Sample 2008 U.S. Economic Indicators  |
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The fall of 2008 was a time of severe economic distress, marked by a broad-based decline in home prices, a rise in delinquencies and foreclosures, and a substantial drop in the values of mortgage-backed securities and other related instruments. Major institutions, including IndyMac Bank and Lehman Brothers, experienced debilitating losses that eventually led to their collapse, while Fannie Mae and Freddie Mac were placed into government conservatorship. There was a growing loss of confidence in U.S. and global financial markets, and credit markets were virtually frozen.
Money market funds, long viewed as a safe investment by millions of Americans, were experiencing massive withdrawals. The run on these funds, in turn, severely disrupted the commercial paper market, a vital source of funding for American businesses. Securitization markets started to seize up, especially those reliant on instruments backed by consumer loans. Banks sharply curtailed their lending. A full-fledged panic had started and was spreading rapidly.
The effects of the crisis extended well beyond Wall Street. State governments faced significant budget shortages; schools, universities and hospitals curtailed spending; and large and small businesses came under pressure to cut costs and eliminate jobs, leaving millions of Americans unemployed.
| AIG 2008 Performance |
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AIG, the world’s largest insurance company and a major participant in the global trade of derivatives and other financial instruments, was encountering severe liquidity problems, primarily as a result of losses on its mortgage-related investment portfolio and collateral calls on credit default swaps (CDS) and other financial contracts. By mid-September 2008, these liquidity pressures brought the firm to the brink of collapse. On September 15, 2008, downgrades by certain credit rating agencies triggered CDS-related collateral calls that the company could not meet.
In light of the unusual and exigent circumstances at the time, the New York Fed and the Board of Governors of the Federal Reserve System—in close cooperation with the U.S. Department of the Treasury—made the decision to intervene to prevent the imminent collapse of AIG. The decision to lend to AIG was motivated by a single goal: to protect the U.S. and global economies and the American people from the devastating effects that its disorderly failure would have caused in the then prevailing economic environment.
The first response of policymakers to the crisis at AIG was to encourage a private-sector solution. A consortium of private-sector financial institutions was convened at the New York Fed, but specific terms for an AIG financing package could not be agreed upon.
At the time of AIG’s liquidity crisis, no effective bankruptcy framework existed for a firm of AIG’s type and size. There was no single regulator to step in and manage the company’s failure, no single court that could sort out the demands of creditors and shareholders, and no practical way to coordinate among the hundreds of U.S. and foreign regulators responsible for overseeing all of AIG’s businesses. The absence of a resolution authority, combined with the size and scope of AIG’s businesses and the existing stress on the economy, would have made the consequences of its failure potentially catastrophic, stressing the need for quick, effective action.
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The failure of AIG, a company with more than 76 million customers in approximately 140 countries—more than 30 milion customers in the United States alone—posed a direct threat to millions of policyholders, state and local government agencies, 401(k) participants, banks and other financial institutions in the United States and abroad, and would have shattered confidence in already fragile financial markets.
| AIG’s Reach in the United States in September 2008 |
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More than 30 million commercial, institutional and individual customers |
More than 180,000 small businesses, not-for-profit organizations and other corporate customers |
More than six million customers with retirement plans or accounts |
Largest life and health insurer |
Largest issuer of fixed annuities |
Second largest investor in U.S. municipal bonds |
Second largest property and casualty insurer |
Major provider of protection to participants in 401(k) retirement plans |
Major provider of retirement services to not-for-profit healthcare groups, schools and universities |
Major participant in derivatives markets engaging with major national and international financial institutions, U.S. pension plans, stable value funds and municipalities |
Holder of more than $10 billion in loans from state and local government entities |
Issuer of approximately $38 billion of stable value wrap contracts |
Issuer of approximately $20 billion of commercial paper, held in large part by money mutual funds |
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If AIG had been allowed to fail and the parent company had filed for bankruptcy, the consequences and effects could have been severe:
- Many of AIG’s insurance subsidiaries could have been seized by their state and foreign regulators, leaving policyholders facing uncertainty about their rights and claims.
- Seizure of AIG subsidiaries would likely have put a moratorium on claims and withdrawals, and could have impaired those claims in the longer term.
- A run on AIG, in the form of a massive cashing in of insurance policies and annuities, would have strained the company’s ability to meet its obligations to millions of policyholders.
- State and local government entities that had lent investment funds to AIG would have been exposed to losses in an already difficult and deteriorating municipal budget environment.
- Workers whose 401(k) plans had purchased guarantees in the form of stable-value contracts from AIG could have lost that insurance.
- Pension plans would have been forced to write down their AIG-related assets, resulting in significant losses in participants’ portfolios.
