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AIG bailout not a free lunch

James Tilson and Robert E. Prasch follow the money at New Economic Perspectives regarding the AIG bailout and a more accurate sense of costs.

“If it’s too good to be true, it probably is.” This old adage came to mind on December 11, 2012 when the U.S. Treasury made the announcement, reiterated unthinkingly by the press, that the AIG bailout was coming to an end with American taxpayers making a tidy profit on the deal. In an effort to capitalize on the news, AIG has spent millions of dollars on a primetime ad campaign thanking America for the bailout, highlighting its success: “We’ve repaid every dollar America lent us. Everything, plus a profit of more than 22 billion.” Unfortunately, this cleverly designed public relations maneuver deceives the taxpayer by distorting the perception of what has been a contentious use of government funds.


Among the shares the Treasury sold were 562,868,096 gifted to them from the Credit Facility Trust. This trust had previously been established by thehtFederal Reserve Bank of New York for the sole benefit of the Treasury Department. When these shares are taken into account, only 65.99% of the total returns from the Treasury’s sale of AIG common stock can be attributed to its original TARP investment, and the remainder should be credited to the FRBNY. The Treasury’s calculation, however, does not adjust for this transfer of shares. The effect is to artificially boost the returns on its politically contentious TARP investment at the expense of the Federal Reserve. Not counting these gifted shares, the Treasury assumes a break-even price of $28.73, but if we examine its investment in isolation, the true break-even is $45.53. After adjusting all cash flows associated with sale of stock, the Treasury’s profit of $5 billion becomes a loss of $12.7 billion.

An accurate evaluation of the Treasury’s investment in AIG should incorporate the effects of this tax advantage. So, rather than an average sale price of $31.18, a more telling number would be the share price controlling for this preferential tax treatment. According to estimates by analysts at Bank of America and JPMorgan Chase, doing so would reduce AIG’s share price by $5 to $6 dollars a share. ( ) If we were to adjust the sale price by $6 per share, the Treasury’s return is reduced from nearly $5 billion to a loss of more than $5 billion. Compounding this adjustment with that from the shares gifted by the Federal Reserve described above, the Treasury’s return is further reduced to become more than a $19 billion loss.

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In Related News, Lee Papa Will Be Selling Obscenity Insurance

Via Lindsay Beyerstein on Twitter, The Onion should now go out of business:

AIG knows a thing or two about bad publicity. Now, a subsidiary of the bailed-out insurer is offering a new type of coverage to defray the cost of bringing in outside experts when a company faces a potential public-relations crisis.

That’s right. AIG is selling “reputation insurance.”

And the best thing about it? All of those links, except Lindsay’s, are at least a week old! Talk about Stealth Marketing!

Maybe they have something to hide?

(For anyone who puzzled for a moment over the title of this post, here’s Lee Papa on Herman Cain. Which turned out to be even truer than he knew.)

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Some People Call Me Mau-rice

It’s not that the data is different; it’s the interpretation.

For instance, Brad DeLong’s What Obama Needs to Do is three(or four) fine suggestions, one point (2) that hasn’t worked yet but bears repeating, and a moment (5) of hope that really does required Congressional action, as Stan Collender noted today.

But the three good points are things several of us have been saying for years now, and the chance that the Obama Administration is rational enough to do them has only increased by the degree to which Larry Summers is no longer there. I want a pony, too.

So when I suggested a few days ago that Buce was Much Too Generous to Maurice (“Hank”) Greenberg here, it’s not that I believe Greenberg was an absolute failure. He built AIG into what it is today—well, what it was before he lead it to what it became, which is (again) about what it is today.

And there’s the rub, if not all of The Real Story. So this will be a Very Long Post, with Muliple Sidebars and Anecdotes. Feel free to skim; it’s below the fold.

In the deep, dark past, bankers were respected members of the community. I mean real bankers: the guys the investment bankers refer to as 9-6-3s: they lend at 9%, they take in deposits at 6%, and they’re on the golf course at 3:00. It wasn’t that they were the only game in town—though often enough they were—but it was a good, straightforward, relatively easy business. As long as you didn’t make a big mess (and there were very few chances to do so) and kept your personal life reasonably under control, you got and maintained a great reputation.

The equivalent of that, in the days before demutualisation, was runnning an insurance company. You took near-term premia, had long-term obligations at a rate below what the market would pay (on average, in most cases), and you just had to, again, manage your personal relationships and your acquisition of clients. (As with derivatives, a small variation in the fourth decimal place means a lot of money.) Get ones who are marginally healthier, where the same payout is made one year later, and you’re a superstar.

