AIG bailout good for banks while investors bleed

By Joseph A. Giannone - Analysis

NEW YORK (Reuters) - The $173 billion government rescue of American International Group Inc is stoking resentment among investors who see it as a backdoor taxpayer bailout of Goldman Sachs Group Inc and other banks.

Six months after the U.S. government stepped in save an insurance giant overwhelmed by derivative losses, AIG continues to bleed red ink. Its stock and bond holders have been crushed, but one group has suffered almost no damage: banks that bought credit protection from AIG Financial Products.

Regulatory filings show that since the Federal Reserve announced its rescue of AIG on September 15, about $50 billion of government money has passed through the company to banks.

"Treasury is providing a massive wealth transfer from taxpayers to Goldman Sachs and other parties and it's something that absolutely should be investigated," said Eric Hovde, chief executive of Hovde Capital Advisors, where he manages financial services-focused hedge funds.

Once the world's largest and most powerful insurance company, AIG for more than a decade aggressively insured credit and mortgage exposure for banks around the world. At its peak, AIG was backstopping a $2 trillion derivatives trading business.

That business proved its undoing when credit markets broke down in 2007, leaving AIG on the hook for huge losses. At the year-end, it had $302 billion of outstanding credit default swaps, which are contracts that insure against debt default.

Filings show that, in the final months of 2008, as it unwound its money-losing credit derivative portfolio, AIG purchased from banks $46.1 billion of assets underlying swaps. With government financing, it paid $20.1 billion cash and surrendered $25.9 billion of collateral -- a 99.8 percent recovery rate.

BETTER DEAL

On the September weekend that investment bank Lehman Brothers Holdings Inc collapsed, the U.S. Treasury and Federal Reserve arranged an unprecedented insurance company bailout: $85 billion in loans for AIG in exchange for an 80 percent stake in the company.

The Treasury and the Fed worried that an AIG collapse could further drag down world financial markets. As markets continued to deteriorate and AIG's derivative losses mounted, Uncle Sam extended ever-more-lenient rescue packages.

The bailout has stirred resentment not just in the U.S. Congress, but on Wall Street, where investors speculate that Goldman and its connections helped it get a better deal.

"The whole point of the bailout is to save Goldman Sachs," said Christopher Whalen, head of financial advisory services for Institutional Risk Analytics. "The whole thing is so rancid and so hideous."

A Goldman Sachs spokesman declined to comment on the AIG bailout or what government funds it received.

Goldman CFO David Viniar in September and in December told investors the firm had no material losses from AIG. The bank says its AIG exposure was either collateralized or hedged.

Last week, AIG Chief Executive Edward Liddy told investors "the vast majority" of taxpayer funds "passed through AIG to other financial institutions" as it unwound transactions.