Edward Liddy, who took over the insurer after it almost collapsed last year, told the board he plans to step down as soon as the directors replace him

TO BE NOTED: From Bloomberg:

"AIG’s Liddy to Step Down Once Board Finds Replacement (Update5)

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By Hugh Son, Erik Holm and Andrew Frye

May 21 (Bloomberg) -- American International Group Inc. Chairman and Chief Executive Officer Edward Liddy, who took over the insurer after it almost collapsed last year, told the board he plans to step down as soon as the directors replace him.

Liddy, 63, recommended the chairman and CEO roles be split, the insurer said today in a statement. AIG said separately that Harvard University Professor Martin Feldstein, James Orr and Morris Offit are stepping down from the board, making way for a new slate approved by trustees overseeing the government’s majority stake in the New York-based company.

Liddy’s replacement will be the fifth CEO since 2005 to run AIG, the world’s biggest insurer until losses on derivatives left it hours from bankruptcy in September. The new leader must find a way to sell assets, stem the exodus of customers and employees and repay the $182.5 billion U.S. bailout while enduring public scrutiny that made Liddy wonder aloud about potential damage to his reputation.

“It really is a terrible job, I’m not sure who would really want it,” said Robert Haines, analyst at CreditSights Inc. “There is so much political baggage that whoever takes over the company is going to find it an extremely difficult and thankless job.”

AIG’s restructuring chief, Paula Reynolds, may be a candidate for the top spot, said Haines. Other possible successors include Ace Ltd. CEO Evan Greenberg, the son of former AIG leader Maurice “Hank” Greenberg, Haines said. Ace sidestepped the subprime investments that overwhelmed AIG.

Liddy said in an interview the insurer has “very strong internal candidates” for CEO and he called Reynolds an “exceptional individual.”

‘Several Years’

Liddy was appointed in September by the government to run AIG after the company agreed to turn over a majority stake in return for a federal rescue. He then helped persuade the U.S. to expand the bailout three times and devised a plan to sell assets and repay the Treasury. Liddy has been separating units, including two non-U.S. life insurers and the property-casualty business, to prepare the operations for public offerings and avoid what he said was the taint of the AIG name.

“It is likely to take several years,” to turn around the insurer, Liddy said in the statement. “AIG should have a leadership team committed to a similar time horizon and prepared to carry the plan to completion.”

Liddy had been the CEO of Allstate Corp., the largest publicly traded U.S. home and auto insurer. He was appointed to AIG by then-Treasury Secretary Henry Paulson, who was CEO of Goldman Sachs Group Inc. when Liddy served on the board of the New York-based securities firm.

Goldman Sachs

AIG paid Goldman Sachs $12.9 billion after receiving U.S. bailout funds. The payments helped settle transactions including credit-default swaps backed by AIG. Goldman Sachs was the biggest recipient of AIG payments after the bailout, and lawmakers including Representative Elijah Cummings have said Liddy’s ownership of Goldman Sachs shares raised the appearance of a conflict of interest.

After AIG was rescued, banks that had bought credit-default swaps from the insurer got $22.4 billion in collateral and $27.1 billion in payments to retire the contracts, the insurer said in March. Congress demanded to know how U.S. bailout money was being spent and pressured AIG to name its counterparties. Goldman Sachs, Deutsche Bank AG and Societe Generale SA were among the largest recipients. The swaps protected the banks against losses on fixed-income holdings.

Losing Confidence

The latest bailout package includes an investment of as much as $70 billion, a $60 billion credit line and $52.5 billion to buy assets owned or backed by the insurer. The terms gave AIG more time to pay back loans because Liddy was unable to sell units as fast as initially planned.

AIG has disclosed deals to sell assets, including a U.S. auto insurer, an equipment guarantor and a Japanese tower, for about $5.6 billion since the September rescue.

Liddy came under fire from lawmakers in March and some called on him to quit because of AIG’s plan to give $165 million in retention pay to employees of the Financial Products unit, whose credit-default swap derivatives helped push the firm to the brink of bankruptcy. The bonus plan was created before Liddy became CEO, and he persuaded some recipients to return part of the awards.

Congressional Criticism

The chief’s job paid only a dollar a year to Liddy, who came out of retirement to salvage the insurer. “My only stake is my reputation,” he wrote to Treasury Secretary Timothy Geithner in March.

Liddy “continued to lose the confidence of the U.S. Congress and of the American people,” Cummings said in an e- mailed statement. “It is critical that the new chairman and CEO of AIG be completely committed to transparency and accountability to ensure that the American people know what is happening with their money and when they will get it back.”

In today’s interview, Liddy called the AIG chief’s post “the most intellectually stimulating job” in the U.S. and said he expects to end his tenure with an “enhanced reputation.”

Geithner praised Liddy for his work.

“Mr. Liddy took one of the most challenging jobs in the American financial system,” Geithner said in a statement released today in Washington. “He shouldered this burden out of a strong sense of duty and patriotism.”

New Directors

The job of finding a successor will fall on the new board of directors. AIG today nominated a slate of 11 board candidates that includes a majority selected by its outside overseers. The proposed board includes five new candidates chosen by the trustees managing the federal stake, plus Liddy.

Directors Virginia Rometty, Michael Sutton and Edmund Tse had previously told AIG they wouldn’t stand for re-election at this year’s annual meeting, scheduled for June 30. Tse, described by AIG as the “architect” of the firm’s global life insurance operations, has been with AIG for about 48 years.

The new candidates are Harvey Golub, Laurette Koellner, Christopher Lynch, Arthur Martinez, Steve Miller and Douglas Steenland. The trustees told Congress May 13 that they’d selected five executives to join the board and AIG would pick one. The names of all the new candidates except Koellner were reported that day.

Liddy had shaken up management at the insurer, appointing a new chief financial officer, investment chief, restructuring head and leader of non-U.S. life insurance.

