AIG
Risk Management MSF 515
Cindy Depina
Chris McClean
Scott Vickery
Mary White
November 28, 2010
Why was AIG bailout necessary – why not let AIG fail?
The bailout of AIG was necessary to help stabilize not only the company itself,
but more importantly to help stabilize the financial sector as a whole. Financial
regulators believed that AIG could not be allowed to fail due to the ripple effect it would
have created on the already strapped financial markets. As stated by Ben Bernanke, the
Chairman of the Federal Reserve, “Economic recovery hinges on the government's ability
to stabilize shaky financial markets.” AIG was a big part of the shaky financial markets.
Protecting the economy from utter financial failure was the intent of the Federal
Reserve. AIG at the time was, and still is, linked or tied to many other financial
institutions in the market. It was widely believed that if AIG had failed, it likely would
have caused many of its key trading partners, including Goldman Sachs, to experience
severe financial crisis or even to fail as well. The snowball effect would have had
catastrophic effects in the United States and all over the world.
As we saw, financial giant Lehman Brothers ultimately failed the same week that
AIG received government support. The United States was already facing a distressed
economy and the collapse of Lehman Brothers sent global markets reeling. The bailout of
firms like AIG and the decision not to bailout others, like Lehman Brothers, caused
substantial debate about the concept of these companies being “too big to fail,” but it is
generally accepted that the US government actions to bolster some of the linchpin
financial firms at the time saved the global economy from greater catastrophe.
Terms of the AIG Bailout
AIG received several bailouts from the US Government in 2008 and 2009. The
total authorized amount of these bailouts was $183.3 billion; however, the actual funding
was $151.3 billion. The first bailout occurred on Sept 16th, when the Federal Reserve
Bank of New York (FRBNY) provided an $85 billion revolving loan facility for 24
months. Pricing under the initial funding was Libor + 8.5%. The funding was supported
by 79.9% ownership stake in AIG.
On November 10, 2008, The U.S Treasury agreed to buy $40 billion in Senior
Preferred Stock under the TARP program. With these funds, AIG received approval
from the Treasury to reduce the FRBNY revolving loan from $85 billion to $60 billion,
as well as, to extend the $60 billion loan facility to 5 years while reduce pricing to Libor
+ 3% on the drawn funds and Libor + 0.75% on the undrawn funds.
Additionally, in November 2008 under the TARP plan the U.S. Treasury
committed up to $29.8 billion to purchase additional Preferred Stock to meet liquidity
needs of the company. Of that total amount, $7.5 billion has been funded.
Also in November 2008, the Fed created two special purpose vehicles (SPV),
Maiden Lane II SPV and Maiden Lane III SPV, to hold AIG’s Residential Mortgage
Back Securities and Collateralized Debt Obligations. The commitment was authorized
up to $52.5 billion; however, the actual amount funded was $43.8 billion.
In December 2009, two more SPVs were created, AIA SPV and Alico SPV. The
$25 billion essential exchanged equity for a reduction of FRBNY’s revolving loan
facility. With this funding the FRBNY revolving loan facility was reduced further from
$60 billion to $35 billion.
As of September 30, 2010, the availability of the FRBNY’s revolving loan facility
has been reduced to $29.18 billion with the sale of assets by AIG.
The following table shows the outstanding balances under the various debt and
equity facilities as of quarters ending March 31, 2010, June 30, 2010 and September 30,
2010:
Facility
FRBNY Revolving
Authorized
Balances as of Sept 30,
Balances as of June 30,
Balances as of Mar 31,
Commitment
2010
2010
2010
$29.18 billion
$20.5 billion
$26.5 billion
$27.4 billion
$40 billion
$41.6 billion
$41.6 billion
$41,6 billion
$29.835 billion
$7.5 billion
$7.5 billion
$7.5 billion
$25 billion
$26 billion
$25.6 billion
$25.1 billion
$22.5 billion
$14.1 billion
$14.7 billion
$15.3 billion
$30 billion
$15.1 billion
$16.3 billion
$17.3 billion
Loan
Equity TARP Preferred
Series D/E
Equity TARP Preferred
Series F
Equity FRBNY AIA
SPV and Alico SPV
Equity FRBNY Maiden
Lane II SPV (RMBS)
Equity FRBNY Maiden
Lane III SPV (CDOs)
Total Outstanding
Total Obligation of
$162 billion
$124.8 billion
$132.1 billion
$134.2 billion
$132.8 billion
$95.6 billion
$101.2 billion
$101.6 billion
AIG*
* Maiden Lane II SPV and Maiden Lane III SPV are not obligations of AIG and not included in AIG’s balance sheet.
