Michael

Bear Stearns, AIG, and the current proposed plan are bailouts. The value of the stock for the shareholders may be less than desired but is better than nothing. As far a holders of unsecured paper, they were bailed out 100%. The other insolvencies were not bailouts.
Whether the stock is common or perferred is mostly technical since the government will still own 80% of the company. Preferred stock has the advantage of being paid before common stock if liquidation occurs and usually pays a larger dividen. It seems pure speculation that the government owned stock will be retired. It wouldn't make any sense for the government to ask for stock and then give it back since the stock only has value is if the rescue plan is successful (if it isn't successful, the stock is worthless).
Ex CEOs of banks, investment banks, and insurance companies do not appear to be the brightest people in the world. All of them recommend to their customers to diversify but their own actions to not diversify have caused both company and personal assets to disappear. If they knew what they were doing, they would have sold their personal stock in the company when the price was at the top instead of the bottom so reading anything into why they sold their stock is pure speculation. James Cayne (Ex CEO of Bear Stearns) had all his assets in the company stock (over $1 billion) and only sold after the bailout. He was very lucky to walk away with about $100 million since if the government allowed the company to become insolvent, he would have probably been on the bread line.

RoadWarriorFromLP

In this case, it is not just a technical difference, because the preferred stock is being used for a specific purpose -- to secure the government loan.

The preferred stock should be retired as the loan is paid off, so at the end of the day, that 80% position should be temporary, not permanent. That would result in the shareholders seeing their position being "undiluted", to invent a phrase, as the government obligation is reduced and the associated preferred shares are eliminated.

It's really not much different than if AIG had simply borrowed money and put the loan on its balance sheet. The issues for the shareholder are whether the loan can be repaid and what the repayment process will do to operations, good and bad.

AIG will be a much smaller company at the end of this, and cannot be expected to generate the revenues that it once did, but odds are pretty good that it should make it in some way, shape or form at the end of this. I would not say that about Wachovia, which is being prepared for a good butchering.

My point was that Greenberg dumped his shares now because he is expecting the creation of this government-held preferred stock to reduce whatever value the existing shares have left. If an insider dumps mass quantities of shares into the market, that is generally not a good sign. (Technically, he may no longer be an insider, but close enough.)

Michael

If that is the case (it would be nice to see a link indicating that), then I agree that AIG may have some value in the future.

I thought that Paulson was driving a very hard bargin (approx. 11% interest rate plus 80% of the stock) but if that is not the case, than AIG is getting a good deal. In the past (Crysler and Lockheed), those companies had to issue warrants to the government to get the loan. So it appears that other than a fairly good interest rate, the government doesn't benefit from any upside potiental if the bailout is successful but may loose it's money if not.

BritGuyTN

Buy $1000 of microsoft. they have a good dividend yield and their stock is depressed right now. They also have an insane amount of cash on hand

RoadWarriorFromLP

The rate is meant to be punitive, more than anything else. The government isn't trying to make a crafty investment with this high rate (LIBOR + 850 bp), but is using it as a hammer over AIG and its management to get them to sell off the assets.

I would think of it more as a federally supported alternative to Chapter 11. The feds replaced the senior management, and created debt and equity terms that were so blatantly onerous that they would ensure that its hand-picked management team would waste no time in selling off assets that will get rid of Uncle Sam's $85 billion burden.

The press release from the Federal Reserve describes it as a loan, not an equity investment: http://www.federalreserve.gov/newsev.../20080916a.htm The convertible preferred is a good way of ensuring that the government loan takes priority to others, including the current shareholders. This analysis of the deal isn't a bad one: http://www.bloomberg.com/apps/news?p...d=aw.hphkcbZ_o

As an investor, I think that you have to ask yourself whether they will raise enough money from the asset sales and/or operations to repay the government, whether the company will become profitable by the time that this is done, and if it is profitable, how profitable it will be. That's hard to judge until we know what is going to be sold

The AIG deal is quite different. The Chrysler bailout was meant to keep Chrysler afloat. They wanted Chrysler to continue to operate and to keep people employed, and made no effort to micromanage the business.

The AIG loan is meant to keep AIG from failing at this moment. The feds may not ultimately care whether AIG can go the distance, just so long as Uncle gets his money back and AIG doesn't implode in such a way or at such at time that it destroys the economic system.

If I was an AIG shareholder, I wouldn't assume that the federal government is trying to keep AIG afloat over the long run. If AIG needs to fully liquidate to repay its government loan and it can do so at a later date without ruining the country, then I believe that the government will take what it is due and let AIG tank.

I think that it is important to keep in mind that Paulson comes from Goldman Sachs, so he is behaving like an investment banker who has the power of government behind him (because that is in fact what he is.) At this point, there is little concern for the shareholders and no concern at all for these companies' management teams; this is all about keeping the US and global economy from going into a depression, while keeping as much cash in the Treasury as possible.