To contact the reporters on this story: Hugh Son in New York at hson1@bloomberg.net; Erik Holm in New York at eholm2@bloomberg.net; Andrew Frye in New York at afrye@bloomberg.net"

OUR PLAN IS EXPLICITY DESIGNED TO AVOID HAVING TO DIVEST AIG ASSETS AT FIRE-SALE PRICES

TO BE NOTED: Via Zero Hedge:

"1
TESTIMONY BY MR. EDWARD M. LIDDY,
CHAIRMAN AND CHIEF EXECUTIVE OFFICER,
AMERICAN INTERNATIONAL GROUP
BEFORE THE U.S. HOUSE OF REPRESENTATIVES COMMITTEE
ON OVERSIGHT AND GOVERNMENT REFORM
WEDNESDAY, MAY 13, 2009
MR. CHAIRMAN, RANKING MEMBER ISSA, MEMBERS OF THE COMMITTEE,
THANK YOU FOR THE INVITATION TO APPEAR BEFORE YOU TODAY.
I APPRECIATE THE OPPORTUNITY TO DESCRIBE FOR THE COMMITTEE THE
BUSINESS PLAN WE ARE EXECUTING IN ORDER TO PUT AIG’S TROUBLES
BEHIND IT, REPAY THE MONIES THAT WE OWE THE AMERICAN TAXPAYER,
AND SECURE AN OUTCOME THAT HELPS TO PUT THE AMERICAN
ECONOMY BACK ON TRACK.
AS YOU KNOW, I WAS ASKED LAST SEPTEMBER TO OVERSEE A
RESTRUCTURING OF AIG FOLLOWING THE GOVERNMENT’S DECISION TO
RESCUE THE COMPANY.
2
WE ARE WORKING HARD TO DETERMINE THE DESTINY OF THE
COMPONENT PARTS OF AIG. OUR PLAN CONTEMPLATES THAT AIG’S BEST
BUSINESSES WILL ESTABLISH SEPARATE IDENTITIES FROM THE PARENT
HOLDING COMPANY. THE PARENT COMPANY WILL BECOME SMALLER.
THE FINANCIAL PRODUCTS UNIT WILL NOT EXIST. THE MAJOR
INSURANCE COMPANIES WILL EMERGE WITH DIVERSE PRODUCTS,
STRONG MANAGEMENT, AND CLEAR GROWTH STRATEGIES WORTHY OF
INVESTOR CONFIDENCE.
HOW LONG THE PLAN WILL ULTIMATELY TAKE WILL VERY MUCH DEPEND
ON HOW QUICKLY AND HOW STRONGLY THE GLOBAL ECONOMY
RECOVERS. AND, BECAUSE WE ARE ALL COMMITTED TO ENSURING THAT
THE MISTAKES OF THE PAST ARE NOT REPEATED, WE MUST TAKE THE
TIME AND EXERCISE THE DILIGENCE TO DO THIS RESTRUCTURING
PROPERLY.
LET ME BE CLEAR – OUR PLAN IS EXPLICITY DESIGNED TO AVOID HAVING
TO DIVEST AIG ASSETS AT FIRE-SALE PRICES. IN FACT, JUST THE
OPPOSITE IS TRUE. WE INTEND FOR TAXPAYERS TO REALIZE THE FULLEST
POSSIBLE VALUE FROM EVERY ASSET DISPOSITION. AND WE INTEND THAT
EVERY COMPANY THAT EMERGES AT THE END OF THE RESTRUCTURING
WILL BE STRONG, TRANSPARENT, AND A CREDIT TO ALL OF ITS OWNERS.
3
WE HAVE ALREADY MADE SUBSTANTIAL PROGRESS IN THIS
RESTRUCTURING EFFORT, PRINCIPALLY IN FOUR KEY AREAS:
1. WE HAVE REDUCED, BUT NOT YET ELIMINATED, THE SYSTEMIC
RISK THAT AIG PRESENTS TO THE GLOBAL FINANCIAL SYSTEM;
2. WE ARE SELLING ASSETS AND BUSINESSES, DESPITE ADVERSE
CONDITIONS IN GLOBAL FINANCIAL MARKETS;
3. WE ARE STABILIZING AIG’S LIQUIDITY SO THAT WE DO NOT NEED
SUPPORT BEYOND THOSE AMOUNTS THAT THE GOVERNMENT HAS
ALREADY AUTHORIZED, ALTHOUGH AS I HAVE SAID BEFORE THE
STATE OF THE ECONOMY WILL BE A FACTOR; AND
4. WE ARE RESTRUCTURING SOME BUSINESSES FOR PUBLIC
OFFERINGS, FOR LATER DISPOSITION, OR TO BE WOUND DOWN SO
THAT FUTURE LOSSES CAN BE MITIGATED OR AVOIDED.
ACROSS THESE FOUR AREAS, WE HAVE, IN RECENT WEEKS, ACHIEVED A
NUMBER OF IMPORTANT MILESTONES, WHICH UNDERSCORE THE
PROGRESS WE ARE MAKING.
IN PARTICULAR, WE ARE TRANSFERRING TWO MAJOR FOREIGN LIFE
INSURANCE COMPANIES – ALICO AND AIA – INTO SPECIAL PURPOSE
VEHICLES IN EXCHANGE FOR A SUBSTANTIAL REDUCTION IN AIG’S DEBT
TO THE FEDERAL RESERVE BANK OF NEW YORK. WE EXPECT TO
4
COMPLETE THE CONTRACTUAL ARRANGEMENTS FOR THESE TRANSFERS
IN THE NEAR FUTURE.
WE ARE ALSO TRANSFERRING THE GLOBAL PROPERTY & CASUALTY
INSURANCE FRANCHISE, AIU HOLDINGS, INTO AN SPV. THIS MOVE WILL
SECURE THE VALUE OF THAT VERY SUBSTANTIAL BUSINESS IN
PREPARATION FOR THE POTENTIAL SALE OF A MINORITY STAKE, WHICH
ULTIMATELY MAY INCLUDE A PUBLIC OFFERING OF SHARES DEPENDING
ON MARKET CONDITIONS.
AND WE CONTINUE TO MAKE SIGNIFICANT PROGRESS IN WINDING DOWN
THE COMPLEX DERIVATIVES PORTFOLIO AT AIG FINANCIAL PRODUCTS.
WE HAVE REDUCED THE FINANCIAL PRODUCTS RISK POSITIONS FROM
44,000 TO 27,000, AND HAVE REDUCED THE NOTIONAL EXPOSURE FROM A
PEAK OF APPROXIMATELY $2.7 TRILLION TO APPROXIMATELY $1.5
TRILLION TODAY.
WE CONTINUE TO EXPLORE MULTIPLE OPTIONS TO BREAK APART THESE