After demutualization, having the stronger balance sheet going in means you’re in a better position to acquire weaker competitors. AIG:Insurance::MannyHanny*:Banks

All with a AAA balance sheet. Safe, stable investment. At least until the Noughts.

Sidebar: In the distant past, I traded for a AAA-rated bank. (You can read all about the bank here. Note that the 2003 subtitle has been replaced in the paperback editions by a more accurate one.)

The thing about working for a AAA is that people come to you. I went to a party with former coworkers—mostly people who are both smarter and more driven than I am, and whose c.v.s have Rather Famous Names, both Before and After—and the department head (who does not fall into either of those categories, but is a sociopath) was talking about how they were planning to schedule meetings with firms such as Coca-Cola and Annheuser-Busch.

I had done a large, complicated deal with Annheuser-Busch that morning. And it wasn’t my firm’s U.S. marketing skills or special product knowledge that got us the deal. It was the AAA rating.

Once they lost, that…well, Gillian Tett can tell you the rest better than I (who left before that happened).

So when people tell me that Maurice Greenberg was incredibly detail-oriented and carefully managed every aspect of AIG and would have gotten it through the crisis, I’m naturally suspicious.

That’s partially because I know someone who fits that description perfectly: Warren Spector. He tracked the errors, he knew when the departments were not producing well, he pulled plugs, and he checked risk positions with the best of them. William Cohan’s sources may not have told him this, but Warren Spector probably could have saved Bear Stearns.

And if there had been a few more people like me speaking with Cohan, House of Cards would have turned out more like Fatal Risk than Indecent Exposure as if it were told from Begelman’s perspective.

Don’t get me wrong; I speak with people at AIG, and there are those there who firmly believe that Maurice “Not the Baseball Player” Greenberg could have saved them, Jack Aubrey-like, from all that followed his reign. But that’s faith, not evidence.

Part of the reason, one suspects, that Cohan marginalizes Spector while Boyd totemizes Greenberg is the AIG Board of Directors ousted Maurice Greenberg at virtually the same time the firm lost its AAA rating. Make no mistake: the Fall happened on Greenberg’s watch, his legendary attention to detail notwithstanding the balance-sheet distortions that were harbingers of Things to Come.

Even if we ignore that his direct “competitors” in the early Noughts notably included his two sons, Greenberg-as-CIO was always the man with the advantage. He never ran the firm when it had to compete with others in a relatively-level playing field.

Credit where due: he found a flaw in the insurance market, and he built a company around it. So did many others, Mike Milken most obviously among them. Building a firm is an accomplishment; running it is not necessarily the same skillset.

Similarly, running a AAA firm is relatively easy. Running a AA or below firm—the firm Maurice Greenberg left his firm in the hands of Martin J. Sullivan, who was (per Wikipedia) his selection—is often a different matter.

It was Sullivan—a UK native—who had to run the AA firm, and on whose watch the AIG Financial Products group under Joseph Cassano went from the operation that compromised AIG’s AAA rating to the area that took the firm down.

Would Greenberg have stopped this? There is scant evidence in favor of such an argument. Greenberg’s objections in 2008 were to the Board’s attempt to save the firm by selling-off “non-core assets.” Similarly, none of his back-benching—dangerous back-benching, arguably, given that his holdings in the company make him more visible than the member from Clan Agnew—from 2005 to 2008 was never about the risk that the Financial Products area was expanding too quickly.

Maurice Greenberg remained, iirc, the largest shareholder of AIG even after his ouster. In his frequent interviews, he made no secret that he was in contact with multiple board members. His rather hand-picked successor shepherded the firm into disaster, a disaster architected with pick-up sticks by workers in and from his native land.

Could Maurice Greenberg have saved AIG? It’s nice to think so, but nothing in his actions, statements, or post-crisis recommendations makes that a likely story.

Maurice Greenberg never ran AIG when it was not The Firm With Which People Wanted to Deal. He built an impressive edifice, but so did the Sons of Noah—and Buce knows how that ended.**

So the story that gets told is a man who was Always On Top. And we forget that this is also the man who put his firm into the position where his successors would never have the same opportunity he did.

But Buce knows better: hubris is always followed by ate. The tale of Maurice “Hank” Greenberg is the tale of A Man Who Had It All, and who left it to be destroyed by his hand-picked successor and his successors.***

That’s not the Success Story we want to tell, but its a lot closer to The Real Story, even ignoring the familial nature of the charges that began this whole discussion.

