HENRY PAULSON, U.S. Treasury Secretary: The streamlined and more effective…
MARGARET WARNER: On Monday, Treasury Secretary Henry Paulson made it clear the government had no interest in bailing out the insurance giant AIG.
JOURNALIST: Is the Federal Reserve giving AIG a bridge loan?
HENRY PAULSON: Well, let me say, the — what is going on right now in New York has got nothing to do with any bridge loan from the government. What’s going on in New York is a private-sector effort, again, focused on dealing with an important issue.
MARGARET WARNER: But after that private-sector effort failed, last night the Federal Reserve, with the support of Treasury, extended an $85 billion bridge loan to the American International Group and took control of the company.
AIG is one of the world’s largest insurers, employing more than 100,000 people in more than 100 countries. It insures everything from homes and cars to complicated securities transactions.
AIG’s exposure to increasingly risky mortgage-backed securities, including insurance it had sold to back those securities, had caused a severe cash crunch for the company.
In a written statement issued last night, the Fed said it took the action because “a disorderly failure of AIG could add to already significant levels of financial market fragility and lead to substantially higher borrowing costs, reducing household wealth and materially weaker economic performance.”
Under the terms of the deal, the government provides an $85 billion loan over two years so AIG can proceed with an orderly sell-off of parts of the company.
All of AIG’s assets are being used as collateral. The government has taken a nearly 80 percent equity stake in the company. Top management is being replaced.
AIG shareholders will retain the remaining 20 percent of the company’s equity stake, but the total value of AIG stock has declined 90 percent over the past year.
There was wary reaction on Capitol Hill. Speaker Nancy Pelosi blasted the $85 billion loan as “a staggering sum, too enormous for the American people to bear the risk.” Majority Leader Harry Reid spoke this morning.
SEN. HARRY REID (D-NV), Senate Majority Leader: We are in new territory here. This is a new game, and we’re going to have to figure out how to do it. I think you could ask — yes, you could ask Bernanke and you could ask Paulson. They don’t know what to do, but they are trying to come up with ideas.
MARGARET WARNER: Alabama Senator Richard Shelby, the ranking Republican on the Banking Committee, said, “My basic worry is the taxpayer and where do we stop? This is uncharted water that we’re running on right now. And what’s going to be the next big house to fall? And will we say, ‘Gosh, we’ve got to bail it out’?”
The reaction around the world, where markets suffered heavy losses, ran the gamut from cautious relief to anxiety about what lies ahead. On the trading floor in Hong Kong…
CASTOR PANG, Sun Hung Kai Financial: It seems that the bailing of the AIG by the U.S. government will become a tranquilizer for the global markets.
MARGARET WARNER: In London…
DAVID BUIK, BGC Partners: I think we need to be cognizant of the fact that the markets are going to remain extremely volatile. We’re not out of the woods by any stretch of the imagination.
MARGARET WARNER: The day ended with Wall Street nervously watching the two remaining independent investment banks, Goldman Sachs and Morgan Stanley, as well as Washington Mutual, the nation’s largest savings and loan.
AIG exposed itself to securities
MARGARET WARNER: And for more on what led to the AIG bailout and what's ahead, we turn it Krishna Guha, the U.S. economics editor for the Financial Times; and Diane Brady, a senior writer at BusinessWeek.
Welcome to you both.
Krishna, beginning with you, explain in more detail, what is it that AIG does?
KRISHNA GUHA, Financial Times: Well, AIG is a large insurance group. You have lots of operating companies that do fairly straightforward, traditional insurance business. They might insure your car, sell you life insurance, that kind of thing.
Those businesses are fine. They're safe. Their finances are in good shape.
But at the parent-company level in recent years, AIG became a very sophisticated, very complicated financial business. It got into derivatives that were initially very profitable, but exposed it ultimately to losses on a lot of complex credit securities, a lot of them ultimately related to housing. That's what got them in trouble.
MARGARET WARNER: Now, explain to us, because there's a lot of talk about these credit-default swaps that AIG issued, what is a credit default swap in layman's terms?
KRISHNA GUHA: Well, it sounds very complicated. In reality, it isn't at all. It's an insurance policy on a bond.
So if I lend you money by buying a bond, I might be worried you won't pay me back, so I can buy insurance from somebody else. That's what a credit default swap is: insurance that pays out if I don't get repaid as I expect.
The problem is, of course, that insurance is only as good as the company standing behind it.
MARGARET WARNER: So if the company -- either I don't pay you back, and there are too many of me who don't pay you back, the insurance company that issued this default swap would be in trouble?
KRISHNA GUHA: Exactly. And, of course, then, when the insurance company gets in trouble, the people who bought insurance from it, corporate insurance, in this case, the people who bought the insurance on the bonds find that they're not protected at all. And that's how this kind of crisis can have domino effects rippling through the financial system.
