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AIG Recoups Collateral, Thanks to Securities Turnaround

Source: WSJ


Posted on 29 Oct 2009

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After shelling out billions of dollars to Wall Street banks last year on souring trades, American International Group Inc. (AIG) has gotten some of that money back, thanks to a turnaround in the very securities that helped level the insurer.

Billions of dollars have flowed from banks into AIG coffers in recent months, according to people familiar with the matter. For the second quarter, the figure may have topped $3 billion, public filings suggest. Goldman Sachs Group Inc. has sent back at least about $1 billion, said people familiar with the matter.

The inflows come as AIG still is struggling under government control while some of the banks it trades with already have reported strong profits. The reversal also illustrates how a move in the federal rescue, closing out some of the soured trades, both helped save AIG and potentially deprived it of billions of dollars.

The money flows follow a rebound in the financial markets, including in bonds tied to subprime mortgages.

The cash that AIG is getting back from Wall Street is tied to credit-default swaps, which act as insurance policies on securities backed by assets such as mortgages and pay off in case of default. AIG sold these swaps to Wall Street banks. Under these contracts, it was required to pony up collateral if the investments they backed fell in value. When the credit crisis hit, AIG had to fork over billions of dollars to the banks, draining it of cash and helping to push it to the brink of a bankruptcy filing. Many of these trades were closed out last year after the government rescue in an effort to stem banks' collateral calls to AIG. But some trades remained in place, including those that recently have reversed in AIG's favor, prompting banks to return collateral.

It isn't clear exactly how much collateral has flowed back to AIG, or how much still is outstanding. The amount of collateral AIG's trading partners held declined by more than $3 billion between the end of the first and second quarters, according to AIG's filings with the Securities and Exchange Commission.

Credit markets continued to rally in the third quarter, suggesting AIG got more collateral back. AIG is expected to report financial results for the third quarter in the next couple of weeks.

The inflow of funds is a welcome development for taxpayers, as AIG owes the federal government more than $80 billion. Still, AIG might have to send collateral back to banks if markets reverse; the trades mightn't settle for years.

he development highlights how the government's decision last November to close out many of these trades aided big banks while costing AIG a chance to get billions of dollars more in collateral back in any rebound.

When the government first rescued AIG in September 2008, it lent AIG up to $85 billion, much of which AIG turned around and handed out to the banks to meet its collateral obligations under the contracts.

Two months after the bailout, the government adopted a new strategy. The Federal Reserve Bank of New York helped create an entity called Maiden Lane III to buy the underlying investments, and arranged to terminate many of the swap contracts.

That was a boon to the banks, which were effectively made whole. The banks pocketed $35 billion in collateral AIG already had paid them, and collected another $26.8 billion in cash for selling the investments at roughly their lowered values. Goldman Sachs got to keep billions in collateral and got paid $5.6 billion for the investments.

Whether that was the best strategy for AIG remains a subject of debate.

At the time, the move eliminated the risk that AIG would have to post still more collateral on the canceled swaps if the investments continued to decline. Last November, AIG's then-chief executive, Edward Liddy, told investors that the company was hemorrhaging cash because it had to post collateral on the swaps and problems with other deals. "We need to stop that and that's what this is designed to do," Mr. Liddy said.

The advantage of that approach was illustrated in the first quarter. Markets continued to fall but AIG didn't have to keep handing over more cash on closed-out deals. But AIG also surrendered any chance of getting some of the collateral back on the canceled swaps.

AIG's former longtime CEO, Maurice R. "Hank" Greenberg, argued publicly at the time that the government should have guaranteed the swap contracts, eliminating the need for AIG to post more collateral. Others have contended that AIG's trading partners should have been forced to accept less money for tearing up the contracts.

Officials have said the government lacked the authority to impose a different solution.

The Treasury Department's special inspector general is expected to issue a report soon on the payments to the banks, according to a person familiar with the matter.

While AIG can't get any of the collateral back on the swaps that were canceled, it still could see some small upside on the deal. The investments held by Maiden Lane III increased in value in the second quarter. If they ultimately end up throwing off enough cash to pay off the loans that funded Maiden Lane III, the New York Fed will get two-thirds of any profits, and AIG will get one-third.


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