Fed Gives AIG $$

As noted in an update to the post below this one, the Fed is going to give AIG an $85 billion loan in exchange for an 80% stake in the company:

Fed Readies A.I.G. Loan of $85 Billion for an 80% Stake, NYT: In an extraordinary turn, the Federal Reserve was close to a deal Tuesday night to take a nearly 80 percent stake in the troubled giant insurance company, the American International Group, in exchange for an $85 billion loan, according to people briefed on the negotiations.

In return, the Fed will receive warrants, which give it an ownership stake. All of A.I.G.’s assets will be pledged to secure the loan, these people said…

So you as a taxpayer now have a large stake in AIG.

Update: Paul Kedrosky:

IG, Risk Homeostasis, Moral Non-Hazard and Apollo Landings: I wish people would shut up about "moral hazard". Yes, bridging AIG through its current crisis is not something you want to do; and yes, it would be better if the market solved its own problem. But even a cursory analysis of the serpentine connections between AIG and capital markets tells you that the latter just can’t happen, so you have to hold your nose, be an adult, and live with the former.

Moral hazard, while real sometimes and in some places, is vastly overrated as an effect. Granted, it’s seductive in the same way that risk homeostasis is — the notion that, for example, people drive faster and take more risks because they have seatbelts — but like risk homeostasis, moral hazard is vastly over-diagnosed. People at major financial services outfits don’t project five years into the future and say, "Lever up, boys and girls. We’ll either make a lot of money now, or be bailed out later." Real people in real markets don’t think that way. Matter of fact, if anything, they’re short-sighted in that regard to a fault.

Further, imagining that people load up with "end of the world" liabilities in an effort to be anointed with "too big to fail" status is muddled non-thinking from run-amok conspiracy theorists. They would be better off sticking to, you know, perhaps denying the Apollo moon landings. Because the idea that a GM can now credibly post-AIG make the case that capital markets will blow up if we don’t assist it too is silly — and suggesting that auto companies (just to pick an example) will now plaster themselves with leverage bombs to make their own "We’re dangerous too!!" case stronger is sillier still.

More: Why Bail Out AIG’s Bondholders? -Felix Salmon. Calculated Risk risk reports: Fed: AIG Deal Done.

Update: John Jansen isn’t happy with the Fed:

Thoughts on A Loan to AIG, by John Jansen: Let me begin by noting that no details have been released on the alleged transaction between the Federal Reserve and AIG and so to comment is dangerous. But I will anyway!

If the Federal Reserve Bank of New York plans to write an $85 billion check to AIG , then Treasury market participants should duck for cover. They will likely raise the money by selling Treasury debt from the System Open Market Account. I have no idea how they would do that but it would be the largest such sale of securities since the dawn of human history.

At this point I run into a problem as I lack a detailed set of facts. I will offer some comment but I understand that I am on rough terrain. Why does the Federal Reserve not control 100 percent of the company? Capitalsim punishes bad risk. These jokers took bad risk in spades, They should be wiped out. The common shareholders should be left with nothing. If this was a good deal for the taxpayers, this would have been a private transaction. The very fact that the Fed is involved speaks loudly to us that no private company believes that this is a prudent loan.

Preferred shareholders? If the deal calls for making them whole, I ask why. There does not seem to be any reason to bail them out.

Bondholders? They should be forced to take a haircut. This is not FNMA or Freddie Mac issuing debt for 40 years with a wink from the Treasury Secretary and the implied backing of the Government. This was a completely private enterprise. AIG debt could have been purchased earlier today for cents on the dollar. To reward the holders of that debt truly creates a windfall profit.

The Federal Reserve is careening down a very slippery slope. The risks of that joyride are understandable and worthwhile if they exact a financial pound of flesh from those at AIG who so bungled their mission. On the surface that does not appear to be the case here.

Update: Was it legal?:

Fed Invokes ‘Unusual and Exigent’ Clause — Again, by David Wessel, RTE: In lending up to $85 billion at a hefty interest rate – LIBOR plus 8.5 percentage points – to insurer AIG, the Federal Reserve once again relied on its rarely used legal authority under Section 13(3) of the Federal Reserve Act to lend to “any individual, partnership or corporation” in “unusual and exigent circumstance” provided the borrower “is unable to secure adequate credit accommodations from other banking institutions.”

Until its loan to then-ailing investment bank Bear Stearns in March, the Fed hadn’t used that lending authority since the Great Depression, lending exclusively to commercial banks and other deposit-taking institutions. They relied on a different section of the Federal Reserve Act to offer loans – which weren’t actually made – to government-sponsored mortgage giants Fannie Mae and Freddie Mac. …

In a Tuesday night statement, the Fed said, “The (Federal Reserve) Board determined that, in current circumstances, a disorderly failure of AIG could add to already significant levels of financial market fragility and lead to substantially higher borrowing costs, reduced household wealth and materially weaker economic performance.” [Note: the term of the loan is 24 months, and "is collateralized by all the assets of AIG and its subsidiaries."]

Update: Tyler Cowen examines some of the Fed’s new properties:

The Federal Reserve now has commercials: Really. View it here.  This one is even better. Here is the Fed on risk protection.  And here: "The Greatest Risk is Not Taking One."  Here is Fed Karaoke.