TRADING BOOKS SO THAT WE CAN REDUCE THE REMAINING RISKS, SELL
OFF PORTIONS OF THE BUSINESS, REPAY OR OTHERWISE RETIRE THE
AIGFP DEBT, AND EXIT THIS SEGMENT OF THE FINANCIAL PRODUCTS
BUSINESS.
5
WE CONTINUE TO WEIGH EVERY DECISION REGARDING THIS
RESTRUCTURING WITH SEVERAL CRITERIA IN MIND: WILL THIS ACTION
FACILITATE A REDUCTION IN SYSTEMIC RISK? IS THIS ACTION THE BEST
USE OF THE FEDERAL ASSISTANCE WE ARE RECEIVING? WILL THIS
ACTION ENHANCE OUR ABILITY TO PAY BACK THE GOVERNMENT? THE
RESTRUCTURING EFFORTS I HAVE DESCRIBED ARE A REFLECTION OF THIS
THOUGHT PROCESS.
SO, TOO, ARE THE GOVERNANCE IMPROVEMENTS WE ARE WORKING TO
BRING TO THE COMPANY. AIG IS AN INCREDIBLY COMPLEX ENTITY. IT
HAS A GLOBAL FOOTPRINT AND AN INTRICATE CAPITAL STRUCTURE
CHARACTERIZED BY OVER 4,000 LEGAL ENTITIES, CROSS-OWNERSHIP,
AND MYRIAD SPECIAL PURPOSE STRUCTURES( NB DON ). OUR RESTRUCTURING
PLAN MUST MAKE AIG LESS COMPLICATED. WE ARE WORKING EVERY
DAY TO STREAMLINE THE ORGANIZATION AND CREATE EFFICIENCIES
THAT WILL ENHANCE OUR CORE BUSINESSES AND IMPROVE
TRANSPARENCY.
THE INFUSION OF SUBSTANTIAL U.S. GOVERNMENT CAPITAL TO AIG
BROUGHT WITH IT A SUBSTANTIAL NEW SET OF RELATIONSHIPS FOR THE
COMPANY: FIRST AND FOREMOST, WITH THE AMERICAN TAXPAYER AS
AIG’S LARGEST SINGLE SHAREHOLDER; WITH THE TAXPAYERS’
REPRESENTATIVES HERE IN CONGRESS; WITH THE FEDERAL RESERVE
6
AND U.S. TREASURY AS OUR PRIMARY DAY-TO-DAY PARTNERS IN
GOVERNMENT; AND MORE RECENTLY, WITH THE TRUSTEES ALSO
APPEARING TODAY.
GIVEN AIG’S UNIQUE SITUATION, THESE RELATIONSHIPS ARE NOT ONLY
NEW, THEY ARE IN MANY WAYS UNPRECEDENTED. WE WORK CLOSELY,
FOR EXAMPLE, WITH THE FEDERAL RESERVE BANK OF NEW YORK AND
THE U.S. TREASURY. REPRESENTATIVES OF THE FED AND TREASURY,
AND THEIR ADVISERS, ARE ENGAGED WITH VARIOUS AIG OFFICES EVERY
DAY. WE VIEW THEM AS OUR PARTNERS.
YET, AS WE FORGE THIS PARTNERSHIP, THE PARTNERS KEEP TO THEIR
RESPECTIVE ROLES: THE FED, LIKE ANY RESPONSIBLE CREDITOR,
MONITORING CAREFULLY AND ADVISING UPON OUR STRATEGIC
APPROACH. AND AIG’S EXECUTIVE LEADERSHIP DEVISING AND
EXECUTING OUR STRATEGIC PLAN AND MANAGING THE COMPANY IN
CLOSE CONSULTATION WITH THE BOARD OF DIRECTORS.
WE ALSO CONSULT VERY CLOSELY WITH THE TRUSTEES – AND WE
APPRECIATE THE TIME THEY HAVE DEVOTED TO IMMERSING
THEMSELVES IN THE INTRICATE DETAILS OF OUR RESTRUCTURING PLAN
AND OTHER CRITICAL ISSUES. THEIR MATURE BUSINESS JUDGMENT IS AN
ASSET TO THIS SITUATION.
7
I HAVE LED AIG FOR EIGHT MONTHS NOW. AND I WANT TO ASSURE YOU
THAT THE PEOPLE AT AIG TODAY ARE WORKING AS HARD AS WE CAN TO
CONTINUE TO SERVE OUR POLICYHOLDERS AND CUSTOMERS, AND TO
SOLVE AN EXTREMELY COMPLEX SET OF PROBLEMS FOR THE BENEFIT OF
AMERICA’S TAXPAYERS.
WE NEED YOUR HELP AS WELL TO ACHIEVE THE RESTRUCTURING OF AIG
SUCCESSFULLY. IT IS CRITICAL THAT WE NOT LOSE SIGHT OF THE FACT
THAT WE ARE PARTNERS. WHEN THE EMPLOYEES OF AIG MAKE
MISTAKES, WE EXPECT TO BE CRITICIZED. BUT RAMPANT,
UNWARRANTED CRITICISM OF AIG SERVES ONLY TO DIMINISH THE VALUE
OF OUR BUSINESSES AROUND THE WORLD – TO THE DETRIMENT OF OUR
SHAREHOLDERS, INCLUDING TAXPAYERS, WHO OWN SOME 80% OF AIG.
WE RECOGNIZE OUR RESPONSIBILITY TO WORK HAND IN HAND WITH THE
GOVERNMENT TO PRESERVE THAT VALUE, AND I ASSURE YOU THAT IS
OUR GOAL. WE CONTINUE TO WELCOME A FRANK AND OPEN DIALOGUE
WITH CONGRESS ON OUR PROGRESS IN RESTRUCTURING, SO THAT YOU
CAN BE IN A POSITION TO SUPPORT OUR EFFORTS. THIS SUPPORT IS
ESSENTIAL AND WILL HELP US TO PRESERVE THE VALUE OF AIG
FRANCHISES FOR THE BENEFIT OF AIG’S STAKEHOLDERS – THE AMERICAN
TAXPAYER MOST OF ALL.
8
WE CANNOT CONTROL THE MARKET CONDITIONS THAT WILL PARTLY
DETERMINE THE TIMING OF AIG’S RESTRUCTURING. BUT WE ARE
CONFIDENT THAT OUR APPROACH IS RIGHT, AND THAT IF WE DO THIS
TOGETHER WE CAN DEMONSTRATE TO THE WORLD THAT RESPONSIBLE
GOVERNMENT AND CAPITALISM ARE STILL THRIVING IN THE UNITED
STATES.
WITH THAT, MR. CHAIRMAN, I THANK YOU AGAIN FOR THE OPPORTUNITY
TO APPEAR BEFORE YOU TODAY AND AM HAPPY TO ANSWER ANY
QUESTIONS YOU AND THE COMMITTEE MAY HAVE."

