Saying It All
Unlike Fannie and Freddie, AIG was royally and truly doomed. The Fed tells us so:
In unusual and exigent circumstances, the Board of Governors of the Federal Reserve System, by the affirmative vote of not less than five members, may authorize any Federal reserve bank, during such periods as the said board may determine, at rates established in accordance with the provisions of section 14, subdivision (d), of this Act, to discount for any individual, partnership, or corporation, notes, drafts, and bills of exchange when such notes, drafts, and bills of exchange are indorsed or otherwise secured to the satisfaction of the Federal Reserve bank: Provided, That before discounting any such note, draft, or bill of exchange for an individual, partnership, or corporation the Federal reserve bank shall obtain evidence that such individual, partnership, or corporation is unable to secure adequate credit accommodations from other banking institutions. All such discounts for individuals, partnerships, or corporations shall be subject to such limitations, restrictions, and regulations as the Board of Governors of the Federal Reserve System may prescribe. [emphases mine]
The notes are for two years at LIBOR + 850. Yes, you read that correctly: 8.50% over the London Interbank Offer Rate.
Three month LIBOR is currently around 2.81%. That makes the all-in Cost of Funds at par right now 11.31%
For comparison, Ford bonds in the secondary market, are yielding around 9.50% for similar maturities.
And the Fed is the only entity willing to offer such terms.
Let’s ignore that they’re making the same mistake they did with Fannie and Freddie, creating a structure that ties the firm to its past mistakes, providing no incentive or changes to the business process, and all the while socializing the risk. Let us just repeat the dismal chorus:
The Fed is the only entity willing to offer AIG terms that are about 180 bp wide of where Ford Motor Credit is trading.
Come to think of it, let’s not ignore the mistakes, for after giving Daniel “son-of-Roger-acts-like-Harry” Mudd $14MM to Just Go Away:
The Fed is the only entity willing to offer AIG terms that are about 180 bp wide of where Ford Motor Credit is trading, and Hank Greenberg—who ran the firm into the ground but remains a major shareholder and on the Board of Directors—will still have a piece of the “nationalised” firm.
Privatize the profits, socialise the risk. Paul Kedrosky is correct when he says we should not throw around phrases such as “moral hazard” and “risk homeostasis,” yet we are left once again to realize and document that those who were paid to be responsible shirked their duties, and we must now wonder—the year after Hurwitz, Maskin, and Meyerson were awarded the Riksbank “Nobel” in Economics whether anyone who has been running and regulating financial firms for the past seven years really understands mechanism design, or even “creative destruction.”
David Leonhardt tries to put a positive spin on things. In the immortal words of Tom Paxton, he “fails miserably” when he also tells the truth:
But if you take a moment to think through the full Chrysler story, you start to realize that it’s setting a really low bar. The Chrysler bailout may have saved the company, but it did nothing, after all, to stop Detroit’s long, sad decline.
He goes on to cite Barry Ritholtz‘s forthcoming book, Bailout Nation:
If Chrysler had collapsed, [Ritholtz] argues, vulture investors might have swooped in and reconstituted the company as a smaller automaker less tied to the failed strategies of Detroit’s Big Three and their unions. “If Chrysler goes belly up,” he says, “it also might have forced some deep introspection at Ford and G.M. and might have changed their attitude toward fuel efficiency and manufacturing quality.” Some of the bailout’s opponents — from free-market conservatives to Senator Gary Hart, then a rising Democrat — were making similar arguments three decades ago.
Instead, the bailout and import quotas fooled the automakers into thinking they could keep doing business as usual. In 1980, Detroit sold about 80 percent of all new vehicles in this country, according to Autodata. Today, it sells just 45 percent.
So let’s be optimistic. In thirty years, we may not have much of the vestiges of AIG to kick around any more, and American insurance companies will look on these as “the good old days.”
Come to think of it, when did optimism and pessimism come to the same result?
UPDATE: Brad DeLong summarizes the situation in one line:
LIBOR + 8.5%—now that’s lending freely at a penalty rate! They’ve given AIG a credit card!