Federal Reserve To Lend $85 Billion To AIG
In exchange for a 80% equity stake in American International Group, the Federal Reserve has agreed to lend up to $85 billion so that it can avoid a disorderly collapse that could adversely effect global financial markets.
The Board determined that, in current circumstances, a disorderly failure of AIG could add to already significant levels of financial market fragility and lead to substantially higher borrowing costs, reduced household wealth, and materially weaker economic performance.
The purpose of this liquidity facility is to assist AIG in meeting its obligations as they come due. This loan will facilitate a process under which AIG will sell certain of its businesses in an orderly manner, with the least possible disruption to the overall economy.
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.
This is far from a government handout, with the current Libor rate, AIG is on the hook for over 11% interest rate for the 2 year loan. The loan is in place for the sole reason so that there can be an orderly sale of the company’s assets.
While AIG was in talks with Morgan Stanley and J.P. Morgan Chase in order to secure a $75 billion lifeline, apparently those talks broke down leaving the company no choice but to accept the government’s offer. The world’s largest insurer has been brought low by losses stemming from credit derivatives it sold on Collateralized Debt Obligations most notably Mortgage Backed Securities.
These credit default swaps are basically insurance policies that investors purchase to protect themselves from losses. In case of default, the seller of the swaps makes payment to the purchaser for the principal or face value in exchange for the underlying security.
When the housing market was booming this was pretty much free money as they never had to make any payments. Now, with defaults and foreclosures at record levels, the payments have flowed out like a torrent which has pulled AIG under.
AIG’s former CEO, Hank Greenberg, who is also one of it’s largest shareholders has come out in criticism of the plan stating the company merely needed a temporary loan not a government takeover and breakup. There is a good chance that stockholders could be wiped out after the dust settles, though frankly management has done a good job of that themselves as the stock has lost over 90% of it’s value over the past year.