criticism of AIG serves only to diminish the value of our businesses around the world to the detriment of our shareholders, including taxpayers

TO BE NOTED:

May 12, 2009, 6:59 p.m. EST

AIG's Liddy: Insurer has cut its systemic impact to markets

Insurer has reduced, but not eliminated, its risk to global markets by selling assets

By Ronald D. Orol, MarketWatch

WASHINGTON (MarketWatch) -- American International Group Inc. Chief Executive Edward Liddy on Wednesday plans to defend the embattled insurer by describing steps it has taken to reduce its size and risk to the global financial system.

"The parent company will become smaller. The financial products unit will not exist. We have reduced, but not eliminated the systemic risk that AIG presents to the global financial system," Liddy said in testimony that he plans to deliver to a House Oversight and Government Reform Committee hearing on Wednesday focusing on the collapse and federal bailout of the mega-insurance company.

AIG (AIG 1.81, -0.09, -4.74%) has received over $180 billion in taxpayer-funded bailout dollars to keep it afloat, in part, because of concern by Treasury officials that the super-sized insurance corporation's collapse would have caused too much collateral damage to the financial markets. In exchange, the administration has received an 80% stake in the company.

AIG also has also come under criticism for paying out $163 billion in bonuses to traders of credit default swaps, considered central to the financial crisis.

Liddy, who took over as CEO of the company in September, argued that criticism the company received, in part, for granting the bonuses hurts the business and billions of taxpayer dollars invested in the company.

"Rampant, unwarranted criticism of AIG serves only to diminish the value of our businesses around the world to the detriment of our shareholders, including taxpayers, who own some 80% of AIG," Liddy said.

In testimony, Liddy said he expects AIG will complete its transfer of two key divisions, American Life Insurance Company, or Alico, and American International Assurance Co., or AIA, into a special purpose entity "in the near future." As part of a deal with bank regulators, AIG is moving the two units into this division in exchange for a substantial debt reduction.

AIG is also transferring its Global Property & Casualty Insurance unit into a special purpose entity to prepare for the potential sale of a minority stake in the business.

He pointed out that AIG has also reduced its exposure to "complex derivatives" from its peak of $2.7 trillion to $1.5 trillion. "We continue to explore multiple options to break apart these trading books so that we can reduce the remaining risks, sell off portions of the business..." Liddy said in the testimony.

Trustees seek new AIG directors

Liddy pointed out that the company works closely with trustees appointed by the New York Federal Reserve Bank. The three trustees are also expected to testify about their oversight of AIG at the hearing on Wednesday. According to a letter to Liddy on May 7, the Trustees are seeking to have a broad review of the insurer's compensation practices with a focus on "performance-based compensation philosophy," by the end of the year.

The three trustees are also planning to seek new AIG board members and will make a decision shortly, according to testimony prepared for delivery on Wednesday. "We are actively seeking new members of the board who could add important skills and perspectives," the Trustees said in testimony.

The Fed appointed Jill Considine, a member of the Council on Foreign Relations and the Economics Club of New York, Chester Feldberg, former chairman of Barclays Americas, and Douglas Foshee, owner of El Paso Corp., a natural gas pipeline system, to oversee the insurer.

The New York Fed said it set up the trust agreement to avoid conflicts with the New York Fed's supervisory and monetary policy functions."

what hope does that offer for the value of the rest of AIG?

TO BE NOTED: From The Aleph Blog:

"What to ask AIG May 12th, 2009

The Committee on Oversight and Government Reform has asked Ed Liddy and the AIG trustees to testify Wednesday. Here are the questions that I would ask, given my recent piece on AIG.

• Are you going to be able to use all of your deferred tax assets? What level of sustained profitability does that imply, and how are you going to get there?
• Are you going to destack your Life and P&C subsidiaries to avoid double counting of subsidiary capital on a statutory basis?
• If relatively clean and simple subsidiaries like Hartford Steam Boiler and 21^st Century got sold for bargain prices near where AIG bought them, and below book value, what hope does that offer for the value of the rest of AIG?
• You’ve lost a lot of money recently. What do you project to be your level of annual sustainable profitability to be over the next three years?
• There are rumors that AIG is slashing pricing to stay alive in the short run on a cash flow basis. Many competitors are alleging this. Is this true?
• What have happened to your efforts to sell AIA and your asset management arm?
• What has happened to your efforts to sell International Lease Finance?
• How is United Guaranty going to survive amid mounting residential mortgage losses?
• As you wind down AIG Financial Products are you finding “deadweight losses” where the subsidiary was fundamentally mishedged?
• How are you dealing with defections of key personnel, and bad employee morale?
• How are you dealing with increased surrender activity in your domestic life subsidiaries? Will you need more capital as a result?
• Are you going to try to sell Alico?
• Are you going to try to sell AIU?
• What are the core businesses that you are going to keep, and why are they worth keeping?
• How will AIG repay the US Government in full?
• How have you reduced risk in your asset portfolio?

