The financial catastrophe overcoming AIG and the subsequent Fed bail-out will go down in economic history as one of the most extraordinary weeks ever. Mairi Mallon delves through the entrails of the AIG crisis.

American International Group (AIG), once the world’s most valuable insurer, was listed earlier this year by Forbes as the 18th largest company on the planet.

Just 12 months ago, if anyone had mooted the idea that it would be taken to the edge of bankruptcy and that it would have to be bailed out by the US government, they would have been laughed out of the room by analysts, industry peers and clients.

So how did AIG, the company that Maurice “Hank” Greenberg, built up from nothing to an international giant that operates in more than 100 countries, fall so far, so quickly?

The answer is credit default swaps, a kind of insurance against bad debts. AIG has sold $80bn in credit default swaps to investment houses to cover their losses on mortgage-backed securities.

And while the rest of its core businesses remained sound, as the housing market crumbled and sub-prime debts became headline news, AIG was suddenly on the line to pay for huge amounts of the losses.

Subprime goo

Three-quarters of the mortgage-related securities that AIG insured were derived primarily from subprime mortgages, which have fallen at unprecedented high rates. In all, AIG has posted losses of $25bn (but AIG Financial Products’ actual exposure to the estimated $450bn of credit default swaps still remains unclear).

Its stock price dropped by 94%. Suddenly it needed to raise more capital to be able to pay its debts.

The potential death-blow came on Monday, 15 September, when rating agencies Moody’s and Standard and Poor’s downgraded AIG. The surge in AIG’s credit spreads and slump in the shares prompted the downgrade. That allowed counterparties to demand more than $13bn in collateral on swap trades. AIG tried to find the money, but failed. When private equity firms failed to come up with the cash, the federal government decided it had to bail out the company as its failure would lead to dire consequences for a market already spiralling out of control.

AIG was forced to cede control to the US Government in exchange for the $85bn loan.

Under a “definitive” two-year agreement, the Federal Bank of New York will have a 79.9% stake in the insurer. The interest on the loan is high but

AIG said the facility was the firm’s “best alternative”.

Under the terms of the deal, interest will accrue at a high rate: 8.5% above the rate of the three-month London Interbank Offered Rate, or Libor, the rate at which banks lend to each other.

The firm will have to repay the loan by, among other things, the sale of certain assets as well as issuing debt.

Borrowings under the facility are conditional on the central bank being “reasonably satisfied” with AIG’s corporate governance, among other requirements.

At the same time, shareholders who have lost billions of dollars in the value of their stock, had been holding emergency meetings in a bid to find a way to raising money to stop the government from being able to take control of their company.

They have been holding talks in private. Reports have said these meetings have included Greenberg, AIG’s former chief executive who was forced out in 2005 after a clash with regulators over accounting practices, representatives for Eli Broad, Shelby Davis of Davis Selected Advisers LP, and Bill Miller of Legg Mason Inc.

Originally, the terms of the federal loan said the United States would get warrants pending shareholder approval, but a later filing omitted mention of any warrants or a shareholder vote.

At a meeting on 22 September, the investors “discussed possible alternatives that may exist that could relieve the taxpayers’ burden while protecting AIG stakeholders”, said Mickey Kantor, a lawyer for the shareholders. Kantor is a former US trade representative and Secretary of Commerce in the Clinton administration.

The shareholders want to ensure AIG will keep or recover the controlling stake if it pays off the loan in the two-year limit.

Quick asset sale

In a bid to boost confidence in the company, the newly-installed chief executive officer Edward Liddy went on CNBC and said he expected AIG to emerge from the crisis as a leaner, stronger company, focusing on its traditional strengths in property/casualty insurance and its international business, especially in Asia.

“We’re going to take those assets which are probably very valuable, but can also be digested by buyers in relatively manageable bites, and we will simply start to market them,” said Liddy, just a week into the top job.

“I hope within the next seven to 10 days to be out there with a plan that lists everything that’s for sale and maybe even execute some of those transactions by then,” said Liddy, a former CEO of insurer

Allstate Corp. “It will look a lot like it did prior to 1998, 1999, with less reliance on the financial services side.”

By the time Global Reinsurance will be on the news-stands, parts of AIG will already have been put up for sale, with speculation that the company’s landmark properties would be first up for grabs.

At the time of going to press, it was not imediately clear if insurance businesses might come up for sale, although The Wall Street Journal reported that AIG might sell Transatlantic Holdings, its reinsurance group, with Swiss Re and Munich Re as potential buyers. Analysts have also said Canadian life insurance company Manulife Financial would be interested in some of AIG’s businesses.

Before the details of the deal emerged, Kristian Moor, AIG executive vice president and CEO of AIG Property Casualty Group, said: “Domestic commercial insurance and foreign general insurance are core, and we have no plans to sell those.”

John Doyle, CEO of AIG Commercial Insurance, the commercial lines division of AIG Property Casualty Group, said the financial problems at the parent company “were never about the insurance subsidiaries”.

Liddy was named AIG’s CEO on Thursday 18 September as part of the Federal Reserve deal, replacing chairman and CEO Robert B. Willumstad.

Willumstad had been installed in June after the ousting of former chief Martin Sullivan.

News reports emerging in the last week in September said the FBI was separately launching a probe into four key finance firms, including AIG, for potential fraud.

Other firms named were Fannie Mae and Freddie Mac and failed bank Lehman Brothers.

Mairi Mallon is a freelance journalist.

Shareholder losses

Hank Greenberg
The dramatic drop in value of AIG stock has left investors billions of dollars out of pocket. Of the casualties, Maurice R. Greenberg, AIG’s former chief executive officer and the man responsible for the growth of the insurance giant, is the most obvious.
According to a filing with the Securities and Exchange Commission in May 2008, Greenberg’s AIG holdings, along with stock he owns jointly with his wife and stock of the C.V. Starr entities he controls, come to 51m shares. At the beginning of September the holdings were worth $1.12bn. At the closing price on 19 September of $3.85, they were worth $196.5m.
Greenberg reported in an SEC filing in September before the federal loan, that he may seek to take control of all or part of AIG through a merger, proxy solicitation or “going private” transaction.

C.V. Starr
C.V. Starr & Co. owns 12.4m AIG shares – including 3m shares attributable to Greenberg’s 24% ownership stake in C.V. Starr. These holdings were worth $47.6m at close of business on 19 September, compared with $271.3m at the beginning of September.

Starr International Company was formerly used as a vehicle for AIG executive compensation plans but is now controlled by Greenberg and other former AIG executives. SICO owned 227.9m AIG shares as of 15 July, and the value of its holdings has dwindled to $877.6m as of 19 September, down from $5.01bn at the beginning of the month.