- The resulting losses to money market mutual funds, to which millions of Americans entrust their savings, would have had potentially devastating effects on confidence, and would have accelerated the run on various financial institutions.
- Global commercial banks and investment banks would have suffered losses on loans and lines of credit to AIG, and on derivatives contracts and other transactions, potentially causing even greater constraints on the availability of credit to homeowners and businesses.
- Confidence in other insurance providers could have been impacted, leading to a possible run on the industry.
Given the unusual and exigent circumstances at the time, the potentially far-reaching consequences of an AIG bankruptcy compelled policymakers to take decisive action to intervene.
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The Board of Governors of the Federal Reserve, relying on its emergency lending authority granted by Congress under section 13(3) of the Federal Reserve Act and mindful of its responsibility to maintain financial stability and with the full support of the U.S. Treasury Department, authorized the New York Fed to extend a secured revolving credit facility of up to $85 billion to AIG. The New York Fed extended that credit to AIG and the company agreed to transfer a controlling stake of 79.9 percent of company equity to a trust for the sole benefit of the United States Treasury. AIG’s chief executive officer was also replaced. The credit facility initially carried a rate of LIBOR plus 8.5 percent—the same terms contemplated by the consortium of private banks that explored a private-sector solution. The credit facility is secured by a pledge of a substantial portion of AIG’s assets.
The initial emergency $85 billion facility successfully stabilized AIG in the short term, but the company’s financial condition and capital structure remained vulnerable to further deterioration in market conditions. In October, borrowing costs continued to rise, credit markets remained essentially frozen and equity markets trended downward.
The Board of Governors approved an additional secured credit facility that permitted the New York Fed to borrow up to $37.8 billion of investment-grade, fixed-income securities from certain regulated U.S. insurance subsidiaries of AIG in return for cash collateral. By November 20, 2008, AIG received approximately $20 billion in cash collateral under the program, which was returned in full when the program was terminated on December 12, 2008, in connection with the formation of the Maiden Lane II facility (see below).
Additionally, toward the end of October 2008, four AIG affiliates began participating in the Federal Reserve’s Commercial Paper Funding Facility (CPFF) on the same terms and conditions as other participants in the program. The CPFF program ended in April, 2010 without incurring any credit losses.
Despite having access to these additional credit facilities, AIG continued to face serious liquidity pressures related to losses on residential mortgage-backed securities, and its exposure to CDS contracts.
The Federal Reserve Board and the U.S. Treasury announced the restructuring of the government's financial support to AIG in order to provide the company more time and greater flexibility to sell assets and repay the government. Measures included certain modifications to the New York Fed’s credit facility, including a reduction of the interest rate to three-month LIBOR plus 300 basis points, and a reduction of the fee charged on undrawn funds to 75 basis points (from the then-existing rate of 850 basis points). The length of the facility was also extended from two years to five years.
In addition, the U.S. Treasury announced its plan to purchase $40 billion of newly issued AIG preferred shares under the Troubled Asset Relief Program (TARP), the proceeds of which were used to reduce the balance of the Fed’s credit facility. The total amount available to AIG under the credit facility was also reduced from $85 billion to $60 billion.
Finally, the Board of Governors, relying on its emergency lending authority granted by Congress under section 13(3) of the Federal Reserve Act, approved the creation by the New York Fed of two new secured lending facilities designed to alleviate capital and liquidity pressures on AIG associated with two distinct portfolios of mortgage-related securities. These new facilities resulted in the creation of two new special purpose vehicles (SPV): Maiden Lane II LLC and Maiden Lane III LLC.
The New York Fed, with the full support of the U.S. Treasury, established the AIG Credit Facility Trust to hold the controlling equity interest in AIG. The Trust was established for the sole benefit of the United States Treasury, the general fund of the U.S. government, and thus effectively for the benefit of U.S. taxpayers. The New York Fed appointed three independent trustees to control the Trust.
The U.S. Treasury and the Federal Reserve announced the outline of a restructuring of the government’s assistance to AIG designed to strengthen the company’s capital position and provide additional time to benefit from market improvements. The measures included an authorization by the Board of Governors for the New York Fed to acquire up to $26 billion of preferred interests in special purpose vehicles formed to hold two of AIG's largest foreign life insurance subsidiaries: American International Assurance Co., Ltd. (AIA), and American Life Insurance Company (ALICO), in satisfaction of an equivalent amount of the outstanding balance of, and the amount available under, the credit facility. This step was intended to reduce AIG’s financial leverage, and thus relieve pressures on the credit ratings of the parent company. Acquiring the preferred interest also facilitated the independence of these two subsidiaries in anticipation of their eventual sale or initial public offering.