That’s all, and I hope Mr. Liddy, who I have met and I think he is a bright guy, will do well. He is a bit of a bagholder in the AIG mess."

since the AIG name is so tarnished that customers might balk at it

TO BE NOTED: From Business Week:

Liddy on AIG's Long Road Ahead
In an exclusive interview with BusinessWeek, CEO Edward Liddy says he expects AIG's turnaround to take years, but adds, "This is not a life job for me"

By Joseph Weber

Edward M. Liddy, the would-be rescuer of American International Group (AIG) who has become a target of wrath over Wall Street excesses and the ravages of the recession, knows all too well what is driving that anger. "There's fear in America," says Liddy, who came out of retirement last September to run AIG for the government for $1 a year. "People are very concerned about their jobs, their homes, their pensions."

And Liddy, who is no fan of the multimillion-dollar bonuses agreed to by his predecessors at AIG even while he tolerates them, knows very personally what such fear and want mean. Liddy, who earned more than $130 million over eight years leading Allstate (ALL) until 2007, grew up so poor that he, his mother, and sister were thrown out of their homes at times after his father died when he was 12. There were days, he says, when food was short in his native New Brunswick, N.J. "We'd have dinner for three and food for two and my mother would say, 'I don't feel well right now. You two go ahead,' recalls Liddy, now 63. "You can believe I know the angst of the American taxpayer and what's happening in economically uncertain times."

But rage and fear, he says, should not blind people to the best way out of the AIG mess. In an exclusive interview with BusinessWeek, the reluctant AIG chief says he and others at the company want only to pay off the $80 billion that the government has poured into the company so far and help it make money on another $50 billion in investments the government has made in AIG-related operations.

A Very Difficult Case to Make

The approaches AIG management is taking, even if they seem to only ramp up the furor, should do just that over time, he says. And Liddy says they should also leave surviving companies that will be able to keep many of AIG's 116,000 global workers employed and its policyholders protected.

Making that case has been enormously difficult for Liddy, a tough-minded executive whose professional climb has been a modern Horatio Alger tale. He worked his way through Catholic University and launched his career at Ford (F) after collecting an MBA at George Washington University. He worked at pharmaceutical company G.D. Searle & Co. and later helped take Allstate out from under Sears, Roebuck and Co. He then led Allstate.

Liddy's tenure at AIG, since taking the helm at the request of former Treasury Secretary Hank Paulson, has been marked by public relations disasters that he didn't create. Only a few days after the federal government launched the bailout of AIG last September, top executives—not including Liddy—wined and dined independent agents at a posh California resort for a week, costing some $443,000. In more recent days, of course, disclosures about some $165 million in retention bonuses have drawn the ire of no less than President Barack Obama.

Liddy himself was skewered over the bonuses this week in a daylong hearing in which he was grilled by a couple dozen congresspeople. One, reflecting the public outcry, says AIG nowadays stands for "arrogance, incompetence, and greed." Says the chronically understated Liddy, "It was a very uncomfortable experience."

Would've Handled Bonuses Differently

Many critics have said the brouhaha over bonuses and marketing meetings also reflects populist rage against Wall Street, anger at how the pinstriped set seems to be making out lavishly at public expense in a game that's rigged against the public. But, as Liddy sees it, it also reflects the huge cultural gap between doing business in the private sector and doing it publicly and in ways answerable to politicians and bureaucrats.

Take the marketing meetings. Such meetings, he says, are the way business is done in the insurance world. Companies such as AIG want independent agents to pitch their policies and other products instead of those of rivals, and bringing those agents to resorts to both school them in the products and reward them for selling them is just ordinary business practice. "Do you hold them in nice places? Yes, because you want people to come," he says. While they are there, he adds, the agents get hefty doses of education in so-called suitability, so they don't wind up selling risky long-term products—say variable annuities—to 85-year-old widows.

As for the bonuses, Liddy would have handled them differently. He says he would have offered less generous payments, made them contingent on performance, and included a "clawback" provision to take the money back if people left. But he says he inherited the contracts for the bonuses from his predecessors who arranged them as long ago as late 2007 and early 2008. He says he feels bound to honor the contracts, arguing that in insurance, in particular, a company is only as good as its ability to keep its promises.

Can Ill Afford Key Staffers Leaving

He adds that the staffers who have collected the bonuses—more properly called retention payments—are needed, too, to wind down some $1.6 trillion worth of complex derivatives contracts so the company can exit that business without facing multimillion-dollar losses.

This, too, reflects the gap between Wall Street and Main Street, he suggests. On Wall Street, multimillion-dollar bonuses are the way people get paid, as they handle business that can cost a company far more if a trade is mismanaged. The people handling the derivatives contracts—whom he pointedly says are not the ones who got the company in trouble over them last fall, since those folks have been canned—have so far managed that business down from $2.7 trillion at the end of December.

"Those people don't want to work for free," he says. They must be paid well, he says, to stay on—especially since they are managing themselves out of work, in effect. The amount of money AIG can lose if they walk or people unfamiliar with the business take over is just too great, he argues. "You can lose 10 times the $165 million in a day on a bad trade, and that's just not a good risk in our judgment," he says.

AIA and Alico to the Fed?

Liddy's game plan to restructure AIG also has run into disastrously bad timing. He has refused to sell a well-regarded Asian subsidiary, AIA, for lowball offers( NB DON ). Though some critics argue that the attempt to sell the unit came too late and involved giving far too little information to prospective buyers, he insists there was plenty of detail and ample time. He himself tried to pitch it to Chinese investors, though they were scared off by the market meltdown in the U.S. The problem, he says, is that would-be buyers—big insurance companies, mainly—have seen a huge slide in their stocks, so they don't have the up to $25 billion to do a deal for the company.

