Season Investments


The Best of a Terrible Set of Choices

Posted on December 11, 2012

“It is hard for us, without being flippant, to even see a scenario within any kind of realm of reason that would see us losing a dollar in any of those transactions.” Joseph Cassano, head of AIG Financial Products, commenting on AIG’s mortgage-related derivatives business on August 9, 2007

It was a little over a year after Joe Cassano spoke these words that American International Group, which had once been a premier player in the global insurance industry, found itself on the verge of bankruptcy and desperate for a bail out from the US government. The bursting of the subprime bubble had lurched the company into a liquidity crisis as mortgage-related securities of all types were in free fall, calling into question AIG’s ability to make good on hundreds of billions in insurance it had written on those securities. Following a downgrade of its credit rating the day after Lehman’s bankruptcy announcement, AIG found itself in a position in which it was unable to post the additional collateral required to back its insurance guarantees. The graphic below, posted on the New York Times website in September of 2008, illustrates the problem very succinctly.


Unlike Lehman Brothers, AIG was quickly determined to be too big to fail, and the US government sprang into action. As the chart below shows, AIG shareholders were obviously not the target of the life preserver (the stock is still down roughly 50% since the bailout).


Rather, the government’s actions were in response to the ripple effects that would have been realized had AIG gone under. Insurance contracts on all types of securities held by institutional and retail investors would have been compromised, resulting in losses for not only the wealthy and sophisticated but also for mom and pop investors with cash savings in money market mutual funds. This idea of bailing out AIG in order to benefit the average American, rather than the company executives, was supported by both presidential candidates during their campaign. 

“[The AIG bailout] should bolster our economy's ability to create good-paying jobs and help working Americans pay their bills and save their money. It must not bail out the shareholders or management of AIG." – Barack Obama, September 2008

“The focus of any such action should be to protect the millions of Americans who hold insurance policies, retirement plans and other accounts with AIG. We must not bail out the management and speculators who created this mess." – John McCain, September 2008

By the time the dust settled the terms of the bailout had been revised three times, and the US government was in for $182 billion. The US taxpayer owned 92% of the crippled insurance giant at the peak. This was hugely unpopular with the American public, especially in light of the $165 million in post-bailout “retention bonuses” AIG paid to the Financial Products division which was largely responsible for the company’s problems in the first place. 

The bailout was also unpopular among policy makers who felt there were no better options. Fed Chairman Bernanke said that the AIG situation made him “more angry” than any other action the government had to take during the crisis, while Tim Geithner later described the bailout as “the best of a terrible set of choices”. Meanwhile, congressional democrats Frank and Pelosi directed sharp criticism at the Bush administration and its appointees (Treasury Secretary Paulson and Fed Chairman Bernanke) for nurturing what they characterized as an out-of-control free market system in need of heavier regulation. 

A Congressional oversight panel chaired by Elizabeth Warren even predicted the entire operation ran the risk of being a complete failure, saying in June of 2010 that taxpayers “remain at risk for severe losses” and predicting that the US government would be a shareholder well beyond 2012. Overall, the panel was incredibly critical of the bailout, calling into question the moral integrity of those responsible for structuring the deal:

“The AIG rescue demonstrated that Treasury and the Federal Reserve would commit taxpayers to pay any price and bear any burden to prevent the collapse of America’s largest financial institutions.” – from Congressional Oversight Panel report on the AIG bailout

All of these sentiments were expressed during a highly volatile time when emotions were running high and everything was being called into question. It would be disingenuous of me to not lump myself in with the naysayers who took exception to the extreme public sector measures being implemented at the height of the crisis. 

We are now four years removed, and the US Treasury has just announced that it will sell its remaining 234 million AIG shares in its sixth offering since the rescue, thereby securing a $4.1 billion profit on its investment in AIG stock. Inclusive of gains the Federal Reserve realized on its investment in beaten down mortgage securities, the total profit from the bailout comes to $22.7 billion

At a roughly 15% cumulative return on investment over four years it would be silly to imply that the American taxpayer was properly compensated for the risk and uncertainty taken on in 2008. After all, there were plenty of other far less risky opportunities that generated substantially higher returns over this time frame. However, when you consider that this bailout prevented an AIG bankruptcy and helped to avert what Princeton economics professor Uwe Reinhardt said would have been a “chain reaction” with “incredible spillover effects”, the entire experiment should be considered a great success. In my view, the naysayers (myself included) have been proven wrong. 

AIG looks like a totally different company today than it did back then. Tens of billions worth of assets have been sold off, and the company employs roughly half the number of people it did at the end of 2007. New leadership has cut its derivatives business and refocused efforts on core property-casualty, life and retirement products. All signs point to a bright future for the company under this restructured business model. But while the economic tethers of the bailout will soon be cut free, perhaps the longer lasting impact will be felt in the realm of regulation. Barney Frank echoed the sentiment of many in Washington when he said, “…this is one more affirmation that the lack of regulation has caused serious problems. That the private market screwed itself up and they need the government to come help them unscrew it.” Indeed, perhaps time will reveal that AIG’s lasting legacy will be its contribution to the regulatory maelstrom set off in response to the necessity of these bailouts during the crisis. But that’s a conversation for another day.

david_headshot_bw.jpgAuthor David Houle, CFA is a founding member of Season Investments. He serves as the firm's Chief Compliance Officer as well as sitting on the investment committee overseeing the management of client assets. David spent nearly ten years in various roles primarily managing individual client assets prior to co-founding Season Investments. David graduated with a degree in Finance from Colorado University in Colorado Springs in 2003 and earned the Chartered Financial Analyst (CFA) designation in 2006. David and his wife Mandy have three children and spend most of their free time with friends and family.

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