A Government Sale of AIG, Caveat Emptor (AIG, C, MS, GS, JPM, FNM, FRE)

Imagine the government and taxpayers finally being out of AIG… Who doesn’t love to hate AIG?  The financial crisis and the bailouts might have been much different had American International Group, Inc. (NYSE: AIG) been properly run, properly regulated, had bothered using real risk-managers, and not started using intergalactic space travel calculations for financial derivatives. The rumor that has been around for a month or more is that Uncle Sam is looking to exit its AIG stake.  If reports going around the web today are true, the rumors that Uncle Sam is looking for a way out of AIG may finally be coming true.  The plan of Uncle Sam to exit Citigroup, Inc. (NYSE: C) has helped to lay the foundation for an AIG exit, but deep down this has issues that tie deeply into Morgan Stanley (NYSE: MS), Goldman Sachs Group Inc. (NYSE: GS), JPMorgan Chase & Co. (NYSE: JPM), and even Fannie Mae (NYSE: FNM) and Freddie Mac (NYSE: FRE).

Taxpayers have extended unusually large assistance to AIG.  There are public figures and interpreted figures over what will really be owed after some repayments are made soon, but this has been at least $80 billion to $129 billion to start.  The real tally is a gray area that largely depends upon how long the payback takes and under what circumstances this payback comes.   It also may ultimately depend upon which direction the wind is blowing in the coming months and years.

Bloomberg has written a long article arguing that the government is “considering a two-year plan to dispose its stake.”  Again, there have been many discussions in recent weeks over how this would occur. The Bloomberg article also points to the preferred shares being converted into common shares and slowly sold off in the stock market.

Our own take is one that is far different.  The government has repeatedly said it wants out of AIG.  Depending upon on which official you listen to, there have been many predictions on both sides.  Some believe that AIG will ultimately pay back every dime to the taxpayers.  Others have voiced that the government cannot expect a positive return in AIG under even the best circumstances.

What if the reality is that the government was plugging a hole in the wall, but knew all along that it was making a bad trade as far as a win-loss in AIG?  The government has made billions in profits on its rescue money elsewhere from the more solid banks and other solid financial institutions.  The banks that were allowed to repay the TARP and assistance obligations.  If the government treated the entire bailout (TARP, TALF, and so on) as a distressed mutual fund bet as a diversified trade, it would have taken a loss on AIG and still claim a major victory.  The verdict would be, “All in all we made money, and we kept a catastrophic system failure from happening that would have drug the world economy back into the 1930’s or worse.”

Then there is another notion.  The government has said over and over that it does not want to own these private companies, AIG included.  But with the pending regulation coming down the pipe (and more regulation is coming, like it or not), Uncle Sam gets to dictate terms that AIG has to permanently agree to.  That is what having close to an 80% stake would allow.  And getting AIG to sign on would force others still being in hock with the government to sign on and endorse whatever the regulation is.  Many government officials are already saying that the SEC charge against Goldman Sachs is proof that reform and regulation are needed immediately, but the problem is that NO due process has run its course yet via a trial or settlement.  So officials are giving a guilty verdict and Lloyd Blankfein hasn’t even done his testimony yet, let alone won or lost the SEC civil trial.

AIG’s new CEO, Robert Benmosche, has indicated that AIG’s asset sales and unit sales have put AIG on the path to be able to repay taxpayers about $51 billion from divestitures of two units.  Our interpretation of Benmosche’s comments would put AIG on the path to repay the Federal Reserve loan(s) and then pay the Treasury. The US Treasury has invested about $47 billion in AIG.

Benmosche’s entrance into the company stopped some fire-sales, and he has indicated that AIG plans to pay down its assistance dollars in part by selling assets and in part getting the troubled units back to operational efficiency to repay the government.  All prior efforts were focused solely upon fire sales with immediate repayments, something which founder Hank Greenberg was sharply criticizing.

Does this sound like the Citigroup Inc. (NYSE: C) plan?  It should.  Uncle Sam hired Morgan Stanley to divest its billions of dollars held in its Citigroup stake, and if the Citi shares remain anywhere close to today’s price then Uncle Sam will have a handy profit.  There is one firm which could probably pull this government exit off easily for Uncle Sam, and that is Goldman Sachs Group Inc. (NYSE: GS).  The problem is that after what came up last Friday as the SEC civil fraud charges, the taxpayers might riot in the streets or dub this a “trading with the enemy” violation if the government hired Goldman Sachs.  That largely leaves J.P. Morgan Chase & Co. (NYSE: JPM), although Jamie Dimon and the current regime are not publicly getting along very well.

This will not at all be a model for Fannie Mae (NYSE: FNM) nor for Freddie Mac (NYSE: FRE) because those are merely being kept alive as subsidized entities so the Treasry does not have to include their liabilities on the balance sheet for an implied guarantee of all liabilities.

So, maybe government officials are floating this out there just to see what the reaction might be.  Maybe there is a real move to exit AIG.  The Citi exit is going to take some time, almost no different from a scheduled insider share sale plan (a 10b5-1 plan).  Getting out of AIG is going to be far from easy.  It will take years as the public float market cap is a small fraction of the fully diluted enterprise value of AIG.

The notion that AIG is back over $40 and has a 52-week trading range of $8.22 to $55.90 effectively matters not.  The notion that 2009 common equity ended up at $69.824 billion and the notion that its net tangible assets were listed as $63.629 billion also matter not.  Whatever is listed on the books, it is effectively spoken for.  To make matters more complicated, unit sales that have been seen the books will be entirely different.

We won’t bother with floating the notion that the US government would spin its AIG shares and interest off to taxpayers as a dividend or as a tax refund.  Imagine if AIG’s critics suddenly found themselves as ‘direct shareholders’ rather than indirect owners via the government.  Imagine if those same holders had lock-up periods, just as the public has demanded of executives and highly paid employees of the financial firms.  What a case study that would make.

The government will eventually get out of AIG, or whatever it and its units will be named down the road.  This process cannot occur in an easy transition, and letting AIG run back entirely on its own too soon might put too many state regulators and federal regulators in a position that AIG could again be a risk to the system.

Stay tuned.

JON C. OGG