Liddy is now planning to put AIA and another big subsidiary, Alico, into a trust and turn that over to the Federal Reserve. The move would take the units off AIG's balance sheet—though AIG would continue to run the companies—and reduce or eliminate AIG's debt to the Fed. Eventually, he says, the Fed could sell the trust or spin off the companies in a public offering. As for the rest of AIG, he expects to change the names of its many insurance companies and perhaps the parent, since the AIG name is so tarnished that customers might balk at it.( NB DON )

Liddy expects that the turnaround of AIG will take several years. Given what he has had to endure, he says he may not be around in the top job to finish the task. But he insists he will stay, despite all the grief and occasional threats he gets, until he positions the company on the road to recovery. "This is not a life job for me," he says, adding he'd much rather be promoting Chicago for the Olympics, helping hospitals back in the Chicago area, and enjoying his family. "I want to get it moving in the right direction."

The CEO took the position because former Treasury Secretary Paulson, a longtime friend, asked him to. He says he felt a need to give back to the country, since it has taken him from rags to riches. Pulling AIG out of trouble would be something good, he insists, for the nation. "The country needs a victory," he says.

Joseph Weber is BusinessWeek's chief of correspondents, based in Chicago."

Almost six months later, we still don’t know the extent of the damage.

From The Baseline Scenario:

"AIG in Review

with 13 comments

Well, it’s done. AIG is getting another bailout.

I have to admit I don’t fully understand the ongoing AIG bailout saga, so I thought I would do a little research to try to figure out what is going on. I thought I would just look up all the term sheets, but I found it’s harder to get that kind of information from the Federal Reserve web site than from the Treasury web site. For example, the original September 16 press release doesn’t say what the terms of the 79.9% equity interest are, and I still haven’t been able to figure that out. If you know the details, let me know and I’ll update this post. In any case, I think this is the best single-page overview you’ll find on the web.

September 16: The Federal Reserve gave AIG an $85 billion line of credit for 2 years at a very high interest rate - 3-month LIBOR (an interbank lending rate, which is generally pretty low) plus 8.5 percentage points on the full amount (whether or not it was drawn down). In exchange, the government (not sure which entity) got warrants on 79.9% of AIG stock - I don’t know what the price was, or if they were ever exercised.

October 8: By early October, AIG had already drawn down over $60 billion of its credit line. The Federal Reserve authorized the New York Fed to “borrow” up to $37.8 billion in illiquid securities from AIG and give it “cash collateral” (I think that means “cash”) in return. The problem was that AIG had lent some securities (call them A) to counterparties in exchange for cash or other collateral (call that B), and had then used B to buy some other securities (C) that had lost value. So when the counterparty wanted to return A and get B back, AIG couldn’t give them B back, because the money was tied up in C. So the New York Fed agreed to take C and give AIG cash so AIG could close out its trade - meaning the Fed effectively got stuck with the risk.

November 10: This time the Fed and Treasury got together.

• Treasury invested $40 billion of TARP money in AIG for preferred stock paying a 10% dividend. Treasury also got warrants with an exercise price of $2.50 on 2% of AIG’s outstanding common stock (although I don’t know how this relates to the original warrants on 79.9% of the common stock.)
• Some of that $40 billion was used to pay back the line of credit, which was reduced from $85 billion to $60 billion. The interest rate was reduced from LIBOR + 8.5 percentage points to LIBOR + 3 percentage points (a huge reduction), and the term was extended from 2 years to 5 years.
• The New York Fed created a new entity called AIG RMBS LLC with $1 billion from AIG and a $19.8 billion loan from the Fed. That $20.8 billion was used to buy residential mortgage-backed securities from AIG. Those securities had a face value of $40 billion but a “fair value” of $20.8 billion, or 52 cents on the dollar. (I wonder what those RMBS were on the books at prior to the sale.) The purpose here was simply to relieve AIG of some toxic assets and minimize its losses on them. Interest on those securities and proceeds from sale will pay back the loan to the Fed, meaning that AIG will take the first $1 billion in losses and the Fed anything else. The $20.8 billion paid to AIG (to buy the securities) was paid back to the New York Fed to retire the lending/borrowing facility created on October 8.
• The New York Fed created another entity called AIG CDO LLC with $5 billion from AIG and a loan of up to $30 billion from the Fed. The purpose of this entity was to buy CDOs from third parties who had purchased “insurance” (credit default swaps) from AIG. Since AIG’s biggest exposure was the possibility of having to pay out on this insurance, the idea was to buy up the assets (CDOs, in this case) that had been insured and require the third party to close the CDS contract. (Imagine AIG had underpriced insurance for houses on the Gulf Coast, and the government was buying the houses in order to cancel the insurance contracts.) According to the Fed web site, it looks like this entity has spent $20.1 billion to buy up CDOs with an aggregate face value of $53.5 billion - 38 cents on the dollar - but I’m not certain I’m reading that correctly. If those CDOs lose value, AIG bears the first $5 billion in losses, and the Fed bears the rest.

So as of November AIG had a $40 billion preferred stock injection and a $60 billion credit line. AIG had also put $6 billion into two new entities which could borrow up to $50 billion from the Fed and use the total funds to buy toxic assets: some from AIG (and I have no idea if we overpaid for those or not) and some from third parties.

March 2 (updated 3/2 7:30 am): The announcements are out.

