Bailout

A second look at the AIG deal

By Felix Salmon

Well done to Kid Dynamite for doing the math on the way that we taxpayers are swapping our AIG debt for equity in the company. There are three big problems here:

1. The fact that we’re doing this conversion in the first place. The preferred stock we currently own pays a regular coupon, while the equity we’re swapping it for was described as worthless by AIG itself not so long ago.
2. The fact that as part of the deal we’re giving current AIG shareholders free warrants to buy stock at $45 per share. Which is very generous of us, but what have they done to deserve this?
3. Most importantly, the fact that the stock we’re swapping into is worth less, at current valuations, than the preferred stock we’re swapping out of. To the tune of about $6.6 billion.

KD has a query in with Treasury about all this; it’ll be interesting to see how they respond.

The only thing I’d note here is that there isn’t a secondary market for the preferred stock we’re swapping out of. So while its face value might be $72.1 billion, its actual market value might well be 10% or more below that figure. In which case it can be argued that the government is getting a good deal here, assuming that it’s actually able to sell its stock into the secondary market at something approximating current levels.

Still the government strategy here does seem to be based on the theory that “the market can remain irrational longer than you can remain insolvent” — that Treasury will be able to monetize all the weird theoretical value that AIG’s current shareholders are ascribing to the company, if only it first gives up any claim to regular coupon payments from AIG.

I hope they’re right, but it is a risky strategy, especially when it seems, from the published conversion rates, that Treasury’s willing to admit that its preferred stock isn’t worth as much as AIG says it’s worth.

Full post as published by Macroprudential on October 01, 2010 (boomark / email).