A Progress Report on Bailout in Lieu of Bankruptcy

The GAO reported this week on the “Status of Government Assistance Provided to AIG.” (You can get the highlights here and a summary here.) I have one simple and intentionally naive question: if AIG (NYSE:AIG) will not be able to repay its commitments to the federal government, why does the federal government not own 100%, as opposed to 80%, of the company? Mary Williams Walsh is on the case in The New York Times:

The report suggested that A.I.G. would struggle just to stay current on its government debt, much less repay it. Under the initial bailout agreement, A.I.G. was to pay a 10 percent dividend on preferred stock, in exchange for $40 billion in capital from the Treasury. A quarterly dividend payment of about $1 billion is coming due in November. The company does not appear to have the means to pay it, and was granted the option of not paying as part of a debt relief package in March. If the company misses four payments, though, the Treasury can elect two directors to its board.

The report also cast questions about a debt restructuring with the Federal Reserve Bank of New York. The plan, outlined in March in broad strokes, would allow A.I.G. to extinguish about $8.5 billion of debt by giving the Fed an ownership stake in the future cash flows of its domestic life insurance businesses. The transaction has not been scheduled nor have details been disclosed, and it is not clear that the insurance units really have $8.5 billion to spare.

The assessment of A.I.G.’s prospects coincided with word that a senior House Democrat was planning to ask the Federal Reserve and the Treasury about possibly easing the terms of A.I.G.’s government debt yet again.

The government’s forgiveness of debt is a transfer from the government to the other equity holders. That these are even being discussed is another reason why the government should stay out of the business of bailing out financial companies.

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