Tuesday, September 16, 2008

Where is a trillionaire when you need them: too big to bail out

AIG has good businesses and bad businesses. Nobody much thinks that the life insurance businesses are problematic. I don’t like life insurance for reasons made clear in the Risk Aversion post – but if you are going to own a life insurance business these are about as good as it gets.

The core business – the US Domestic Broker Group (DBG) is the best diversified primary insurance company in the US. That doesn’t make it a good business but it is OK. [Insurance businesses are the ultimate payers of US legal settlements – and I wouldn’t really want that much litigation risk…]

There are other OK businesses in there.

The good businesses generate about 20 billion per year pre-tax. That is a lot of dosh.

There are some staggeringly bad businesses in there too. AIG Financial Products probably has blown up something between 30 and 100 billion. Ultimately we have no idea what the AIGFP losses are – but we do have some idea of the huge margin requirements.

The management has been profoundly stupid. In the last annual report the letter tells us how now is a great time to expand in mortgage insurance in Australia. Australia is the greatest remaining bubble in residential real estate.

I knew in March 2007 that AIG was up to its neck in super-senior exposure. That is what bought the company down - and in March 2008 AIG management still had little idea that it was in mortal danger.

Moreover past management lied about profitability. That is what the whole finite insurance thing with Berkshire was about - and it will lead to jail terms for several executives. Companies with a record for lying tend to find it hard to get money because nobody trusts them in a pinch...

But here is the rub.

There is no suggestion that the core insurance companies of AIG are impaired. AIG parent company however needs a huge amount of money – say 70 billion dollars - and it needs this largely to meet funding requirements driven by AIGFP. 70 billion is a number that petrifies everyone who looks at it.

But 70 billion is actually not that much compared to the core insurance companies. They should be easily able to repay that. Its only 3.5 years’ profits and should be repayable in 8-10 years provided there are no plagues or other nasty insurance stories.

So now suppose that you were a wise independent multi-trillionaire. Would you lend 70 billion to AIG at 10% secured by whatever you could and with an attached option to buy 60% of AIG at a notional price?

I think you would. It wouldn’t be a bad deal. (You would not do it if you accepted AIG's open ended fat-tail liabilities.)

But unfortunately I can’t see any trillionaires out there. Warren Buffett won’t do it because frankly he is not quite that rich and he will not amalgamate the life insurance companies into Berkshire. Buffett has one-giant shot in his armoury - and this one is not it.

And therein is the problem with AIG. There are no multi-trillionaires and AIG is too big to bail out.


PS. I don’t want to do politics on this blog. But I suspect its time for the Fed to lubricate a multi-bank bail out. The deal is as suggested here. 70 billion at 10% for with 60% of the equity.

I am not sure how the Fed lubricates it other than say putting an envelope around the losses of AIGFP.

As for the stock - I am sitting on the sidelines.


1 comment:

Eric Bonneau said...

Dear John,

As we know, the solution you described here was implemented for AIG with the US FED acting as the trillionaire savior.

Given that the exposure of AIG to Lehman may have already been factored in, do you foresee better days ahead for AIG and are you still standing on the sideline in regards with AIG stock (common or pref)?


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