No Exit: Goverment Deal to Bail Out of AIG Unfairly Punishes Taxpayers -- Again [Updated]

AIG Chairman Robert Miller says the insurer's newly announced divorce settlement with the feds could generate a "big profit" for American taxpayers. Why does that recall a late-night TV pitchman trying to sell me a ShamWow?

Fact is, this deal reeks as much as the government's $182 billion bailout of the company. Under the deal announced today, the U.S. Treasury would convert its roughly $49 billion worth of preferred shares in AIG into common stock.

Treasury Secretary Tim Geithner expressed confidence the agreement would expedite the government's retreat from AIG. He said in a statement:

The exit strategy announced today dramatically accelerates the timeline for AIG's repayment and puts taxpayers in a considerably stronger position to recoup our investment in the company. While there is a lot of work ahead to execute the terms of this agreement, today we are much closer to seeing a clear path out.

By way of comparison, the government in March predicted it would take at least nine months to finish selling Treasury's 30 percent stake in Citigroup (C). But it looks increasingly as if the feds won't meet that deadline. Since the AIG stock swap will result in the government having a roughly 92 percent stake in the company, it's hard to conceive of the feds exiting their position before 2013 at the earliest. Former AIG chief executive Maurice 'Hank' Greenberg is even more pessimistic. He thinks the process will take at least a decade.

Another problem, as Yves Smith explains, is that the government has repeatedly watered down the terms of the bailout. Among other things, it reduced the interest rate AIG pays on its taxpayer loans while increasing the size of the handout. AIG also has been allowed to drag out the process of divesting assets, which is supposed to help repay its debts. She writes:

[T]he deal has been retraded a full four times, each time with the Uncle Sam putting up more dough and worsening its footing, through a combination of lowering its interest rate and taking a less senior position. A private sector creditor would do the reverse: more credit would be extended only on more, not less, stringent terms.

Let's not kid ourselves: all this fancy financial footwork is to divert public attention from the fact that AIG will deliver big losses to the taxpayer.

Exchanging preferred for common shares presents other complications. Preferred shareholders may earn dividends, for instance, and are also at the front of the creditor line if a company goes bankrupt. So despite the government spin about speeding its exit from AIG (it's an election year, after all), we're a long way from disentangling ourselves from AIG.

Why is the government being soft on AIG? The conventional wisdom is that the insurance giant is systemically important to the global economy. Under that narrative, retold into lore, the feds had no choice but to save AIG. Everyone knew its collapse would've swamped the financial system, the story goes. That deprived financial regulators of any leverage in negotiating with AIG's counterparties and, later, prevented them from leaning too hard on what was, after all, a government-controlled company.

Echoing this line, respected financial journalist Edward Jay Epstein wonders what all the fuss is about.

Whether or not the Treasury recoups its investment in AIG is still an opened [sic] question, but, by saving AIG it prevented the collapse of the international financial system. So where is the scandal?

What is clear is that rescuing AIG rescued certain parts of the financial system -- namely, Wall Street, a handful of large foreign banks and these parties' respective investors. Clearer still is that what should've happened -- the government forcing AIG to sell itself off brick by brick in order to make good on its debts -- didn't.

Says economist Dean Baker of the Center for Economic and Policy Research:

Had it not been for the bailout, most of the major center banks would have been wiped out. This would have destroyed the fortunes of their shareholders, many of their creditors, and their top executives. This would have been a massive redistribution to the rest of society -- their loss is our gain.

It is important to remember that the economy would be no less productive following the demise of these Wall Street giants. The only economic fact that would have been different is that the Wall Street crew would have lost claims to hundreds of billions of dollars of the economy's output each year and trillions of dollars of wealth. That money would instead be available for the rest of society.

Image from Flickr user Mike Licht
Related:

• Ex-AIG Exec Joe Cassano is Free, Rich and --in His Mind -- Innocent
• New Documents Show Goldman Sachs Would've Lost Billions in AIG Collapse
• How the Feds and Goldman Sachs Used AIG to Hose U.S. Taxpayers
• Geithner Deal With Wall Street Over AIG Swaps Cost Taxpayers $13 Billion
• AIG is a Symptom, Not the Cause, of a More Serious Disease