So Buce’s conclusion is, I believe, accurate: Eliot Spitzer did not destroy AIG. I can make a much better case that Maurice Greenberg did, but can live with the story as it is currently told, where Greenberg led the firm until it entered uncharted waters, and then was forced to turn the rudder over to his First Mate.

*They may have gone by Chase, but the takeovers were run by the old Manufacturers Hanover team, up to and including J. P. Morgan.

**Genesis 11:1-9 for the rest of you.

***And Ed Liddy, who was a ridiculous choice even by Tim Geithner standards.

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Accounting for Scott Sumner

Robert Waldmann

This whole post is after the jump as my accounting is not ready for prime time.

Scott Sumner thinks he is the first to note that the cost to the US government of bailing out the big banks is more likely to be a profit than a cost. Clearly he doesn’t read angry bear much, as I have been predicting that for months.

His accounting strikes me as very odd. Last I hear, the total cost of bailouts (including GSEs, AIG, GM and Chrysler) was predicted to be $87 billion. This does not include the cost of the FDIC honoring its contracts which was not discretionary and not a bailout by any normal use of the word.

Now Sumner reports the good news that the cost not including GM and Chrysler will be only 158 billion ?!?

Huh what happened ? First I think he forgot about roughly 125 billion when he wrote “Last time I wrote on this subject the eventual cost to the government from bailing out the big banks was estimated at a negative $7 billion–in other words a profit to Uncle Sam of $7 billion.” I believe that when he wrote “the government” and “uncle Sam” he meant “The Treasury”. Uncle Sam also has this little organization called the Federal Reserve Board. Last I heard it was predicted to make a profit of 125 billion out of its bailout efforts. Not all of that involved big banks, but I just don’t believe that the government made only 7 billion out of its direct interactions with big banks. In any case, the 125 billion (or probably more now) seems to have escaped Prof. Sumner’s notice entirely.

The news which he reports is that the current guess is that the cost of bailing out AIG is going to be about zero. That is, the amount AIG owes is roughly equal to the expected present value of future repayments.

Sumner gets his huge loss overall because he describes the cost of bailing out Fannie and Freddie as “$165 billion and rising.” I believe this is the amount they owe the Treasury minus zero. Sumner argues that big banks and AIG were OK investments and GSEs weren’t because in one case he includes expected discounted repayments and in the other he decides they are zero.

It is worth noting that the GSE rescue involved loans at 10% per year and the GSE debt is not equal to money transferred from the Treasury to GSEs plus the interest the Treasury paid on that extra debt. Oh no. It is the amount transfered plus penalty interest rates charged on that amount.

Basically, I beleive that Sumner did not stick to a consistent definition of “cost” and redefines the word so as to generate meaningless numbers which confirm his prejudices.

Also he doens’t understand the extent of the US government and thinks it is just the department of the Treasury.

One of us is profoundly confused.

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Congress thinks by analogy….and so we are stuck

by cactus

Congress thinks by analogy

I don’t remember what link I followed to get to this, but never in my life did I expect to agree 100% on any issue with David Stockman. Yes, that David Stockman. Holy wow:

DAVID STOCKMAN: Credit default swaps, OK? And we weren’t bailing out AIG. We were bailing out the banks, because the banks had bought a lot of low-caliber or subprime loans, wrapped some insurance around it from AIG, and said, presto, we have a AAA, a security on our balance sheet.
They didn’t. They had garbage on their balance sheet. And the bailout was to make sure that they didn’t suffer multi $10 billion write-downs on that AIG-supported loan.

PAUL SOLMAN: So, if you had been in the administration after Lehman Brothers, you wouldn’t have supported bailing out AIG?

DAVID STOCKMAN: No, absolutely not. It was the single most, you know, drastic error in policy in modern history, going back to the 1930s. This was exactly the wrong thing to do.

It’s destroyed any basis for fiscal discipline in the United States. I was a member of Congress, and I know how they think. And they think by analogy. If you did it for John, you have got to do it for Bob. There is no way that any congressman is ever going to vote against farm subsidies or ethanol subsidies or housing subsidies or anything else, refrigerator subsidies, once we have made this tremendous bailout for Wall Street, and we stepped into AIG.

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by cactus

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AIG, Logic, Insanity, and Tim "I Saw Nothing" Geithner

Go read:

  1. If you’re only reading one post, see FT Alphaville, which incorporates and expands upon…
  2. Tom Adams and Yves Smith’s posting at Naked Capitalism discussing the document and the reality of the situtation.
  3. the document itself is available from either The Long Room or the Huffington Post.