• The $40 billion in preferred shares that Treasury got in November are being exchanged for $40 billion in preferred shares that are on better terms for AIG. There’s no way to get around this point. It’s the Series D to Series E conversion on the term sheet. The new preferred shares pay a “non-cumulative” dividend, which means they basically pay no dividend. More specifically, they only pay a dividend if AIG decides to pay the dividend. And they are non-cumulative, meaning that if AIG skips a dividend payment, they never have to pay it. (With a cumulative dividend, if you skip one payment, it gets added onto the next one.) The only condition is that if AIG skips the dividend for eight quarters in a row, Treasury can appoint some members of the board of directors.
• In addition, Treasury is providing up to $30 billion more in cash in exchange for more preferred shares on yet different terms. That’s the Series F on the term sheet. I don’t see anything about dividends, so this is basically an interest-free five-year loan.
• The terms on the credit line will be improved by reducing the floor on the interest rate (previously 6.5%). In addition, the credit line will be reduced by up to $34.5 billion, according to the two following provisions.
• Two life insurance subsidiaries will be put into separate trusts. After AIG and the New York Fed agree on the valuations of those subsidiaries, the Fed will buy up to $26 billion in preferred stock in these trusts. That money will be used to pay down the credit line.
• AIG will create new entities that own the rights to the cash flows from certain blocks of life insurance policies. The New York Fed will loan these entities $8.5 billion, which AIG will turn around and use to pay down the credit line. The $8.5 billion will be paid back (or not) by the new entities from the life insurance cash flows. (In other words, AIG is securitizing the life insurance policies and the Fed is buying the securities for $8.5 billion.)
• AIG is issuing convertible preferred stock equivalent to a 77.9% ownership share to Treasury. This looks like Treasury is exercising the rights it got under the original loan agreement. The terms of the convertible preferred stock were not released as far as I can tell, but we can probably assume there are no dividends.

In summary: AIG gets better terms on the first $40 billion in preferred stock; AIG gets $30 billion more in cash in exchange for new preferred stock on even better terms; and the credit line gets reduced by giving Treasury some assets (that AIG was presumably unable to sell on the open market). The overall effect is to reduce AIG’s debt burden and shift more risk to the taxpayer. Whether the taxpayer got a good price for taking on that risk is far too complicated for anyone to figure out from just reading a term sheet, since it depends on the nature of the assets.

I know that AIG is different in many respects from the banks that everyone is worried about. In particular, AIG was a net seller of CDS protection, while most banks are (should have been?) net buyers of protection. But one thing still scares me. When the weekend of September 13-14 began, AIG said it needed $40 billion. After digging through the books, Goldman and JPMorgan put the price tag at $75 billion, and declined to put together a consortium to lend the money. The Fed lent $85 billion, thinking that would be enough. Almost six months later, we still don’t know the extent of the damage.

Update: I rewrote the March 2 section.

Update 2: Does anyone else find it strange that, less than one week after announcing that future capital will be given to banks in the form of convertible preferred shares with a 10% dividend, Treasury has already issued preferred stock on three different sets of terms (one to Citigroup and two to AIG), none of which are consistent with last week’s announcement? Also, with the AIG Series E and F, we have reached a new high (or low) of generosity, with a noncumulative dividend in one case and no dividend in the other. Of course, this is a company we already “own” - we control most of the equity, and we have implicitly guaranteed the debt - so maybe none of these terms really matter.

Written by James Kwak

March 1, 2009 at 11:11 pm"

Me:

From Nov. 10th:

http://www.ft.com/cms/s/0/86c1cf26-aefc-11dd-a4bf-000077b07658.html?nclick_check=1

“The Federal Reserve and the US Treasury now understand they are dealing with systemic risk rather than one company’s problems,” said Mr Liddy, a former chief executive of the insurer Allstate and board director of Goldman Sachs.

In an effort to defuse a possible political backlash over the use of yet more taxpayers’ funds to save a stricken financial institution, Mr Liddy said the government could make money out of the latest deal( NB Don ).

He pointed to the 10 per cent interest payable by AIG on the $40bn-worth of preferred shares to be acquired by the government as well as the interest on a $60bn loan from the authorities, which is set at 3 per cent over the London interbank borrowing rate.

Mr Liddy also said that most of the gains from a rise in the value of AIG’s toxic assets over the next few years would be retained by the Fed, not the company. A special vehicle is being set up to take over the billions of dollars in illiquid credit default swaps and mortgage-backed assets owned by AIG.

“The taxpayer is going to do very well out of this deal,” Mr Liddy said. ( NB Don )

The debt securities which triggered AIG‘s collapse continued to plague the company in the third quarter. Included in its net loss was a pre-tax charge of around $7bn related to AIG Financial Products’ credit default swap portfolio, as well as a pre-tax impairment charge of $18.3bn from the group’s investment portfolio.

Mr Liddy said that in the frantic moments that preceded the first rescue of AIG, regulators had not paid enough attention to the cash drain on the company’s resources caused by the toxic assets.

Since the Fed did not regulate insurers, it had initially overlooked the pitfalls of the previous bail-out, he added.

Despite receiving an $85bn government loan in mid-September, AIG was in danger of running out of money due to the high interest rate charged by the government and the need to put up capital as its assets continued to depreciate. ( NB Don )

Mr Liddy said that with the new plan, the authorities wanted to avoid a repeat of the credit markets paralysis that followed the collapse of investment bank Lehman Brothers, which went bankrupt just before the first rescue of AIG.

“The collapse of Lehman caused the credit markets to freeze up. Had AIG gone, it would have been even more significant,” Mr Liddy said.

Mr Liddy pledged to press on with a wide-ranging programme of asset sales aimed at raising funds to repay the $100bn in capital injected by the government. (NB Don )

He said the extension of the duration of the main government loan from two to five years and the cutting of the loan’s value from $85bn to $60bn would ensure AIG did not have to dispose of businesses at fire-sale prices.( NB Don )

“We have more capital so we don’t have to sell good assets in bad markets,” ( NB Don ) he said. AIG has not announced a single major disposal so far, partly because potential buyers have not been able to get funding.

Mr Liddy has said he wants to sell most of AIG’s life assurance operations, and close its troubled financial services unit, to create a smaller company focused on its general insurance business around the world.

However, he reiterated that he wanted to keep a majority interest in its Asian life assurance and savings business – one of the jewels in AIG’s crown.”

