9 billion; Merrill Lynch got $6.8 billion. AIG also funneled billions into foreign banks, including $11.8 billion to Germany's Deutsche Bank and $8.5 billion to Britain's Barclays PLC.
Asked if he'd favor trying to see if those AIG contracts could be broken so the government could recover some of those payouts, Rep. Barney Frank, chairman of the House Financial Services Committee, stopped short of endorsing the idea. But he said "that's something that has to be examined."
"I would want to know the consequences of not paying those debts," Frank, D-Mass., told The Associated Press.
Other critics want the government to go further. They say AIG's trading partners should be forced to take less than 100 percent of the value of their derivatives contracts with AIG. They noted that the protection AIG offered -- in the form of complex products called credit-default swaps -- was unregulated and that AIG's trading partners knew the risks and should have to assume some losses.
"If you're in Las Vegas, and you leave the casino to go play craps with a bunch of people on an alley way, you shouldn't be able to go to the state and ask for your money back," said Barry Ritholtz, a financial analyst and author of "Bailout Nation: How Corrupt Money Shook Wall Street."
No bailout recipient has burned through more taxpayer money than AIG, which is now about 80 percent owned by the government. A 90-year-old insurer, it was listed as recently as last year as the world's 18th largest publicly traded company. Back then, AIG's stock traded for about $40 a share. Today, you can buy one share for just under a buck.
The government has made four separate attempts to save the company, including a $30 billion cash injection two weeks ago. The latest lifeline came as AIG reported a $62 billion fourth-quarter loss, the worst three-month performance in U.S. corporate history.
AIG's dire reality has raised doubts about the government's claim that it will recoup much of its investment in the company.
The government's plan to get its money back rests on breaking up and selling AIG's profitable units, including its insurance and aircraft-leasing arm. But given the company's financial woes and the depressed value of financial assets right now, experts doubt those businesses could fetch a high enough price today to reimburse taxpayers for the full $170 billion.
AIG could wait a few years, in hopes of selling the assets at a higher price. But by then, taxpayers will be owed an even larger amount, once interest is added in.
Federal Reserve Chairman Ben Bernanke, defending the $30 billion lifeline the government provided to AIG, said earlier this month that the government may eventually be able to "recover most or all" of the taxpayers' investments.
That's a step back from the rhetoric used by Bush administration under then-Treasury Secretary Henry Paulson. Last fall, Paulson said the government's capital injections into financial firms were "investments" that would likely make money.
AIG, meanwhile, expresses optimism. Spokeswoman Christina Pretto said the company's "No. 1 priority is to repay taxpayers."
She said the company expects to repay about $34.5 billion "over the next several months."
It would do so partially with equity stakes in two large overseas insurance companies and partially with securities backed by cash flow from the U.S. insurance business. The government could then sell those stakes to raise money toward the $170 billion it's owed.
Pretto said the Fed is receiving interest and principal payments on $41.6 billion in securities it bought from AIG's business partners to wind down AIG's obligations to them. She said the government should see profits on those investments, which include complex mortgage-backed securities that AIG agreed to insure.
But Mark Williams, a former Fed examiner and finance professor at Boston University, said the AIG wind-down inevitably will cost taxpayers money. And he thinks it will take much more money -- perhaps an additional $200 billion -- to finish winding down AIG's financial dealings so its core businesses can be sold off.
"No longer can we call it an investment," he said. "We just have to call it what it is -- and that's sinking money in a hole."