Insuring bad bets
MARGARET WARNER: Diane Brady in New York, tell us as much as you can how and why -- what led to the Fed essentially reversing course last night and deciding to bail out AIG after all?
DIANE BRADY: Well, clearly the last thing they wanted to do in an election season was come forward and say, "Once again, we're putting taxpayer money on the line." The issue is they went to the markets and the markets said, "You know what? We're not going to help out AIG. There's not enough money on Wall Street now. Everybody has their own problems."
And in essence, they were the last stop, and they had to do something just to contain the mess, because the issue wasn't AIG is so big it can't fail, it's too important. The issue here is that they were insuring bad bets. And as those bets are unraveling, the domino effect could be profound on other financial institutions.
MARGARET WARNER: And in the Fed's view, much more profound than Lehman Brothers?
DIANE BRADY: I think so. I think there's a lot of things -- for example, let's start with the fact that AIG has $440 billion in its portfolio of these credit default swaps. That's a huge amount of money that potentially is at risk. They do not want to see this cascade through the system.
An investment bank, while it's tragic when it goes under, is not going to have the ripple effect that the world's largest insurance company and a global financial services giant the collapse of that would have.
MARGARET WARNER: So, Krishna, what is the worst-case scenario here? I mean, are the taxpayers on the hook potentially for the $85 billion or, as Diane was pointing out, this $440 billion of credit default swaps that it's got listed on its books?
KRISHNA GUHA: Well, as things stand, the taxpayer is on the hook to a maximum of $85 billion. That's the amount that was lent to the company.
And don't forget: There are a lot of protections here. The federal government will get paid back out of the sale of these good, quality operating businesses, these traditional businesses I was describing to you. The loan is secured.
And, of course, if there's any profit left over at the end of this -- who knows, there just could be -- then the taxpayer will share that through its 80 percent stake in the equity.
So there's no question there are serious risks on these loans and there is a possibility that the taxpayer could end up having to shoulder a loss.
MARGARET WARNER: And, Diane, the shareholders in AIG, meanwhile, come out on the short end.
DIANE BRADY: Very much so. And I think they had to send that message to Wall Street. There has been all this talk of moral hazard. What people don't want to see is companies, the titans of Wall Street getting off in tact.
So essentially what they did is they wiped out the shareholder value, in essence, in return for essentially letting the company survive in various forms.
Financial storm in the markets
MARGARET WARNER: And, Diane, what's the process now under which AIG is going to sell off its assets? Somebody -- there was one story I read today describing it as a giant yard sale.
DIANE BRADY: I think that's a good way to look at it. They replaced the CEO. We have the former Allstate CEO, Liddy, who has come in. What he's charged with doing is making sure that they sell off the assets in an orderly fashion.
As Krishna said, there is a lot of good companies here. This is not a business that was failing on all fronts. It's the gold standard in insurance. There are a lot of people who will be interested in these assets. The issue at the moment is, who has the cash?
MARGARET WARNER: And who are the average stockholders, the common stockholders in this, in AIG, the ones whose stake has now been reduced to 20 percent, and they're going to essentially have to stand in line behind the federal government getting paid back?
KRISHNA GUHA: Well, it would be the usual combination of individual and institutional investors. In the end, a lot of the ultimate beneficiaries of those shares will be people's pension plans and so on. So there's no question that this pain is widely shared throughout society.
MARGARET WARNER: And, Krishna, after the government takes this huge step, the markets tank again today 450 points. What explains that, if you can answer that, if anyone can answer that?
KRISHNA GUHA: Well, first up, we have to say this is really scary, right? The government didn't let this company fail. It stepped in $85 billion and still the markets plunged. That tells you how intense the fear is, how intense this financial storm raging through the markets is right now.
It's scary. It's really at historic proportions. One element of the concern today was concern about money market mutual funds. If people start losing money on these funds, will there be mass redemptions, mass pulling out of money from these funds?
Another concern, would Morgan Stanley and Goldman Sachs be next to come under fire? And people are also concerned that they don't really understand the model for government's intervention here. Who decides and on what basis which companies are rescued and which are let to die?
MARGARET WARNER: Diane, what were you hearing in terms of today up in New York about why the markets went south so, so strongly and really stayed there?
DIANE BRADY: Well, I think there's a lot of skittishness, obviously. I walked through the jewelry district on my way here, though, and I can tell you the people who sell gold are pretty happy, because they've just had the biggest jump in nine years.
People want to park their money somewhere where they know it will be safe. And if you look at what's happened in the short-term treasuries, essentially what people are saying is, "I don't care. It's almost like putting it in my bed. I just don't want to lose money at this point."
That's the fear in the markets. There's also fear about the dollar. You let the government continue to print money, build up big deficits, I think a lot of foreign investors are looking at the U.S. market now and saying, "What's my long-term risk here?"
MARGARET WARNER: Diane Brady, Krishna Guha, thank you both.
KRISHNA GUHA: Thank you.
DIANE BRADY: Thank you.