Additional measures included a reduction in the interest rate on the credit facility; changes to the terms of the U.S. Treasury’s existing TARP investment; the establishment of an additional TARP facility of up to approximately $29.8 billion that AIG could draw upon as needed in exchange for the issuance of additional preferred equity to the Treasury; and the authorization by the Board of Governors of a potential securitization of certain life insurance cash flows in amounts up to $8.5 billion. In February 2010, AIG announced that it would not pursue the securitization option.
In accordance with the restructuring announced on March 2, 2009, The New York Fed agreed to receive from AIG $16 billion of preferred equity in the SPV formed to hold AIA, and $9 billion of preferred equity in the SPV formed to hold ALICO, in satisfaction of an equivalent amount of the outstanding balance of, and amount available under, the revolving credit facility.
The New York Fed received preferred interests in the AIA and ALICO SPVs, and accordingly reduced the outstanding balance of, and amount available under, the $60 billion revolving credit facility by $25 billion. The New York Fed’s preferred interests earn an annualized return of 5 percent until September 22, 2013, and 9 percent thereafter. Under the terms of the transaction, subject to certain limited exceptions, all proceeds from the voluntary sale, public offering or other liquidation of the assets or businesses held by the SPVs are required to first be used to redeem the New York Fed’s preferred equity interests, until the preferred interests have been redeemed in full.
AIG agreed to sell AIA to U.K.-based insurer Prudential plc. for $35.5 billion. (Following further negotiations, the deal was terminated by the companies on June 2, 2010. AIG is considering other options to monetize AIA.)
AIG announces the sale of ALICO to U.S.-based insurer MetLife, Inc. for approximately $15.5 billion, including $6.8 billion in cash. Upon closing, net cash proceeds will be used to partially redeem the New York Fed’s preferred interests in the ALICO SPV. The noncash consideration of MetLife securities will be sold over time, and proceeds from their liquidation will be used to further redeem the New York Fed’s preferred interests and subsequently to reduce any outstanding balance of the credit facility.
AIG announced plans to conduct an initial public offering of AIA by seeking a listing of AIA on the Hong Kong Exchange, subject to regulatory approvals and market conditions. Proceeds will be used to redeem the New York Fed's preferred interests in the AIA SPV and subsequently to reduce any outstanding balance of the credit facility.
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In connection with its assistance to AIG, the rights of the New York Fed are those of a creditor.
Since September 2008, the New York Fed has operated under a credit agreement that contains significant conditions and protections to help ensure the full repayment of the loan extended to AIG, as well as accrued interest and fees.
In its role as creditor, the New York Fed regularly receives information from AIG regarding the company’s financial condition and operations. The New York Fed, in coordination with the Treasury, works with AIG management in ongoing efforts to implement of the company's business and restructuring strategy. In accordance with the terms of the credit facility, the New York Fed sends observers to each of the company’s board of directors meetings.
The New York Fed has a dedicated team, led by senior officials, whose sole role is to review AIG’s financial condition, monitor the use of cash and exercise the New York Fed’s contractual consent rights over decisions that may impact the company’s ability to repay its loan. The team has frequent on-site contact with the company to ensure that the New York Fed is informed of funding needs, cash flows, liquidity, earnings, asset valuation and overall progress in pursuing corporate restructuring and the divestiture of assets.
From the outset of its intervention, the New York Fed has been focused on addressing two overarching goals with respect to AIG: 1) the stabilization of AIG; and 2) obtaining full repayment of the assistance that has been provided. |
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The New York Fed is also assisted by professional advisors in its daily monitoring of AIG. The New York Fed team’s ongoing oversight of the company is supplemented by a number of firms in a range of fields, including accounting, investment banking, asset valuation and legal advice. Under the terms of the revolving credit facility, AIG reimburses the New York Fed for advisory fees and other out-of-pocket expenses.
To the extent that the New York Fed is a party to certain transactions with the company, the New York Fed does, when appropriate, provide comments to certain AIG securities filings and related disclosures. Such comments are intended to strengthen the accuracy and consistency of the disclosure in question, and any such comments are provided with the full understanding that AIG is ultimately responsible for its own disclosure obligations under federal securities laws.
The New York Fed does not have statutory authority to supervise or regulate AIG or its subsidiaries. The company’s regulated subsidiaries are supervised by numerous government bodies, which include U.S. state insurance regulators and the financial and insurance supervisors of many foreign jurisdictions. Also, as a publicly listed company in the United States, the parent company is subject to the rules and regulations of the Securities and Exchange Commission. AIG’s management team and board of directors are responsible for the day-to-day management of the company, as well as for its accounting, auditing and controls.
Over time, significant progress has been made to stabilize the company by reducing its risk profile and implementing an orderly restructuring plan. Many of the risk areas that brought AIG to the brink of failure have been addressed, or are in process, including the orderly wind-down of the AIG Financial Products. |
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