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WSJ: Sale of AIG Financial Products Unit Faces Challenges

Source: Wall Street Journal

Posted on 13 Jan 2009

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The effort to wind down the unit that led to the downfall of American International Group Inc. is moving ahead, and the sale of one business line could be announced in coming days.

But the executive hired to contain the huge risks amassed in the unit, known as financial products, has challenges ahead. Further steep market deterioration could make his efforts more difficult and add pressure to the global insurer -- an issue flagged by Moody's Investors Service. "We have letters of intent" for the sale of one line, says Gerry Pasciucco, new head of AIGFP, who joined AIG last fall after the government bailout rescued the company from potential bankruptcy. Mr. Pasciucco says he wouldn't be "so foolhardy" as to say there could never be a liquidity risk to AIG but adds, "I don't feel at all pessimistic."

AIG is trying to sell off or contain the huge risks it amassed in its financial products unit, where multibillion-dollar problems brought the company to its knees and into taxpayers' arms last year. FP sold thousands of contracts that protect customers from dangers such as currency moves, interest-rate changes and losses on asset-backed securities.

AIG needed the government bailout largely because of obligations associated with the financial products unit, which operated independently from the company's highly regulated insurance subsidiaries around the world.

Previously, Mr. Pasciucco, 48 years old, was vice chairman of the capital-markets group at Morgan Stanley, where he worked for 24 years.

FP sold, among other things, credit-default swaps, terms of which can require AIG to post collateral if investments they protect go sour or if AIG's own credit ratings get downgraded. Both those things happened in the 18 months or so before the bailout, forcing AIG to come up with billions.

In recent weeks, the government and AIG have contained the threat from many swaps linked to multisector collateralized debt obligations backed by, among other things, subprime mortgages. They formed an entity to buy the CDOs, essentially canceling most of those deals.

There are still significant risks on the unit's books. Moody's said last month that the unit's exposures "represent a source of additional earnings and liquidity risk for AIG." Moody's cited, in particular, two other types of swaps. One type was swaps protecting other financial firms, largely European banks, against losses on about $250 billion of loans, as of the end of the third quarter. The other was a portfolio protecting about $50 billion in corporate loans.

Those swaps have put relatively few strains on AIG. As of Nov. 5, AIG had posted $37.3 billion of collateral to its trading partners on the CDO swaps, but just $2.6 billion on the other two types. In some cases, the other types of swaps also have different contract terms that could limit when or even whether AIG must post collateral, and if so, how much.

In a filing last fall with the Securities & Exchange Commission, AIG said that the "maximum amount" of collateral it could have to post is "the net notional amount" of the swaps, which in the case of these two types of swaps was $300 billion at the end of the third quarter. The net notional value of those types of swaps fell sharply from the end of the second quarter, when it stood at $360 billion, so the risk associated with those deals has been falling.

The government initially lent AIG as much as $85 billion in September. It has since revised the bailout twice, and the current deal is a package of about $150 billion in aid, up to $60 billion of which is a loan. In exchange for the bailout, taxpayers have an 80% stake in the company.