Michael

I'm not sure how the preferred shares ensures that the government loan takes priority other than the government has veto rights over dividens. Unless something is written into the agreement that the government loan is paid of first in case of bankruptsy, I don't see how the preferred share help this situation. I still think that the fed should have gotten warrants for any upside potiential.

Did you notice that Fortis (Dutch/Belgium banking/insurance company) seems to be having major problems? If they become insolvent, who can save them since the company has more assets/debt than the GDP of either the Netherlands or Belgium?

I think the real killer in Europe would be if UBS became insolvent since its assets/debt is about 4x the GDP of Switzerland.

Of a much more minor concern would be RBS.

It seems that most financial institutions have been over leveraging themselves.

RoadWarriorFromLP

I think that it's more a matter of maintaining overall control, which the government has attempted to do at several levels. They have taken the assets as collateral (although that may be somewhat theoretical, as whatever existing secured liens that they may have would take priority), the preferred shares give them voting rights, and the convertible feature allows them to permit them to participate in the upside if there is any (although I have my doubts that the government would ever exercise those rights.)

The government is basically calling the shots until they get their money back, including who gets to run the business and the pace at which they sell the assets. At the end of that process, who knows if there will even be a company left. I suspect that there will be, at the very least, quite a large insurance business remaining, but I don't know enough about the various business units and assets to be sold off in order to truly know the answer to that.

Frankly, I doubt that there will be much of an exchange of actual cash. I would expect there to be some sort of government-backed asset transferred to AIG that will devised in such a way that the company will never get to turn it into cash in the real world, unless the worst case scenario arises. I see this package as more of an accounting plug meant to soothe the markets than a true loan meant to infuse cash into the business.

I don't follow Fortis, but thanks to your post, I will take a look at them. FWIW, I've started looking at Allied Irish Bank (trades on the NYSE), which appears to have a pretty good balance sheet, but has to contend with a declining Irish economy and a pack of short sellers ready to bet on its demise.

Michael

This is what I understand from several of the web sites that I visited. The government wanted warrants or 80% of the common shares in exchange for the revolving credit line of $85 billion. Neither of those were possible without shareholders approval and there wasn't enough time to get the approval. So the Fed said it would take 80% of convertible preferred shares (redemption value of $500,000 total) instead since that would be allowed without shareholder approval. When the shareholders meet, they are expected to approve conversion of the 80% preferred stock to common stock and if they don't, the Fed will call in the loan and walk away from the deal.

From everything I've read, the Fed will definately own 80% of the company. If that was not the case, why would shareholders be unhappy with the deal and are currently trying to line up financing so that they can vote against the deal during the next shareholders meeting?

RoadWarriorFromLP

Yes, until the loans are repaid. The government shouldn't own any interest in the company once they have been repaid.

The point being is that the dilution should be temporary. Accordingly, if you presume that AIG will survive the next couple of years, I would assess its future value based upon its expected future operations, and I would not presume that the government will be diluting the company's value at that time. The dilution may lower the shares' value in the short term, but not over the long run.

Michael

You keep saying that over and over again but nowhere on the internet it indicates that is the case.

Why are major shareholders trying to line up private financing if that was the case?

RoadWarriorFromLP

Because the government's money comes with a lot of strings attached and shoves these large shareholders to the bottom of the priority ladder.

Presumably, these large shareholders are trying to create negotiation leverage in the hopes that they can get better terms, and guys like Greenberg want to regain control of the company.

They aren't going to succeed. If they want to try to line up private financing, let them -- that's a pipe dream, they aren't going to get it. Private equity firms would demand even more onerous terms than this.

It is implied through the deal structure. The money from the government is a revolving credit facility, to be repaid through the sale of assets. The convertible preferred gives the government voting priority over the common shareholders.

The government isn't going to convert its preferred interest into common shares. Likewise, it's difficult to imagine that the government is going to call up a broker and sell these shares.

Before you panic about the 80% equity position, ask yourself what they would possibly do with it. The government is not going to behave like a normal shareholder. This isn't an investment in a conventional sense, but a way to patch up the company so that it doesn't destroy the economy.

Michael

I guess we aren't going to agree until we find out the terms in a few months.

Trying to acquire financing for a troubled company on the open market is extremely difficult these days. Considering that Warren Buffet paid $5 billion to get approx 20% of Morgan Stanley (a much more stable company) plus a 10% dividen, an 80% ownership of AIG for the loan would not seem unreasonable. After all, the value of 80% of AIG when the bailout occurred was only about $4 billion (sort of a finders fee). The government could have asked for a 14-15% interest rate instead which would have had the same financial negative impact to shareholders.

