From The Economist:
FORGET the banks and the carmakers. The biggest bets that American taxpayers have made are on three less famous firms: American International Group (AIG), an insurer, and Fannie Mae and Freddie Mac, two mortgage-finance agencies. The state now owns about $170 billion of shares in banks. It has so far invested over $160 billion of equity in the toxic trio, and this number is likely to rise towards $300 billion. Include other kinds of help, such as loans, and the total pumped into the three firms could eventually reach $800 billion (see table), or 6% of GDP. “I had no idea what I was in for,” admitted Edward Liddy this month as he stepped down after a gruelling year running AIG. Americans must feel the same way.
The case that was made to taxpayers last year for bailing out the three is intact. Through its derivatives activities and giant insurance business, AIG was so entangled in the financial system that it could have brought it down. Fannie and Freddie, which own, guarantee and help securitise about half of American mortgages, were judged as vital to a healthy housing market. Banks and foreign governments held buckets of their paper, too, in the belief it had implicit state backing. Defaults would have badly hurt relations with China, the largest foreign-government creditor.
What has changed is the size of the bill. AIG’s bail-out has been revised upward four times as its losses have mounted. “They tried to put on a band aid and then realised they needed a tourniquet,” says Rob Haines of CreditSights, a rating firm. When the government first began to help the two mortgage agencies in July 2008, it said capital injections were “not something we expect”. That looks like a bad joke now. The question is no longer whether the trio will receive vast sums, but whether taxpayers will get any money back.
Of the three firms, AIG represents their best hope, even though its credit spreads are still at levels that suggest a real risk of default. The government fired a blunderbuss of money at it, with six different categories of intervention (see table). Safest are probably the direct loans from the Federal Reserve, the commercial paper that the Fed has guaranteed and the loans that it is likely to make that are secured by life-insurance policies. These instruments are fairly high up the pecking order if the firm goes bust. The $25 billion preferred-equity stake that the Fed owns in two of AIG’s insurance subsidiaries is also pretty safe: they may be worth as much as double that sum....MORE