AIG’s Restructuring to Improve Risk Management
The rapid and nearly complete failure of AIG called attention to the importance of
risk management, forcing regulators and company executives to ask how things went
wrong so quickly. As AIG accepted the federal government’s bailout money and looked
forward to its return to viability, it was clear that changes were necessary in the way it
identified, measured, and treated risk.
An early example of these changes came when the Department of Treasury
announced it would purchase $40 billion in preferred stock from AIG under the
Emergency Economic Stabilization Act. This move came with certain stipulations to help
assure that the company would use taxpayers’ money responsibly. Among requirements
to limit executive compensation, bonuses, and expenses, AIG also had to create a formal
risk management committee that would report directly to the board of directors. (US
DOT, 2008)
Several months later, the US Treasury Department and Federal Reserve
announced that they were restructuring the government’s assistance in supporting AIG,
citing the “systemic risk” it posed to the country’s economy as well as the “fragility” of
the markets at the time. (FRS, 2009) This restructuring, which was announced on March
2, 2009, included improved terms of the Treasury’s stock investment, a $30 billion equity
capital facility to allow the company to raise more money, and a repayment of a $26
billion capital facility to the Federal Reserve Bank of New York. Although these moves
primarily focused on building AIG’s financial strength, risk reduction was a driving
force. At the time, the company’s Vice Chair and Head of Restructuring said, “The U.S.
Treasury, the Federal Reserve, and AIG have taken actions that will allow AIG to achieve
a complete restructuring over the next several years through a process that protects
policyholders, continues to reduce risk, and produces strong, focused franchises that can
operate as independent entities.” (AIG, 2009) According to the company’s web site, a
major objective for all its restructuring efforts is “reducing excessive risk by winding
down AIG’s exposure to certain financial products and derivatives trading activities.”
(AIG, n.d.)
AIG also continues to bolster its internal risk management expertise and culture,
hiring additional risk managers and committing more communication and meeting time
to discussion of risk. In testimony in front of Congress during the summer of 2010, AIG’s
former risk manager explained that management had had good oversight across the
various business units but had not planned for the severe levels of risk that eventually
combined to bring down the company. To help solve this problem, AIG Executive Vice
President Peter Hancock, who now oversees the company’s finances, investments, and
risk management, explained, "For a place this big … we need a broader number of senior
leaders who are thinking about the whole and a culture where there's a sense of curiosity
and accountability for something larger than just the nominal patch that each person is in
charge of." (Ng, 2010)
References
AIG Financial Supplements (Q-10) Third Quarter September 30, 2010. Retrieved from:
http://www.aigcorporate.com/investors/financial_reports.html
AIG (n.d.) Restructuring and Rebuilding. Retrieved on November 24, 2010 from
http://www.aigcorporate.com/restructuring/keyrestructuring.html
AIG (March 2, 2009) U.S. GOVERNMENT PROVIDES SUPPORT FOR CONTINUED
RESTRUCTURING OF AIG. Retrieved from:
http://www.niagroup.com/AIG/US_Govt_Restructuring_AIG.pdf
CBC news. WSOCTV.com.
Federal Reserve System (March 2, 2009) U.S. Treasury and Federal Reserve Board
Announce Participation in AIG Restructuring Plan. Retrieved from
http://www.federalreserve.gov/newsevents/press/other/20090302a.htm
Hartley, Chris (November 2, 2010) AIG to Pay Back Bailout with $37 billion.
Financialfeed.net. Retrieved from:
http://financialfeed.net/aig-to-pay-back-bailout-with-37-billion/85540/
Ng, Serena (September 15, 2010) AIG Refines it Risk Approach. The Wall Street
Journal. Retrieved from:
http://online.wsj.com/article/SB1000142405274870465210457549404241006279
2.html
US Department of the Treasury (November 10, 2008) Treasury to Invest in AIG
Restructuring under the Emergency Economic Stabilization Act. Retrieved from:
http://www.treas.gov/press/releases/hp1261.htm