Weekend Economists Tickle the Ivories September 20-22, 2013

[Demeter]

24. It Was Not a Free Lunch: The True Cost of the AIG Bailout

http://neweconomicperspectives.org/2013/01/it-was-not-a-free-lunch-the-true-cost-of-the-aig-bailout.html

“If it’s too good to be true, it probably is.” This old adage came to mind on December 11, 2012 when the U.S. Treasury made the announcement, reiterated unthinkingly by the press, that the AIG bailout was coming to an end with American taxpayers making a tidy profit on the deal. In an effort to capitalize on the news, AIG has spent millions of dollars on a primetime ad campaign thanking America for the bailout, highlighting its success: “We’ve repaid every dollar America lent us. Everything, plus a profit of more than 22 billion.” Unfortunately, this cleverly designed public relations maneuver deceives the taxpayer by distorting the perception of what has been a contentious use of government funds.

THE BAILOUT

Readers may remember that AIG’s bailout began on September 16, 2008. That day, AIG’s stock dropped 60 percent at the opening of the New York Stock Exchange. Investors feared the imminent collapse of the insurance giant from a series of collateral calls on its derivative contracts. With a ratings downgrade the night before, AIG needed to deliver collateral of over $10 billion. Later that evening, the Fed created a 24-month credit-liquidity facility from which AIG could draw up to $85 billion in exchange for a 79.9 percent equity stake in the company. By May 2009, this and other programs of support from the Federal Reserve and the United States Treasury amounted to more than $180 billion.

The White House, Treasury, and the Fed have never failed to remind the citizenry that the several bailouts of 2008-09 “succeeded” in the narrow sense that most of the nation’s largest financial services firms survived. By contrast to these privileged firms, over 400 smaller banks were allowed to fail, millions of people lost their jobs, and millions lost homes to foreclosure, many of the latter in proceedings later found to be of dubious legality. We should also remember that when these bailouts were authorized, there was no clear expectation that the loans would be paid back in full. In fact, a report by Bloomberg revealed that a draft of a presentation summarizing the Treasury’s proposed investments described them as “highly speculative.”

As things stand today, the Treasury has completely exited its AIG investment. Its December 11, 2012 sale of stock resulted, we are told, in the full recovery of the government’s commitment along with an approximately $22.7 billion combined return for the Treasury and the FRBNY, marking an incredible reversal of the original expectation of catastrophic loses. Sadly, the Treasury’s statements are highly misleading. In its accounting for the AIG bailout, the Treasury simply left out a number of salient facts when it announced that American taxpayers made a profit. Stated simply, we did not. The Treasury claims to have achieved a return of $5.0 billion, but neglects to mention that the Federal Reserve gifted them more than 500 million shares of AIG. Moreover, they simply ignored the unique and preferential tax treatment accorded to the company that is estimated to have inflated its share price by at least $5. Additionally, its estimates fail to compensate taxpayers for the true cost of capital or the risk assumed in its investments. After adjusting for the aforementioned factors, we find that the Treasury’s investment in AIG was actually very costly for taxpayers. As mentioned, the bailout began on September 16, 2008. After a series of complicated restructurings and additional government support, the Fed’s credit facility was repaid in full, including interest and expenses. By the time it was all over, the Treasury had acquired a 92 percent common equity stake in the company, which was sold over time subject to market conditions at an average price of $31.18. At least initially, the terms of the secured loan were designed to protect the interests of the U.S. government and taxpayer...

CONCLUSION

With the sale of the last of its stake in AIG, the Treasury has reported a $5 billion profit. Given the “creative” nature of the accounting used to derive this number, one is inclined to speculate on the motivations behind this announcement. Perhaps the Treasury hoped to reduce the public’s anger over a series of bailouts that appeared to exhibit the worst features of crony capitalism. As described above, Treasury’s estimate neglected to mention that approximately one-third of the AIG stock it sold came from the Federal Reserve rather than the initial TARP investment. Special tax treatment afforded uniquely and singularly to AIG also buoyed the share price — and will continue to provide AIG with billions of dollars in tax liabilities over the coming decade. The Treasury also failed to discount their returns by an amount even remotely reflecting the degree of risk involved. By including these omissions in the estimate it can only be concluded that the Treasury, and thereby United States’ taxpayers, actually lost money in the course of bailing out AIG.