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AIG bailout worsens 'too big to fail' problem
April 4, 2011, Monday
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AMERICAN International Group (AIG) - the insurance giant and poster child for the financial crisis - will once again sell its stock to the public in a "re-IPO" recently set for May.
The firm, which was shaken by soured bets on mortgage derivatives, says it is recovering from its near collapse in 2008 and is now a leaner, healthier firm looking forward to a bright future.
American taxpayers, who shelled out US$182 billion to prevent AIG's crisis from sending a tidal wave through the financial markets, will be repaid in full, AIG chief executive Robert Benmosche insisted recently.
In January, the firm paid back US$21 billion borrowed from the Federal Reserve Bank of New York, and the series of stock sales starting this spring could reduce taxpayers' holdings by two-thirds by the end of the year if all goes well.
But can the firm ever return to its former glory, having sold some of its prime assets to repay debts? Does it make sense to keep AIG together rather than let its disparate operations go their separate ways? Most important: What has the AIG story told us about how well the government handled trouble at a huge financial services firm, whose missteps hurt so many innocent bystanders?
"I would not call the bailout a success," says Wharton insurance professor Kent Smetters. "But the alternative is always hard to assess."
Too large to fear
Even though the taxpayer may eventually not lose in this case, Smetters worries that the AIG bailout and other post-crisis government actions "have likely worsened the too-big-to-fail problem" by signaling that the government will step in to help in a crisis involving a big firm connected to others, making it easier for companies to continue taking unsound risks.
"We all know this could all happen again," adds Wharton finance professor Richard Marston. "Specifically, banks are far too large to ensure that the fear of failure will discipline them. Large banks know that they are too 'systemically' important for us to let them fail."
Executives heading large financial firms are sure to be cautious for a while, Marston adds, but "then they will be succeeded by new people who did not get burned last time."
Though not a bank, AIG was a major player in the financial markets and was the biggest insurance company in the US until disaster struck in September 2008 because of bad bets made by a London-based operation. Using derivatives called credit-default swaps, AIG had written insurance policies on mortgage-backed securities. When the housing bubble burst, the securities lost value and AIG was on the hook for enormous claims.
Losses peaked at US$25 billion for the third quarter of 2008. Worried that an AIG collapse would have a domino effect on other financial firms, creating upheaval in the financial markets and economy, the federal government stepped in with a series of bailouts that eventually totaled US$182 billion, taking majority ownership of the firm in exchange.
Whether that was necessary is open to debate. The financial markets had been roiled by the September 15, 2008, bankruptcy of Lehman Brothers, a global financial services firm that had asked for government help but been denied, and many regulators and lawmakers were afraid that a bankruptcy by AIG shortly afterward would create havoc.
While it's impossible to know what would have happened if AIG had fallen into bankruptcy, Wharton finance professor Richard J. Herring wonders whether the results would have been as bad as many predicted. "I still harbor doubts about whether the AIG bailout was necessary, since the one thing that went reasonably well in the Lehman Brothers fiasco was the settlement of the derivative contracts, including the credit default swaps," he says.
Moral hazard
In the AIG case, he points out, it was only the derivatives business that appeared to pose a risk to other firms; the more mundane insurance operations were sound. Many of the problems that ensued, like the credit crisis, were not so much a result of the troubles at Lehman and AIG as they were the result of a perception - based on the different treatment of the two firms - that the government "didn't have a game plan or even consistent policy goals," Herring notes.
The AIG bailout "heightened the degree of moral hazard in the system more than any other event," he adds, referring to the way risk-taking is encouraged by the belief that the government provides a safety net.
"AIG had done everything it could to evade competent regulation and supervision, yet it was treated more generously than any other institution when its bets turned sour."
US taxpayers now own 92 percent of the company. To get free of that, AIG plans to sell those government-owned shares to the public, starting with an offering - expected to total US$15 billion to US$20 billion - in May.
Before then, the company will conduct a series of "road shows" to convince potential investors that the stock is a good bet. Since the government's stake is worth about US$64 billion, depending on the share price, additional sales will be required to reduce the public's stake to zero.
