U.S. Revamps Bailout of AIG

Taxpayers Exposed to Greater Risk in New Plan; $30 Billion More From TARP Funds

By Liam Pleven, Matthew Karnitschnig and Deborah Solomon
Wall Street Journal
March 2, 2009

The federal government is overhauling its $150 billion bailout of American International Group Inc. in a bid to bolster the battered insurer, but its plan will expose U.S. taxpayers to more financial risk.

The new deal, the government's fourth for AIG, represents a nearly complete reversal from the one first laid out in mid-September. Back then, federal officials acted as a demanding lender, forcing the insurer to pay a steep interest rate for what was expected to be a short-term loan. Now the government is relaxing loan terms by wiping out interest in hopes of preserving AIG's value over a longer period.

The plan raises the possibility that the 90-year-old firm will be broken up completely, with businesses being hived off in separate stock offerings, although that process would likely take years. The company is planning to combine its giant property-casualty insurance operations into a new unit, with a new name and separate management, and to sell nearly 20% of it to investors.

Under the latest plan, the U.S. will give AIG access to up to $30 billion in new cash from its Troubled Asset Relief Program, or TARP, but will also cut the insurer's $60 billion credit line with the Federal Reserve to between $20 billion and $25 billion.

With the latest move, AIG will have the benefit of up to $70 billion from the TARP program; it got a $40 billion TARP investment in November. The total amounts to 10% of the $700 billion financial-sector rescue fund, money that most lawmakers did not expect would go toward propping up a troubled insurer. Officials believed they had little choice but to use the TARP money, particularly because they lack the authority to unwind a troubled firm such as AIG the way the government can do now with failing banks.

The AIG funding eclipses the $50 billion that Citigroup Inc. has received from three Treasury programs, and the $45 billion that Bank of America Corp. has received, although each of those firms might receive additional funding in coming months, if necessary. The two banks also have commitments from the U.S. government to back potential losses down the road, putting hundreds of billions of dollars in public funds on the line.

The decision to approve a third revision of the AIG bailout amounts to a calculated bet by Treasury Secretary Timothy Geithner and Federal Reserve Chairman Ben Bernanke -- both architects of the original bailout -- that there would be even greater risk to letting AIG fail.

Fed officials feared that a bankruptcy filing by AIG could be disastrous for the economy, which is in worse shape than it was six months ago. While AIG is trying to unwind many of the derivatives contracts in its Financial Products unit, deepening trouble at AIG would create more trouble for municipalities that have business relationships with the firm.

In addition, a bankruptcy risked driving away many of AIG's roughly 74 million policyholders, forcing them to replace insurance contracts at a difficult time, adding to economic troubles in the more than 100 countries in which AIG operates.

AIG's revised deal effectively cuts the interest and dividend payments that the insurer must make to the government. That eases the financial burden on the company, which is expected to report a $60 billion quarterly loss on Monday.

The deal will put the government more directly into the insurance business. A key aspect of the plan involves creating trusts to hold two AIG units that sell life insurance overseas: Asia-based American International Assurance Co. and American Life Insurance Co., which operates in 50 countries. The government will be given preferred shares in each trust, which will likely pay a 5% dividend. Those stakes will be used to repay the $38 billion already borrowed from the government.

But AIG and the government have yet to agree on how to value those businesses. That's a major issue for both the company and taxpayers, because it will help determine how far AIG will go to reducing the outstanding government debt. If those AIG franchises lose value after the trusts are created but before they can be sold, that could hurt taxpayers. Already taxpayers are exposed to tens of billions of dollars in soured AIG assets, via participation in investment vehicles that the government helped finance.

In addition, AIG will package $5 billion to $10 billion in life-insurance assets into bonds to give to the government, reducing its federal debt by the value of the bonds. The government can either hold them or sell them to investors.

Officials at the Fed believe the restructured rescue package gives the U.S. government adequate collateral to protect taxpayers. Two elements of last fall's rescue -- the creation of special-purpose vehicles for certain debt and mortgage assets -- will remain in place and provide interest and earnings to help cover the government's commitments.

The latest version of the bailout came as AIG faced potentially crippling cuts to its credit ratings. Downgrades would likely have forced the company to post billions of dollars in collateral on an array of financial contracts, and could also have triggered the termination of many corporate insurance policies, costing AIG billions more.

In a November filing with the Securities and Exchange Commission, AIG warned that a one-notch downgrade of its long-term rating could require it to pay out about $8 billion to its counterparties.

The major credit-rating companies signed off on the latest package, according to people familiar with the matter, clearing the way for the deal to go forward. The revision was negotiated over a period of months between AIG and U.S. government officials, these people say.

The government chose not to require any additional management shake-up as a condition of the bailout's revision. Federal officials installed AIG's current CEO, Edward Liddy, at the time of the initial rescue.

Mr. Geithner was involved in the negotiations and signed off on the structure of the revised deal and the amount of new TARP money. He met with Mr. Liddy on at least one occasion, according to people familiar with the matter.

Sudeep Reedy contributed to this article.

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