Washington - American taxpayers awoke on Wednesday to learn they may end up owning one of the world's largest insurers. They might now lose some sleep wondering whether the government's $85bn loan to American International Group was a wise investment.
If the gamble succeeds, the company nurses itself back to health, unhinged financial markets calm down and taxpayers turn a profit.
If it fails, the American public feels the hit - and possibly finds itself rescuing other major financial institutions, swelling the deficit and potentially driving up interest rates on mortgages, student loans and other debt.
Analysts said on Wednesday the odds are pretty high that the rescue will be a good investment for taxpayers, with AIG paying off the loan at a relatively high interest rate and the government potentially making money off its nearly 80% equity stake in the company.
In 1979, the US guaranteed $1.2bn worth of loans to the struggling automaker Chrysler. When the company rebounded four years later, the government reaped more than $300m in profits.
While relatively unknown outside of financial circles before Wednesday, AIG is a colossus on Wall Street and financial districts around the globe, with operations in more than 130 countries and $1 trillion in assets on its balance sheet.
AIG in a 'mess'
Besides life, property and other insurance offerings, AIG provides asset-management services and airplane leases. Its myriad businesses are also linked to mutual funds, annuities and other retirement products held by millions of ordinary Americans.
But perhaps the biggest concern about AIG is the dizzying array of complex financial instruments it structured for commercial banks, investment banks and hedge funds around the globe - many of which were directly or indirectly linked to the value of US mortgages.
"AIG is in this mess because they got leveraged up to their eye balls," said Professor John Coffee of Columbia University Law School.
AIG is required to post capital as collateral to back the securities and derivatives it issues, and those requirements increase if its credit rating is downgraded, as happened on Monday night.
AIG "essentially became the insurer of the financial industry," said Barry Ritholtz, chief executive of FusionIQ, a research firm. "As we've seen, that turned out to be not such a great trade."
The company's staggering reach, combined with the speed with which it faltered, is what forced the government to intervene after private rescue attempts fell apart and pushed the company to the edge of bankruptcy.
A handsome profit
"A failure was seen as having catastrophic implications. It met the threshold of too big and too intertwined to fail," said former Federal Reserve economist Brian Sack now at Macroeconomic Advisers.
Over the weekend, the government refused to pony up taxpayer money to rescue troubled investment bank Lehman Brothers. That was seen as drawing a line in the sand after the Fed financially backed JPMorgan's takeover of Bear Stearns and then the Bush administration seized control of mortgage finance companies Fannie Mae and Freddie Mac.
But that turned out to be wrong.
The government agreed to loan up to $85bn to AIG over two years in exchange for the right to buy 79.9% of the company. The hope is that the money will give the company enough time to reorganise and sell assets to repay the loan.
The interest rate the government is charging AIG for the loan is high - 11.5%. Because the government can borrow money right now at around 3.4%, taxpayers stand to make a handsome profit if all goes well.
The government is first in line to be paid back on the loan, which is backed by the assets of the entire company.
Key to the US being repaid for its loan is whether AIG can sell its assets, how quickly and for what price.
Money-making devision
For the company, that might mean putting some of its profitable, noncore assets, such as its aircraft leasing business, on the block. AIG's breakup value could top $150bn, according to a preliminary estimate from FBR Capital Markets.
"The odds are pretty high that it will end up being a good investment for taxpayers," said Mark Klock, finance professor at George Washington University. "I think that AIG will be able to dispose of assets in an orderly fashion in the next year or so and the government will actually get back the money lent out - and more - in interest," he said.
It will be up to AIG to decide which assets to sell and the timing, which some analysts said should be done quickly because the publicised difficulties at the company could begin to turn customers away. The government does, however, have veto power.
One unit that analysts said will likely be sold is the International Lease Finance, which leases out more than 900 aircraft with asset values topping $44bn at the end of the second quarter. This division has been a moneymaker for AIG, tallying $873m in operating income in 2007 and $555m in the first half of this year, according to securities filings.
Another possibility for sale is AIG's foreign life insurance business, with profits of $1.5bn in the first half of this year on top of earnings of $6.19bn in 2007. Gary Ransom, an analyst with Fox-Pitt Kelton, pegged the value of that business at as much as $50bn.
But Ransom also noted the foreign life insurance business is also probably the hardest to sell because it includes many different divisions operating across many countries.
"I would say everything is on the table," Ransom said. "At this point, the goal isn't to keep AIG as the owner of businesses."
If AIG is keeping some operations, the commercial lines and property and casualty operations are possibilities because they are among the divisions that are most closely associated with the company.
"They would love to sell off the bad stuff, but the only option they have is to sell off the good stuff," said Kent Smetters, an associate professor insurance and risk management at the Wharton School of Business.
- AP