Why US keeps backstopping a flattened AIG

“No one wants to inject capital in these companies if they see the government ahead of them” in terms of getting money back in the event of a bankruptcy, says Doug Roberts, chief investment strategist at Channel Capital Research.com in Shrewsbury, N.J. “Why take the risk?”

The move does increase the risk to taxpayers, however. “They no longer have a preferred position,” notes Mr. Roberts.

Despite its financial problems, AIG, in a statement issued Monday says its underlying businesses “remain strong, well-capitalized, and competitive.”

Since last September, the company has made progress in reducing “the excessive risk” from exposure to “certain financial products,” it says.

Peril of derivatives

AIG got into trouble after its London office sold enormous quantities of derivative-type financial products. These are complex financial instruments that are supposed to act like mortgages, commodities, or other financial products. According to news reports, AIG’s main clients were European banks.

When the US government made its first investment in AIG – some $85 billion – last September, the company planned to repay the taxpayers by selling some of its assets. However, now the company says the sharp decline in global economic conditions has adversely affected its ability to divest those assets.

“The very same global forces that we face have greatly diminished the ability of qualified buyers to raise the capital necessary to buy AIG’s businesses right now,” said Paula Rosput Reynolds, AIG’s vice chairman and head of restructuring.

That’s one reason AIG now will give the US equity stakes in two subsidiaries – Asia-based American International Assurance Co. and American Life Insurance Co. – in return for a reduction in $26 billion in debt it owes the government. The company also expects to transfer to the Federal Reserve Bank of New York securitization notes that are part of its insurance operations of up to $8.5 billion, a move that will also reduce the amount it owes the US.

The company’s executives say its insurance operations are fine.

“They’re secure, they are protected,” said Edward Liddy, the company’s CEO, in an interview Monday morning on the “Today” show. “It’s all the other ancillary businesses that are causing this. And it’s the decline in asset values around the globe.”

A disavowal of ‘public ownership’

In its joint statement, the US Treasury and the Fed said, “Public ownership of financial institutions is not a policy goal and, to the extent public ownership is an outcome of Treasury actions, as it has been with AIG, it will work to replace government resources with those from the private sector to create a more focused, restructured and viable economic entity as rapidly as possible.”

Roberts, the investment strategist at Channel Capital, is doubtful. Even with the latest AIG restructuring moves, the US government will still own about 80 percent of the ailing company.

“What it comes down to is you are effectively nationalizing the company,” Roberts says. “Then, why will anyone invest additional capital in AIG? So, the government is dancing around, saying there is still some value left for common shareholders.”

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