Just like the warrants with Crysler and Lockheed, the government would sell those shares on the open market after AIG became stable.

As I mentioned in an earlier post, Fortis (about the size of AIG) is in financial trouble but has just been bailed out with a 11.2 billion-euro ($16.3 billion) rescue from Belgium, the Netherlands and Luxembourg.

http://www.bloomberg.com/apps/news?p...Fhk&refer=home

RoadWarriorFromLP

You meant Goldman Sachs, not Morgan. But you can't compare Goldman to AIG.

Goldman is the top I-bank on Wall Street, and is playing this for what it's worth. AIG was on the brink of failure, and would have been forced into Chapter 11 -- or, more likely, Chapter 7 liquidation -- had the federal government not intervened.

Really, these two deals are apples and oranges. You can't value their equity similarly. Had AIG been allowed to fail, its shares would be trading next to WaMu and Lehman at pennies per share, not the $100+ where Goldman is today.

Michael

Yes I meant Goldman Sachs. I wan't comparing Goldman to AIG but just showing that a solid company like Goldman is being raked through the coals to acquire money in todays market.

Michael

This is my understanding of the government bailout of the banks and what the government is trying to accomplish. Please comment if you do not agree.

First we have to understand what a CDO (Collateralized Debt Obligation) is and how it is created. A CDO is much the same as a corporate bond which has a face value (ex. $10,000), pays a coupon interest rate (ex. 7%), and has a maturity date (ex. 30 years). The primary difference between corporate bonds and CDOs is that corporate bonds are backed by the assets of a company and a CDO is backed by parts of many different homes plus a CDO pays a variable interest rate depending on the foreclosure rate, variable interest rate of loans in the CDO, and the loans will be paid off prior to the maturity date.

The CDOs are created when mortgage companies sell the loans of hundreds or even thousands of homes to investment banks. The investment bank may create thousands of CDOs from those loans (value of all loans / $10,000 = number of CDO issued). The prospectus of the CDOs are sent to a ratings company such as Moodys and they then rate the CDOs. The investment bank now creates a market to sell the CDOs and will buy them back (price depends on demand) even if the investment bank doesn't currently have buyers on the assumption that they will find buyers in the future (investment bank acts as a market maker). The investment bank will also distribute coupons received from the mortgage company that is managing those loans to owners of the CDOs.

Everything worked fine until a large amount of foreclosures occurred. Some CDO were grouped with a large amount of sub-prime loans, 0 down loans, and alt-prime loans but they were all rated as triple A. Even though a CDO with a large number of sub-prime loans may have paid a higher interest rate, investors lost confidence and started to redeem the CDOs at the investment banks. Also investors couldn't determine which CDOs were better than other CDOs so wouldn't purchase any.

According to the news, the bailout is supposed to purchase distressed mortgages. However, that is not usually true since most mortgages are packaged into CDOs, most mortgages in the CDO are good mortgages, and the CDO cannot be broken apart. Only in the case of mortgage companies (if there mortgages were not previously packaged into CDOs) can the Fed really purchase distressed mortgages. So mostly the Fed will be purchasing CDOs, holding those CDOs until the market gets better, will be receiving the coupon interest rate during that time, and then selling those CDOs when the market gets better. The Fed now becomes a market maker.

The biggest problem for the Fed will be to try to determine the value of the CDOs that they will be purchasing. The prospectus will tell the percentage of sub-prime, alt, and prime loans as well as which mortgage company issued the mortgages. The Fed can also determine the percentage of homes in foreclosure and can determine the address of each home in the CDO. With a good computer program, they should be able to get a fairly accurate picture of the CDO so that it can be priced. Any other CDO in the same CDO group would be priced the same. Once the CDO is priced by the Fed, a reverse auction will be done for those CDOs and the Fed will only pay a price that is within a certain range of their discovered price.

So what does all this accomplish? Currently banks can bring CDOs to the Feds discount window and use them as collateral for a low interest loan. This allows the banks to get temporary money to make payments but the loan must be repaid in 30 days so the bank must acquire permanent money during that time. If a run occurs on deposits or redemptions of corporate bonds, the discount window only solves the problem temporarily but is not a long term solution. If the banks can sell their CDOs to raise cash when needed, this should give them more breathing room to try to solve the problems of the bank. However, this bailout will not solve the problem of banks that don't have a near term turnaround plan implemented. So the main reason for the bailout is to provide liquidity for the banks and not to purchase distressed securities. Liquidity would be provided whether either distressed or good securities are purchased.

I don't see a lot of risk to the tax payer. If everything goes as planned, the government may possibly be able to make money but I don't think it will cost the tax payer more than about $100 billion unless the real estate market completely falls apart.