Backdoor Bailouts

A.I.G. the troubled insurer has already received close to $160 billion in emergency funding from the U.S. government. In return the American public now holds 80% of the stock of AIG. But as The New York Times reports, this by no means suggests that not even more money needs to go in the AIG pit:

Is A.I.G. the taxpayer gift that keeps on taking? Sure looks that way. And while no one can say with certainty whether more money will be needed, the sheer volume of derivatives engineered by a small London unit of A.I.G. suggests that taxpayers haven’t seen the bottom of this money pit.

Some $440 billion in credit default swaps sat on the company’s books before it collapsed. Its biggest customers, European banks and United States investment banks, bought the swaps to insure against defaults on a variety of debt holdings, including pools of mortgages and corporate loans.

Because of the way A.I.G. wrote its swaps, and because the company had a double-A credit rating at the time, it did not have to put up collateral to assure its customers that it would be able to pay on the insurance if necessary. Collateral would be required only if A.I.G.’s credit rating were cut or if the debt underlying the swaps declined.

Both of these “unthinkable” events occurred in 2008. Suddenly, A.I.G. had to cough up collateral it didn’t have.

SO, you see, the rescue of A.I.G. also involved a bailout of its many customers, none of whom the insurer or the government is willing to identify.

Nevertheless, Edward M. Liddy, the chief executive of A.I.G., explained to investors last week that “the vast majority” of taxpayer funds “have passed through A.I.G. to other financial institutions” as the company unwound deals with its customers.

On Wall Street, those customers are known as “counterparties,” and Mr. Liddy wouldn’t provide details on who the counterparties were or how much they received. But a person briefed on the deals said A.I.G.’s former customers include Goldman Sachs, Merrill Lynch and two large French banks, Société Générale and Calyon.

So let’s get this straight. The government is providing emergency funding for AIG in order to honour committments by AIG versus other (investment) banks. A true “back door bailout” therefore.

Good luck to the American tax payer. They’ll need it.