Bailout....ours and them

In US, the great land of capitalist lately been reduced to a  land of selective socialism….socialized financial industry. What has happened over there?

The greed of behemoth financial institution caused their downfall and the misdirection of the political leaders lead them be a  capitalist greed. Just reflect back to the fall of AIG, once the biggest insurance company in the world. 

A decade ago, Sen. John McCain, a Republican President aspirant, embraced legislation to broadly deregulate the banking and insurance industries that proponents said would result in greater economic growth.

In 2002, McCain introduced a bill to deregulate the broadband Internet market, warning that "the potential for government interference with market forces is not limited to federal regulation."

Three years earlier, McCain had joined with other Republicans to push through landmark legislation sponsored by then-Sen. Phil Gramm (Tex.), who is now an economic adviser to his campaign. The Gramm-Leach-Bliley Act aimed to make the country's financial institutions competitive by removing the Depression-era walls between banking, investment and insurance companies

That bill allowed AIG to participate in the gold rush of a rapidly expanding global banking and investment market. But the legislation also helped pave the way for companies such as AIG and Lehman Brothers to become behemoths laden with bad loans and investments. 

It is ironic that now McCain condemns the executives at those companies for pursuing the ambitions that the Gramm-Leach-Bliley Act made possible, saying that "in an endless quest for easy money, they dreamed up investment schemes that they themselves don't even understand." 

Anyway, credits (ahem…) have to be given to AIG.  The insurance company been in the forefront of the industry.  Whether introducing new insurance products to  finding new and exciting ways to mistated their reserve levels through phony reinsurance deals (see Gen Re/AIG case earlier in the decade), to selling protection on billions of subprime residential CDSs (Credit Default Swaps).  The company has written down about $20 billion in subprime related transactions. Note: AIG also participated in CDS of corporate bonds. 

Credit default swaps (CDS) function much like insurance on another party’s debt. So, for example, investors that purchased a mortgage-backed security issued by, say, Lehman Brothers may also have purchased a credit default swap issued by AIG that would pay if Lehman defaulted on its bonds (e.g., by going into bankruptcy).

Credit default swaps are essentially unregulated insurance contracts. Not technically securities, they do not have to be registered with the SEC. Not technically insurance, their issuance by AIG was not overseen by state insurance regulators.

This meant that AIG was apparently not required to disclose the full extent of its liability, or to hold reserves against these contingent liabilities, as they would for the life insurance policies their (currently) healthy subsidiaries write. So, when the rating agencies threatened to downgrade AIG, it is not surprising that the counterparties to these contracts would have required AIG to pony up more collateral.

This, AIG could not do.

Thus, a liquidity crisis.

AIG initially went to the Fed asking for $40 billion, they got $20 billion from their subsidiaries, and before the Fed bailout, based on the news, Goldman and JP Morgan were tasked with trying to raise $70 billion of bridge financing for the company.

 In this a bailout?

 Based on the bit and pieces that I gathered from the report. The bailout contained: 

1. The Fed is giving AIG a credit line of  US$85 billion limit, with interest rate at current level 12% (It is indexed to market interest rates). AIG will use this to ensure they can continue making payments on their other liabilities in the short term.
2. The Fed line of credit is collateralized by AIG’s full assets. This means that if AIG is forced into bankruptcy despite the bailout, the Fed will get paid before AIG’s bondholders.
3. The Fed does not own any AIG stock, but has warrants (similar to stock options) on just under 80%, meaning that the Fed not can buy 80% of AIG at a fixed price. There is no mentioning of the price.

 Who get bailed?

AIG’s shareholders are not getting bailed out.  At best, they just lost 80% of their assets to the Fed.

AIG may or may not be fundamentally solvent. AIG has huge assets and huge liabilities which currently nobody is quite sure what the correct price. They needed the bailout because they have liabilities coming due today which they weren’t able to raise cash to cover. The Fed line of credit lets them pay their current liabilities and gives them time to rearrange their finances in hopes of being able to cover future rounds of liabilities with their assets.

If AIG is fundamentally solvent in near future, AIG has a chance to pay bondholders back in full. If it isn’t, then bondholders will be taking a bigger haircut than without the bailout because  they now  are subsidiary to Fed US$85 billion loan. Therefore AIG bondholders are getting bailed out somewhat.

The real beneficiaries of the bailout are AIG’s counterparties — companies and investors to whom AIG has contractual obligations (most significantly credit default swaps — essentially insurance for bondholders against the possibility that their creditors won’t pay their debts). These are the people that to be bail out, because they behaved responsibly by buying insurance for their risky assets from an apparently solid insurer, and because it is the possibility of AIG defaulting on its counterparties which holds the biggest risk of a cascading failure wrecking a big chunk of the financial system.

 Now just compared the bailout done  in  Malaysia’s  bolehland by the dimwits BN/UMNO. Just perused through some of the bailout that cost money from the taxpayer pockets.

1. IWK: The dimwit (i.e. the former PM) raised  RM200 million for bailout of Indah Water Konsortium (IWK), the financially hobbled concessionaire managing the national sewerage system. But that was not all that the country lost. According to DAP national chairman, Lim Kit Siang, the soft loans granted by the government to IWK amounted to about RM1.4 billion and they were ‘clearly irrecoverable losses’. 

2. KPB: Remember the former dimwit’s rescue of Konsortium Perkapalan Bhd (KPB) (then owned by his son Mirzan), which was submerged in debts of about RM1.7 billion, using funds from Petroleum Nasional Bhd (Petronas)? The Petronas-controlled national shipping carrier Malaysian International Shipping Corporation Berhad (MISC) was used to acquire KPB’s shipping assets with cash said to be as much as RM1 billion. 

3. MAS: The diwits bought back a controlling stake in the Malaysia Airlines System Bhd. (MAS) at the same price for which it sold it in 1994. But the carrier, which had a light debt load then, was grounded by its RM9.5 billion debt and was headed for a fourth straight year of losses.  Bankruptcy was imminent. 

The national carrier was first sold to then chairman, Tajudin Ramli,  without an open bidding process. In the bailout, the government used the tax payers money to pay RM8 a share when the shares of the ailing airline were trading at only RM3.6. It was believed that the government paid close to RM1 billion more than the market value for the stake held by the airline’s former chairman – who had no experience in the airline business before he took over the company and was widely blamed for running the airlines into the ground. 

4. Time dotcom: The manner in which the government rescued Time dotCom, a subsidiary of Time Engineering (then saddled with a RM5 billion debt), itself a publicly-listed company of the dimwit’s UMNO-linked Renong Group, added yet another ugly dot to its integrity. 

In a land where anything is possible, Bolehlanders watched in disbelief when:

• Kumpulan Wang Amanah Pencen (KWAP) or the Pensions Trust Fund coughed up RM904 million to buy 273.9 million unwanted Time dotCom shares, incurring an instant loss of RM280 million. 

• Employees Provident Fund (EPF) spent RM269.28 million on 81.6 million (unsubscribed public portion of the initial public offering (IPO)) of Time dotCom Bhd shares at RM3.30 – when the share was hovering between RM1.96 to RM2.10 and even less -  eventually suffering a loss of over RM100 million belonging to the rakyat. 

• Danaharta (the agency tasked with removing bad loans from the banking system) and  Khazanah (the Government’s investment arm) got involved in the bailout, when it was clearly not their mission to be a vehicle to bail out failed IPOs of companies. (Khazanah acquired 30 per cent of Time dotCom for some RM2.1 billion.).