If the FRB of NY really believed that their only option was payment in full and not telling anyone about it, then Tim Geithner’s leadership abilities make Ben Bernanke look like Dwight Eisenhower.

BarryO is, apparently, finally trying to make clear the distinctions between TARP, TLGF, TALF, CPLF, Maiden Lane, Maiden Lane II, Maiden Lane III, etc. and the actual Stimulus Package. A good place to start: One was a huge giveaway that has led to overreported profits and high taxpayer expenses. The other was passed by Congress.

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SILOs –more action needed?

Tax advantaged “sale-leasebacks” with strapped-for-cash municipalities (SILOs, in the ever-present tax acronym set) came back to light when the Washington Metro train crashed a week ago. The cars were ones that were involved in the metro authority’s SILO deals with various banks, and the authority didn’t have any spare cash left to fund replacements. See this A Taxing Matter posting on the Metro SILOs, Jun 25, 2009.

I won’t rehash the entire discussion of SILOs covered there. Just note that the transit SILO deals were contrived to permit banks to “buy” the federal income tax depreciation deductions on municipal equipment. The municipalites couldn’t use the deductions, since municipalities are tax-exempt entities. The buying corporations were subject to US tax (usually, a bank) and they were looking for every way possible to avoid paying tax–they would essentially pay a fee to the municipalities, sharing part of their tax savings, for serving as an accommodation party in these deals. They “purchased” the municipalities’ property with nonrecourse debt, and then had “lease income” that was offset by both interest deductions and depreciation deductions, generating artificial losses from the accelerated depreciation. Most of the purchase price was set aside to defease the seller’s obligation under the lease, with the excess the fee for accommodating the tax shelter.

Jim Lehrer covered transit agency SILOs in the March NewsHour, depicting many of the transit agencies as motivated by their desperate need for capital–and encouraged by the federal Dept. of Transportation to use these means to get some. So there is a vicious double circle of irony here, that as states and localities cut taxes during the GOP years, under the flawed assumption that lower taxes means higher revenues, the states and municipalities also cut back on the funding needed by these important public service agencies, and an arm of the federal government encouraged these transit agencies to enter these deals, and at least 30 of them did, serving as accommodation parties in tax shelter deals with banks, so that banks would pay even less taxes than they already did.

Future SILOs were generally undone by new section 470, one of the few revenue raising provisions in the 2004 tax act. (The 2004 Act otherwise amounted to a pile of tax breaks for US corporations, such as the rate cut on repatriating offshore profits. It was misleadingly labeled the “American Jobs Creation Act” to signal the purported justification for all the corporate tax breaks. It didn’t lead to the creation of many jobs.) The new section disallowed to U.S. taxpayers a “tax-exempt loss”, defined as the excess of deductions other than interest and interest deductions allocable to tax exempt use property over the aggregate income from the property. Exceptions allowed certain “true” leases–essentially, ones in which the obligation of the seller-renter had not been defeased by the payment from the buyer and where the buyer had actually put some equity into the deal (the provision requires only 20% of genuine, at-risk equity). There are fewer tax benefits to true leases, so even with the exception, the provision deters leasing deals.

One hitch–the act only applied prospectively, and the transit deals (just one of the varieties of SILOs that were being done at the time of the 2004 change) got special treatment, in that any deals in the pipeline were allowed to be grandfathered in as long as they were done by 2006!

The IRS pursued the old deals with pre-2004 Act tools and won SILO (and LILO–the earlier “lease in, lease out” deals) cases against Fifth Third Bank, BB&T, PNC and other banks. See, e.g., IRS Wins AWG SILO Tax Shelter Case, TaxProf Blog (May 28, 2008) (dealing with the Ohio court’s decision in 2008-1 USTC 50,370, in favor of the IRS in a SILO case involving two US national banks’ “purchase”, with nonrecourse loans from German banks whose proceeds were used by the “seller” to defease the lease obligation, of a German waste facility used to acquire beneficial tax deductions); Ohio Judge Rejects Tax Claims on $423 Million Alleged Purchase of German Facility Made by Cleveland & Pittsburgh-Based Banks, DOJ (May 30, 2008); DOJ, Ohio Jury Finds Cincinnati-based Bank not Entitled to $5.6 Million Tax Refund (LILO transctions); BB&T Corp, 2008-1 USTC 50,306 (4th Cir.) (striking down tax treatment of financial service company’s lease of Swedish wood-pulp manufacturing equipment as a LILO shelter); DOJ, Statement of Assistant Attorney General Nathan J. Hochman on Today’s Decision in BB&T Corporation v. United States (Apr. 29, 2008).

