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Friday, February 18, 2011

Federal Government Assistance for American International Group (AIG)

Baird Webel
Specialist in Financial Economics

In the beginning of 2008, American International Group (AIG) was one of the world’s largest insurers, generally considered to be financially sound with an AA credit rating. By the end of the year, it was near bankruptcy and had been forced to seek up to $173.4 billion in financial assistance from the U.S. government. The CEO had been replaced at the government’s behest, executive compensation was under limits, and shareholders in AIG saw their equity diluted by a new 79.9% stake held by the government. The overarching AIG holding company was regulated by the Office of Thrift Supervision (OTS), but because the company was primarily an insurer, it was largely outside of the normal Federal Reserve (Fed) facilities that lend to thrifts facing liquidity difficulties. AIG was also outside of the normal receivership provisions that apply to banking institutions. Had AIG not been effectively deemed “too big to fail” and given assistance by the government, bankruptcy seemed a near certainty in September 2008.

The losses that led to AIG’s essential failure resulted largely from two sources: the state-regulated AIG insurance subsidiaries’ securities lending program and the AIG Financial Products (AIGFP) subsidiary, a largely unregulated subsidiary that specialized in financial derivatives. The transactions that led to the immediate losses were dealt with relatively quickly in 2008, albeit with significant outlay of government funds. Although the securities lending program was relatively straightforward to discontinue, the AIGFP derivative operations extended well beyond the transactions that caused the immediate losses and have taken longer to wind down. AIG reported approximately $500 billion in notional net value of derivatives as of September 2010, down from approximately $2 trillion in September 2008.

The government assistance to AIG has been largely ad hoc. It began with an $85 billion loan from the Fed in September 2008. This loan was on relatively onerous terms with a high interest rate and required a handover of 79.9% of the equity in AIG to the government. As AIG’s financial position weakened, several rounds of additional funding were provided to AIG and the terms were loosened to some degree. The Fed assistance has been successively replaced with assistance from the Treasury through the Troubled Asset Relief Program (TARP). Under a restructuring finalized on January 14, 2011, the Treasury now holds 92.1% of the common equity in AIG, which would be worth approximately $67 billion if they could be sold at market prices from the end of January. In addition, the Treasury holds subsidiary equity interests worth approximately $20.3 billion. Funds disbursed under TARP as of January 31, 2011, total $67.8 billion with the possibility of another $2 billion at AIG’s discretion. Current Fed involvement consists solely of $26.2 billion to be repaid to the Fed by Maiden Lane II and Maiden Lane III, two limited liability corporations (LLCs) that served as Fed vehicles to purchase troubled assets from AIG during the crisis. As of February 2, 2011, the Fed would also see $3.5 billion in capital gains from these LLCs.

Congress has held several hearings specifically focusing on the intervention in AIG. Congressional attention and anger has been focused on perceived corporate profligacy, particularly bonuses for AIG employees. Bills in the 111
th Congress that would have placed specific taxes on or otherwise restricted such bonuses included H.R. 1586, passed by the House on March 19, 2009; S. 651, introduced on the same day; and H.R. 1664, passed by the House on April 1, 2009. The 112th Congress has not advanced legislation or held hearings focused specifically on the AIG intervention.

Date of Report: February 10, 2011
Number of Pages: 21
Order Number: R40438
Price: $29.95

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