Here we go again, another bailout.
The U.S. government stepped in Tuesday to rescue American International Group Inc., one of the world’s largest insurers, with an $85 billion injection of taxpayers’ money.
It was the second time this month that the US taxpayer has reached into its pocket and put money down to rescue a private financial company. It was also the same reason; that its failure would further disrupt markets and threaten the already fragile economy.
Under the deal, the Federal Reserve will provide a two-year $85 billion emergency loan to AIG, which teetered on the edge of failure because of stresses caused by the collapse of the subprime mortgage market and the credit crunch that ensued. In return, the government will get a 79.9 percent stake in AIG and the right to remove senior management.
The move was similar to government’s seizure on Sept. 7 of mortgage giants Fannie Mae and Freddie Mac, where the Treasury Department said it was prepared to put up as much as $100 billion over time in each of the companies if needed to keep them from going broke.
The Fed said it determined that a disorderly failure of AIG could hurt the already delicate financial markets and the economy.
It also could “lead to substantially higher borrowing costs, reduced household wealth and materially weaker economic performance,” the Fed said in a statement.
All in all from what I have read and the understanding of the situation, it looks like this is a good move. AIG has many assets not directly tied up in the MBS market which will be sold to pay off the debt to the US taxpayer.
The White House said it backed the Fed’s decision Tuesday.
“These steps are taken in the interest of promoting stability in financial markets and limiting damage to the broader economy, ” White House spokesman Tony Fratto said.
“The administration is approaching an unprecedented step, but unfortunately we are living in unprecedented times. Hearing of these plans, you have to stop to catch your breath. But upon reflection, the alternatives are much worse,” said Sen. Charles Schumer, D-N.Y.
In a statement late Tuesday, AIG’s board of directors said the loan will protect all AIG policy holders, address concerns of rating agencies and buy the company time to sell off assets.
“We expect that the proceeds of these sales will be sufficient to repay the loan in full and enable AIG’s businesses to continue as substantial participants in their respective markets,” the statement said. “In return for providing this essential support, American taxpayers will receive a substantial majority ownership interest in AIG.”
Those with Lehman on their CV’s looking for jobs, will be wondering why AIG was given assistance and not them but AIG is a different kettle of fish. Lehman had assets, of course, but the vast majority of value in the company was wrapped up in its reputation and ability to do business. Any financial institution that has a problem with its cash flow and insufficient assets to justify a loan which could be paid back, are going to be in trouble.
AIG will, probably, be able to dispose of the businesses it has and pay this loan back pretty quickly.
The interesting thing, however, is that I have not seen an explanation of what happens when the loan is paid back. Does the US government keep the equity? One would assume therefore that long term this is a marvelous equity play for the US taxpayer when AIG and the wider economy recovers. Manchester United fans will also be pleased to know that their team is now sponsored by the US government..
With more than 74 million customers around the globe, AIG provides coverage for everything from cars to homes to businesses. And with more than $1 trillion in assets and more than 116,000 employees, this bail-out has wide reaching implications, and all in all it look to be a good move.
Regulation
This bail-out does bring us back to the moral hazard issue, but it also provides a perfect excuse for the government (whoever that may be in the upcoming elections) to bring in regulations like we have never seen before.
Personally, and those who read our comments will know, we are positive about the regulatory system in general. It does its job, however, over-regulation is an issue that is going to be lost in the scramble to have a law named after some senator. Which will, no doubt, be copied by the UK.
Our feeling is that regulation itself is partly to blame for the crisis we have seen. Not a failure of regulation, although that is part of it, but the over regulation, or should I say ‘overly costly’ regulation that prevents proper competition.
Consolidation
The financial service industry over the last 20 years has gone consolidation mad, to a point where huge organisations dominate the market and this is only getting worse. Barclays buying some Lehman assets and BoA buying Merrill are recent examples.
This consolidation of the industry creates financial behemoths capable of absorbing the huge cost of ever changing regulation. Small companies, who could perhaps offer a broader, more controllable solution to the issues in the financial markets, are being squeezed out, in our opinion, to the detriment of the industry.
Cost
From financial advisors who cannot afford to be directly regulated so they join big networks, to traditional stockbrokers whose margins are so thin, that it is hardly worth it, there is an inequality. Running a small stockbrokers will cost you £30,000 – £50,000 per annum in direct regulatory cost plus your compliance guy(s) who will be on a similar salary. Any brokerage that creates deals where they have higher margins than 10% are pilloried by the regulators and press alike.
Compare that to restaurants where the food we eat is marked up by at least 60% (a cup of tea/coffee, actually costs about 10p-15..do the math on that), and you can see that margins in the financial industry are not huge. The way to make the most of crappy margins is to get bigger, either more money under management a la hedge funds or consolidate….
More regulation, across the board, will kill smaller companies. Before this year, I am sure the regulators would have loved this. To be able to deal only with giant firms with hundreds in compliance would be a dream come true… we know that some of the biggest and oldest firms in the world could not be saved by compliance…
Solution
In our opinion, the regulators should look at a separation of the industry, a demerger of the giant companies into separate operating entities concentrating on one area.
Banks are banks, taking in and loaning out money. Trading houses trade, corporate finance houses do corporate finance, stockbrokers broke stock and insurance companies insure cars, houses, boats etc (not complex financial derivatives).
A simplistic view, I know,and it won’t happen but this would be easier to regulate. A regulator may pooh-pooh an idea like this but if the regulatory regime is so great, why are we in this mess? More regulation will cause more cost and therefore more consolidation until there is one ‘Uber-bank’ doing everything… that, to me, is a scary prospect.
AIG Bail-Out – Regulators To Blame?
On September - 17 - 2008
HF Markets is a group of professionals located from North America to Europe and Asia, all working together to provide consultancy services for companies wishing to take their business public or raise funding for expansion and acquisition projects.