(This is excerpted by Shanghai Daily from an article from China Knowledge@Wharton, http://www.knowledgeatwharton.com.cn. To read the full, original version, please visit: http://bit.ly/g5uBhx)
The firm, which was shaken by soured bets on mortgage derivatives, says it is recovering from its near collapse in 2008 and is now a leaner, healthier firm looking forward to a bright future.
American taxpayers, who shelled out US$182 billion to prevent AIG's crisis from sending a tidal wave through the financial markets, will be repaid in full, AIG chief executive Robert Benmosche insisted recently.
In January, the firm paid back US$21 billion borrowed from the Federal Reserve Bank of New York, and the series of stock sales starting this spring could reduce taxpayers' holdings by two-thirds by the end of the year if all goes well.
But can the firm ever return to its former glory, having sold some of its prime assets to repay debts? Does it make sense to keep AIG together rather than let its disparate operations go their separate ways? Most important: What has the AIG story told us about how well the government handled trouble at a huge financial services firm, whose missteps hurt so many innocent bystanders?
"I would not call the bailout a success," says Wharton insurance professor Kent Smetters. "But the alternative is always hard to assess."
Too large to fear
Even though the taxpayer may eventually not lose in this case, Smetters worries that the AIG bailout and other post-crisis government actions "have likely worsened the too-big-to-fail problem" by signaling that the government will step in to help in a crisis involving a big firm connected to others, making it easier for companies to continue taking unsound risks.
"We all know this could all happen again," adds Wharton finance professor Richard Marston. "Specifically, banks are far too large to ensure that the fear of failure will discipline them. Large banks know that they are too 'systemically' important for us to let them fail."
Executives heading large financial firms are sure to be cautious for a while, Marston adds, but "then they will be succeeded by new people who did not get burned last time."
Though not a bank, AIG was a major player in the financial markets and was the biggest insurance company in the US until disaster struck in September 2008 because of bad bets made by a London-based operation. Using derivatives called credit-default swaps, AIG had written insurance policies on mortgage-backed securities. When the housing bubble burst, the securities lost value and AIG was on the hook for enormous claims.
Losses peaked at US$25 billion for the third quarter of 2008. Worried that an AIG collapse would have a domino effect on other financial firms, creating upheaval in the financial markets and economy, the federal government stepped in with a series of bailouts that eventually totaled US$182 billion, taking majority ownership of the firm in exchange.
Whether that was necessary is open to debate. The financial markets had been roiled by the September 15, 2008, bankruptcy of Lehman Brothers, a global financial services firm that had asked for government help but been denied, and many regulators and lawmakers were afraid that a bankruptcy by AIG shortly afterward would create havoc.
While it's impossible to know what would have happened if AIG had fallen into bankruptcy, Wharton finance professor Richard J. Herring wonders whether the results would have been as bad as many predicted. "I still harbor doubts about whether the AIG bailout was necessary, since the one thing that went reasonably well in the Lehman Brothers fiasco was the settlement of the derivative contracts, including the credit default swaps," he says.
Moral hazard
In the AIG case, he points out, it was only the derivatives business that appeared to pose a risk to other firms; the more mundane insurance operations were sound. Many of the problems that ensued, like the credit crisis, were not so much a result of the troubles at Lehman and AIG as they were the result of a perception - based on the different treatment of the two firms - that the government "didn't have a game plan or even consistent policy goals," Herring notes.
The AIG bailout "heightened the degree of moral hazard in the system more than any other event," he adds, referring to the way risk-taking is encouraged by the belief that the government provides a safety net.
"AIG had done everything it could to evade competent regulation and supervision, yet it was treated more generously than any other institution when its bets turned sour."
US taxpayers now own 92 percent of the company. To get free of that, AIG plans to sell those government-owned shares to the public, starting with an offering - expected to total US$15 billion to US$20 billion - in May.
Before then, the company will conduct a series of "road shows" to convince potential investors that the stock is a good bet. Since the government's stake is worth about US$64 billion, depending on the share price, additional sales will be required to reduce the public's stake to zero.
(This is excerpted by Shanghai Daily from an article from China Knowledge@Wharton, http://www.knowledgeatwharton.com.cn. To read the full, original version, please visit: http://bit.ly/g5uBhx)
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