Explaining Paulson’s AIG safety net
Imagine for a minute, that you’re a middle aged guy in the southern Orange County enclave of Monarch Beach, California at the St Regis Hotel and Spa enjoying a back massage from an attractive, busty Swedish female in a tight white golf shirt and curving white pants. You’re on an expense account with your colleagues, living the life you dreamt about as an early 20s college grad. All those years of school, all those reports, all of those business meetings you slogged through, have culminated into this climatic high of total relaxation and visual pleasure. You deserved it, you think.
- The Jonas Brothers of Upscale Hotels
On the other hand, the company that is sponsoring this trip is on the brink of losing one of its key businesses that insures mortgaged back securities. That company is AIG. Should you be on this business trip at all? It his just some selfish indulgence? Let’s briefly review what exactly AIG does today to help answer this question.
AIG is a diverse multinational conglomerate that has over $1 trillion in assets and almost $80 billion in equity. They sell almost any insurance you can possibly imagine and they have side businesses as well; anything from leasing planes to ski resort ownership.
As you perhaps know, AIG was hemorrhaging money in their insurance of mortgage-backed securities, sometimes called credit default swaps (CDS). This was an investment, a bet if you will, that AIG offered to people in hoping that certain mortgages would not be paid and go into default. In the wake of the current mortgage crisis, many people are now owed money off of homeowners defaulting, and as such, AIG has been paying out a lot of money, to the tune of $18 billion over the last three quarters.
With this large loss, AIG asked for help from the federal government to shore up their balance sheets, and on 16 September 2008, Treasury Secretary Henry Paulson with the help of his friends at the United States Federal Reserve extended to AIG an $85 billion bridge loan if they needed it. The terms of this loan are highly unfavorable to AIG: Interest rate of 8.5% on top of the 3-month LIBOR rate, which hovers somewhere around 4.5%, in addition to the feds seizing almost 80% of AIG’s equity and using virtually all of AIG’s assets as collateral. Since then, the federal government has made available an additional $37.8 billion. Since 3 October, AIG has drawn $61 billion from the government’s loan.
Contrary to my libertarian leanings, I think this loan was a great opportunity both for the United States government and AIG. The unfavorable terms of the loan give AIG motivation to become a more streamlined business. If AIG eventually fails, then the government will be the owner of their trillion dollars worth of assets, many of which are quite profitable.
But right now I’d like to get back to the ethics of spending $400,000 of company money on a resort vacation weekend in Southern California. One of the ironies of all of this, is that the money was being spent in an area that was hard hit by the mortgage crisis. At least they are flowing money to the local economy. Practical amusement aside, many people in the general public met this story with immense outrage.
- Can AIG weather the storm?
Anderson Cooper dedicated almost 35 minutes of his program to it. He wants to “keep ‘em honest.” Local news in Houston led the newscasts with people on the street interviews expressing outrage. But, in fact, I think a lot of the outrage is rooted in the primitive emotions of jealousy. The company sponsored the trip before the government loan, and the persons who went on the trip were part of their life insurance business, which is based out of Houston, Texas, not even in the same stratosphere as the CDS business based in New York.
Sure, $400,000 is an extravagant amount to spend on a week of vacation for high-performing executives, but who are we to say that they didn’t deserve it? It is ultimately up to AIG how they want to spend the money the government gave them. If they want to depreciate their assets by blowing $400 grand on a week in California, so be it. It’s either their gain, or their loss.
And it’s apparent from the terms of their loan, they have much to lose.
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I agree with you that it is AIGs money to spend. Given that the US Government decided to extend them a $123 billion line of credit, they have a lot of spending to do. What I don’t understand is why the US Government isn’t getting any blame for this vacation — they own 80% of the equity and therefore control the company. They could have easily said the trip was canceled. Put blame where blame is due; with Mr. Paulson.
Well, I think one point should be clarified: AIG isn’t 80% owned by the government, it is “potentially” 80% owned by the government since the equity stake was in warrants which have yet to be exercised. So given this, I would question the government control of the company. Presumably, with the right to potentially own 80% of the company at their own will, they would exercise some control, but to this in depth of a level I’d have to question. To further that, I believe the government are almost taking passive stakes in these companies.
But, I agree with this article that the media and public outrage from the 400k+ vacation is quite unwarranted. I think the thing to note here is that 400k is essentially nothing in the scheme of AIG’s operations. Morale certainly had to be low among the company (even the affiliated divisions that aren’t part of the business that was crippled). Given these circumstances, AIG’s main priority had to be restoring morale. Talent, motivation, and belief in the success and values of a company are indispensable characteristics to any organization’s employees. If 400k was the price that this business segment had to pay for this, then I would say that is probably the best and safest investment AIG has made in a long time.