Why bailing out AIG might be a good bet

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Australian money manager John Hempton offers the clearest explanation of AIG’s predicament that I’ve seen:

The core business – the US Domestic Broker Group (DBG) is the best diversified primary insurance company in the US. … There are other OK businesses in there.

The good businesses generate about 20 billion per year pre-tax. That is a lot of dosh.

There are some staggeringly bad businesses in there too. AIG Financial Products probably has blown up something between 30 and 100 billion. Ultimately we have no idea what the AIGFP losses are – but we do have some idea of the huge margin requirements. …

There is no suggestion that the core insurance companies of AIG are impaired. AIG parent company however needs a huge amount of money – say 70 billion dollars – and it needs this largely to meet funding requirements driven by AIG FP. 70 billion is a number that petrifies everyone who looks at it.

But 70 billion is actually not that much compared to the core insurance companies. They should be easily able to repay that. Its only 3.5 years’ profits and should be repayable in 8-10 years provided there are no plagues or other nasty insurance stories.

So now suppose that you were a wise independent multi-trillionaire. Would you lend 70 billion to AIG at 10% secured by whatever you could and with an attached option to buy 60% of AIG at a notional price?

I think you would. It wouldn’t be a bad deal. …

The only multi-trillionaire around, though, is the U.S. government. Which is a strange sort of trillionaire, I know, given that it’s $10 trillion in debt (and that doesn’t count the present value of future commitments to Social Security and Medicare and yada yada yada). But it could swing the deal financially. Politically, maybe not so much.