Understanding AIG’s financial problems

I think Prof. Rogoff was slightly quick to say US government is letting wall street firms fail and calling it a good sign.

Fed is providing upto USD 85 billion of liquidity support (capital) and US government will now own 79.9% of AIG’s equity.

The AIG facility has a 24-month term. Interest will accrue on the outstanding balance at a rate of three-month Libor plus 850 basis points. AIG will be permitted to draw up to $85 billion under the facility. 

The interests of taxpayers are protected by key terms of the loan. The loan is collateralized by all the assets of AIG, and of its primary non-regulated subsidiaries.  These assets include the stock of substantially all of the regulated subsidiaries.  The loan is expected to be repaid from the proceeds of the sale of the firm’s assets. The U.S. government will receive a 79.9 percent equity interest in AIG and has the right to veto the payment of dividends to common and preferred shareholders.

Loan is expected to be repaid after from sale of assets?? I think that is too much of optimism. Even in AIG’s press release similar optimism is shown.

Fed had to again reach out to an exigent clause to bail out AIG. After Lehman’s analysis (bankruptcy and source of problems), it is time to take a peek at AIG’s financial mess.

I just took a look at AIG’s Q2 2008 financial statement. Its business is divided into 4 segments (see this for details):

  • General Insurance
  • Financial Services
  • Life Insurance & retirement services
  • Asset Management

The income/loss in each division in Q2 2008 is as follows (in billions):

  • General Insurance :  $ 0.8
  • Financial Services : $ (-5.9)
  • Life Insurance & retirement services: $ (-2.4)
  • Asset Management : $ (-0.3)
  • Total: $ (-5.4)

So total losses are USD 5.4 billion in Q2 2008 and losses are a staggering 13.2 billion in the 6 months ended June 2008.

The main troubles are in 2 divisions: financial services and Life Insurance & retirement services and they continue to bleed. Fin services losses also includes $ 5.6 billion of unrelaised market valuation loss on CDS portfolio:

Capital Markets reported a $6.24 billion operating loss in the second quarter of 2008, due to $5.56 billion of unrealized market valuation losses related to AIGFP’s super senior credit default swap portfolio and a $518 million credit valuation loss. In addition AIGFP experienced low transaction volumes due to challenging market conditions.

I am not one bit surprised over this CDS. Eurointelligence points:

AIG was a huge Credit Default Swap writer, and that insurance required collateral to be posted, depending upon such factors as credit rating and credit spreads;

The recent crisis has posted numerous concerns over CDS market. I had posted number of times about the problems in these markets.

What I don’t understand is huge losses in the Life Insurance & retirement services. I was seeing Nouriel Roubini’s commnets on CNBC in the morning and he was critical of the investments done by AIG. He said this money should have been invested in safer securities as it is for retirement and life insurance. But it was invested in all kinds of exotic (he called it toxic) financial instrumnets. I could not get much clarity from AIG’s press release and would have to look more into details

Addendum:

IRDA has issued a statement saying AIG’s insurance venture with Tata is safe

Big Picture points more links

 

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3 Responses to “Understanding AIG’s financial problems”

  1. Sachin Says:

    If I am not mistaken AIG has claimed to have more than $1 trillion in Assets.

    Also, the terms and conditions of this loan are such that the government loan will have to paid back before any other creditors are paid.

    Fed gets a high rate of interest.
    it gets first claim to AIG’s assets .
    it gets an option to buy equity in the company at throwaway prices.
    and last, the whole deal prevents a market panic..

    Doesn’t this make the whole deal a win-win situation for the Fed?

  2. Money market mutual funds next to shut shops? « Mostly Economics Says:

    […] I am not sure how far this crisis will go. After analysing why biggies collapsed (Lehman, AIG), I had mentioned about Fed going broke as […]

  3. US bails-out AIG again « Mostly Economics Says:

    […] articlein the morning about the re-design of bailout package of AIG (see my post on AIG problems here). The article talks about AIG officials in touch with base to make the bailout package less severe […]

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