A key player in the financial crisis was insurance giant AIG, which sold a huge volume of credit default swaps supposedly protecting buyers of mortgage-backed securities from losses due to default. But AIG had nowhere near the capital necessary to honor these guarantees when things went bad, and much of AIG’s liabilities ended up being picked up by the Fed and the Treasury. On Tuesday the U.S. Treasury announced that it had sold the last of the common shares in AIG that it had acquired as compensation for its emergency assistance to AIG and reported that the Treasury and the Fed had together earned a profit of $22.7 billion as a result of their assistance to AIG. I was curious to take a look at how this story ended up having a happy ending.
The Treasury’s statement included a table detailing the government commitments and associated profits which I found very confusing and difficult to reconcile with earlier publicly released information. Fortunately, the Treasury’s blog (hat tip: Economist’s View) offered more details. I reproduce their graphic below.
The first two numbered entries in the Treasury’s timeline above evidently refer to the Fed’s September 16, 2008 statement that it stood willing to lend up to $85B to AIG, and subsequent October 8 statement that it was willing to commit an additional $37.8 B. The subsequent H.4.1 releases of the Fed’s assets and liabilities showed direct credit extended by the Fed to AIG (blue region in the graph below) to have been $28 B as of September 17, 2008 and to have grown from there each week to reach a maximum of $90.3 B on October 22.
The figure above highlights several major restructurings of the Fed’s AIG holdings. The first occurred in November and December of 2008, when the Fed established Maiden Lane II and III. Maiden II bought MBS held by AIG while Maiden III was to “purchase multi-sector collateralized debt obligations on which the Financial Products Group of AIG has written credit default swap contracts.” The Federal Reserve Bank of New York reports that Maiden II and III were established with $19.5 B and $24.3 B, respectively, borrowed from FRBNY. The credit that the Fed had initially extended directly to AIG (the blue region in the graph above) was reduced by an amount very nearly equal to the new capital infused into Maiden Lane II and III (brick and yellow), with the result that the sum of the three was fairly steady from November 2008 through December 2009. It is not clear to me from the H41 accounts how the capital infusion from the Treasury of $40 B in November of 2008 was used to reduce the Fed’s exposure. One possibility is that there may have been some other categories of exposure or loss which the Treasury money helped cover. Perhaps some of the securities pledged by AIG as collateral for the initial loans could be replaced by higher quality assets underlying Maiden II and III thanks to the Treasury’s new capital, so that the money effectively went to cover an unrealized earlier loss on the Fed’s balance sheet. I welcome instruction from knowledgeable readers who may know the correct answer to this.
The second restructuring occurred in December 2009 with the creation of AIA Aurora LLC and ALICO Holdings LLC. The Fed’s statement at the time said these were “created to directly or indirectly hold all of the outstanding common stock of American International Assurance Company Ltd. (AIA) and American Life Insurance Company (ALICO), two life insurance subsidiaries of AIG.” The Fed valued these assets (turquoise in the graph above) initially at $25 B, a move that coincided with a $25 B reduction in credit directly extended to AIG, so that again the sum of the four categories in fact remained fairly steady from November 2008 through January 2011.
The third major restructuring occurred on Jan 14, 2011, when the Fed retired the AIG loans and closed its AIA/ALICO positions, with the following explanation:
The cash proceeds from certain asset dispositions, specifically the
initial public offering of AIA Group Limited (AIA) and the sale of American Life Insurance Company (ALICO), were used first to repay in full the credit extended to AIG by the FRBNY under the revolving credit facility (AIG loan), including accrued interest and fees, and then to redeem a portion of the FRBNY’s preferred interests in ALICO Holdings LLC taken earlier by the FRBNY in satisfaction of a portion of the AIG loan. The remaining FRBNY preferred interests in ALICO Holdings LLC and AIA Aurora LLC, valued at approximately $20 billion, were purchased by AIG through a draw on the Treasury’s Series F preferred stock commitment and then transferred by AIG to the Treasury as consideration for the draw on the available Series F funds.
Here is the first place where I can clearly understand from looking at the Fed’s publicly reported balance sheet how the Treasury infusion of capital resulted in a reduction of the Fed’s exposure.
The key question in my mind was what was the market price that the Fed received when it disposed of the assets held by Maiden II and III. The Federal Reserve Bank of New York two weeks ago released details on purchase and sale prices of all assets held by Maiden III. That spreadsheet shows how Maiden III netted the Fed $6.64 B in excess of funds initially committed by the Fed. This number, when added to the $2.85 B earlier reported to have resulted from Maiden II is consistent with the $9.5 B combined profit claimed for Maiden II and III in the Treasury table reproduced above. Although the summary as reported by the Treasury puzzled me, the details provided in the Fed spreadsheets persuaded me that the bottom line has been accurately described.
I am surmising that the drop in interest rates and rise in equity prices since the fall of 2008 are important factors in accounting for how the government was able to come out ahead financially as a result of these transactions.
That these operations ultimately resulted in a profit rather than a loss for taxpayers is welcome news. As events turned out, the bailout of AIG proved not to be money just poured down a hole.