AIG: ONE SICK PUPPY- Even More Government Money on its Way?

In Sunday's New York Times, there is a good discussion of the three individuals who brought down Merrill Lynch. We all knew about O'Neal, but the two other guys, Fakahany and Semerci, whose pictures are side by side with Stan need their own hall of shame. http://www.nytimes.com/2008/11/09/business/09magic.html?em I had read previous stories about how people got fired for trying to rein in the irresponsible risk taking of this troika and this article details some of how sensible risk management was systematically disgarded in the pursuit of highly leveraged profits. Merrill was one of the investment banks that increased its leverage, I believe subject to check, to 44 to 1 after the SEC rule change in 2004. (see paragraph starting with "The seminal event in the train wreck....." in my first post:Marsha Blackburn and the Bailout

With Board of Directors being sycophants of management, it is possible for a limited number of individuals to bring down a company with tens of thousands of employees, many of whom are contributing to the overall welfare of the corporate entity. Shareholders will just get the shaft and exercise virtually no control over the affairs or decisions in the companies owned by them.

Another company destroyed by the feckless actions of a few individuals pursuing their own financial interests at the expense of everyone else is AIG. The WSJ reported Sunday night that the government and AIG were working out the details of a new arrangement replacing the prior ones, improving the terms for AIG and providing more government money to this reckless company. http://online.wsj.com/article/SB122627437470412029.html?mod=testMod#printMode According to the WSJ, the original 85 billion loan 2 year loan with a 8.5% coupon + 3 month LIBOR would be replaced with a 5 year loan at 3% + 3 month LIBOR. In addition, the government would buy 40 billion of preferred stock using part of the 700 billion in TARP money. That is not all. The primary- incredibly stupid-credit default insurance swaps written by AIG would be resolved by the government forming a new entity, funding it with 30 billion dollars with AIG putting up 5 billion (where is their share coming from, the 40 billion or the 60 billion government infusion?). This entity would then try to acquire the assets that AIG insured and this could be very difficult. Of course, the individuals who took hundreds of millions in compensation to create that particular mess are not contributing any of that money. This is not the end of it yet. The government would pump in another 20 billion, with AIG, putting up 1 billion, to buy from AIG residential mortgage securities at 50 cents on the dollar.

This indicates to me that the government substantially underestimated the financial cost of the AIG bailout. It does represent a major direct involvement by the government in the financial market. The government is no longer leaving it up to AIG to resolve its own problems that generated its downfall. This new effort is an attempt by the government to directly control the resolution of two major issues that continued to threaten the viability of AIG and the money already sunk into this company.

The only way to justify what the government is doing is that the failure of AIG would result in a depression, or an uncontrollable financial meltdown. Otherwise, this company should fail with the carcass carved up in bankruptcy court and the pieces sold to the highest bidder, with the credit insurance policy contracts cancelled in the bankruptcy and the buyers of that insurance being taught a valuable lesson. Do not buy insurance in a non-regulated market, not regulated by the state insurance commissions with stringent capital adequacy and segregation rules. But I can not quarrel with the judgment that AIG was to big to fail particularly after seeing what happened after Lehman was allowed to fail. But that is different than saying what should happen to the company from a moral and equitable viewpoint. It is certainly not right, equitable, fair or just that the people who created this mess, by taking risks primarily for their own personal benefit, will not contribute any of their ill-gotten gains to its resolution. You would think that the new Congress would create regulations of the credit default insurance market, requiring collateral to be set aside and segregated when the contract is entered into, so that the insuring party can more properly assess the risk to its balance sheet. Writing tens of billions of dollars of credit insurance by using only the credit rating of AIG initially is a prescription for a catastrophe. It had to look like free money to those few individuals in London responsible for writing these policies and claiming a handsome ransom for themselves (33% to 46% of the revenue taken in compensation http//www.nytimes.com/2008/09/28/business/28melt.html?hp). At a minimum, the market in trading these swaps needs to be public and regulated just like the futures and options market, and the issuer of the insurance needs to be regulated just like any insurance company . see http://www.newsweek.com/id/161199
My prior post: AIG: STUPID IS JUST TOO GENEROUS A TERM TO DESCRIBE THEM
http://www.bloomberg.com/apps/news?pid=20601087&refer=home&sid=akmnbe4McIsIould
http://seekingalpha.com/article/101457-understanding-credit-default-swaps-a-case-for-regulation
http://www.ajc.com/business/content/printedition/2008/10/09/creditswaps.html

I would expect that this new arrangment between AIG and the U.S. will have a positive impact on the bonds of AIG subsidiaries that have been smashed after AIG lost its AAA credit rating and started to fall into a tailspin. This new plan will give AIG more time to sell these subsidiaries, like American General and International Lease Finance. I would anticipate that the market will react positively to this deal assuming that it is finalized as well as the announcement from China of its 586 billion stimulus program http://www.marketwatch.com/news/story/Exporters-pace-Tokyo-resource-stocks/story.aspx?guid={47C17A0F-4DB0-4FC8-8093-BA8D5E2AEF48}(will China sell Treasuries to fund that program?) .