After the court victories, the IRS offered a SILO settlement for these deals that permitted them to keep 20% of their claimed tax losses and waived the penalties, if they terminated the transactions. IRS Commissioner’s Remarks Regarding LILO/SILO Settlement Initiative (Aug. 6, 2008); Donmoyer, IRS Offers to Settle 45 leasing Tax-Shelter Disputes, Bloomberg.com (Aug. 6, 2008); Service Launces LILO, SILO Settlement Initiative, J. Acct. (Oct. 13, 2008). It later announced that “hundreds of taxpayers settled similar cases involving tens of billions of dollars.” DOJ, Justice Department Highlights FY 2008 Tax Enforcement Results (Apr. 13, 2009). On leaving office, Korb statedthat “taxpayers representing over 80 percent of the dollars involved have elected to take advantage of the settlement initiative.” See Korb Interview. (Dec. 19, 2008).

The settlement offer required taxpayers to terminate the transactions by Dec. 31, 2008, else they would be deemed terminated by that date, with taxpayers still able to claim the partial loss benefit through the actual termination date if they terminated the transaction by Dec. 31, 2010. That’s a fairly strong incentive for termination, but the municipalities may be on the hook for hefty termination payments under their contracts. Even worse, the AIG situation provided a perfect trigger for causing a technical default to apply. AIG guaranteed these deals, so when its credit rating went down, the transit agencies are in technical default and liable for hefty penalty payments. (see NewsHour video, above).

There are real problems here, including the idea of one agency of the government supporting its “clients” (transit agents of municipalities) entering into deals like this that result in corporate tax cheats robbing the government of important revenues. Another problem is the idea of the banks that were instrumental in causing the fiscal crisis–by risky, speculative behavior that disregarded the systemic risks–using AIG’s collapse because of that fiscal mess as an excuse to get municipalities that are especially cash-strapped because of the fiscal crisis (and finding their ability to borrow or get tax revenues severely restricted) to pay over large penalty amounts under their shelter contracts. It seems like an unfair windfall for tax cheating Big Banks at the cost of the people.

And of course, just extending the 2004 provision to make grandfathered SILO/LILO transactions illegitimate and their tax deductions disallowed doesn’t solve this problem, since these are windfalls that the tax cheaters would get under their “lease” contracts.

Rep. Menendez of NJ has proposed a potential solution–the “Close the SILO/LILO Loophole Act” S. 1341, introduced in late June. His bill, he says, would “help protect WMATA and other transit agencies who are being threatened by banks seeking to gain a windfall from the current economic climate while potentially putting transit agencies at risk.” See press release, As Lease-Back Deals Are Raaised as an Issue in Metro Crash, Menendez Says legislation Can help Unwind Deals, PolitickerNJ.com (Jun 26, 2009); Davis, Bill Would Tax Banks that Sue Agencies , Star Ledger (Jun 24, 2009); Letter from Menendez to Hoyer (Jun 26, 2009) (noting a need to “protect transit agencies from banks who are seeking to exploit a technicality that would result in agencies having to pay banks millions of dollars that could otherwise be used to shore up equipment and ensure safe operations, even though they have not missed a single payment to the bank”). The bill imposes an excise tax equal to 100% of any “ineligible amount” collected by “any person other than a SILO/LILO lessee” as a party to a SILO/LILO transaction. Ineligible amounts are proceeds from terminations, rescissions, or remedial actions in excess of those under defeasance arrangements. The bill also would deny deductions for attorney fees and other costs attributable to seeking to recover ineligible amounts.

It’s messy, but it does end up with the right results, it seems. I note, though, that there are no additional co-sponsors at this time. Doesn’t look like Congress is hopping on the bandwagon.

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One is History, One Parody: You Make the Call

George Will, guest-posting chez Berube:

But hope is not a financial plan, and rewards come only to those who work for them. It is time for the Democrats to grow up, learn the lessons of adulthood, and begin dismantling a tax system which creates so many disincentives to wealth creation. Justice demands that bonuses must be paid, yes. But true justice demands that bonuses be tax-free.

The WSJ editorial page on “the real AIG outrage,” a piece that appears to have been written by Hank Greenberg’s publicist:

AIG can argue that it needs to pay top dollar to survive in an ultra-competitive business, or it can argue that it offers services not otherwise available in the market, but not both.

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