Asian businesses are like Banamex for Citi. It’s pretty clear that this plan is failing. However, I’ve yet to get a clear picture of why it’s failing. Theoretically, we’ve given AIG enough money to get through this downturn. It could be:
1) No one wants to buy anything from AIG
2) AIG is asking too much money for the assets
3) The assets are turning out to be worth less and less
4) AIG is still losing money on current investments

From Bloomberg:

http://www.bloomberg.com/apps/news?pid=20601103&sid=addciQsRKwjc&refer=us

“AIG’s ability to repay “every single penny” owed to taxpayers, as Liddy vowed in December, is doubted by investors who drove the company’s stock about 80 percent lower since he took over in September. AIG may post a fourth-quarter loss of about $60 billion next week, said the people, who declined to be identified because talks with the government are private.

“There isn’t a great deal of confidence we can take AIG’s word at face value,” said Bill Bergman, analyst at Morningstar Inc. “AIG shares trading this close to zero suggest there are real losses out there, and if there’s no value for shareholders, taxpayers may be taking some very significant losses.” AIG gained 10 cents to 56 cents in New York Stock Exchange composite trading at $10.47 a.m….”

And:

“Government help “allows unhealthy insurers to grab more market share in the short term at levels that are unsustainable in the long term,” said David Sampson, head of the Property Casualty Insurers Association of America, an industry group, in a statement this week.”

In other words, AIG is the problem. The brand is the problem.Buyers believe that the losses are real. They will not appreciate. If they are correct, this could be an enormous loss to the taxpayers. It never occurs to people that, if foreign investors or any other investors thought that AIG was sound, they could invest in it or buy the assets at their asking price. Either investors in AIG take the losses, or the US taxpayer will. Which will it be? What am I missing? A miracle?

Don the libertarian Democrat

2 Mar 09 at 11:35 am

Reply

``Perception trumping reality once more.'': A Philosphical Treatment By Richard Fuld

We just heard Liddy, now, from Bloomberg, let's listen to Fuld:

``Here we go again,'' Fuld erupted at one point, the person recalled. ``Perception trumping reality once more.''

It was vintage Fuld, a man so physically imposing, so volcanically explosive that, even at age 62, he scared underlings and competitors alike. He was raging on the captain's bridge, while a storm engulfed the company he had willed into becoming one of Wall Street's finest. Couldn't the short-sellers see how much he had done to shed bad assets? Couldn't they understand what a great franchise it still was?

Fuld was grounded enough in reality to know one thing: ``We've got to act fast,'' he said, ``so this financial tsunami doesn't wash us away.''

Fuld's an epistemologist. Who knew? Oh dear, weather words. It's bad.

"Then, on the morning of Sept. 14, after a series of weekend meetings at the New York Fed, a private deal to save the firm from bankruptcy was hatched. The government persuaded a syndicate of banks to backstop a new entity that would take over $55 billion to $60 billion of Lehman's troubled assets, and London-based Barclays Plc agreed to acquire the rest of the firm, according to people familiar with the negotiations.

When the U.K.'s Financial Services Authority refused to sign off on the Barclays purchase late that morning, U.S. officials refused to take any steps to save the deal. At about 2 a.m. on Monday, Sept. 15, Lehman filed the biggest bankruptcy in U.S. history."

Why?

"The Dow Jones Industrial Average fell 504 points on the day Lehman collapsed, triggering an increase in bank borrowing costs and a run on money-market funds and financial institutions around the world. By Tuesday, Paulson and Bernanke had reversed course, agreeing to an $85 billion bailout of foundering American International Group Inc., at the time the world's largest insurer. The government has since decided to make $250 billion of capital infusions to bolster major U.S. banks. Only Lehman has paid the ultimate price of the financial meltdown to date -- obliteration by bankruptcy."

Still, some claim it wasn't a mistake. Go figure.

"As cut off from information as Fuld may have been, it wasn't as if he didn't recognize the firm's problems. In November 2004, more than two years before the bull market reached its peak, Fuld was telling people around him that low interest rates and cheap credit would create a bubble that could one day pop.

``It's paving the road with cheap tar,'' he told colleagues in a meeting at the time. ``When the weather changes, the potholes that were there will be deeper and uglier.''

Weather again. Here's my point: An actual human agent saw the problem and did nothing.

"Fuld also warned against taking on too much risk, such as leveraged loans, which are used to finance buyouts of firms, as Lehman tried to compete with commercial banks that used their bigger balance sheets to support investment banking operations. ``We're vulnerable if we throw our balance sheet around,'' Fuld said, according to a person at the meeting. "

He's a kind of Cassandra apparently, not the head of a business.

"Lehman used its balance sheet to finance leveraged buyouts anyway. So did other Wall Street firms forced to compete with commercial banks, which were allowed to practice investment banking after the 1999 repeal of the Glass-Steagall Act.

Leveraged loans weren't Lehman's undoing, though. Fuld saw the dangers they posed and rid the firm of the riskiest ones in the fourth quarter of 2007, according to company filings.

What Fuld failed to do is take advantage of a rebound in the prices of fixed-income assets at the time to sell some of Lehman's $84 billion mortgage portfolio. He took false comfort in having hedged the firm's mortgage positions at the end of 2006. Because of the hedges, insiders say, Lehman executives were sanguine after the July 2007 implosion of two Bear Stearns hedge funds that had invested in subprime securities. Fuld even loaded up on mortgage-backed securities at the beginning of 2008, not seeing how vulnerable the firm would be when the subprime cancer metastasized to other asset classes."

I thought that he'd predicted a bubble?

"To Fuld, the idea was outrageous. The hit was a matter of wrong perceptions, not weak fundamentals. So he got on the phone with the firm's biggest clients to tell them Lehman was no Bear Stearns, and he ordered other executives to do the same."

Objects in the mirror are bigger than they appear.

"Why Fuld was unable to find a buyer for all or part of Lehman remains a matter of dispute. It was not for want of trying, although some people familiar with those efforts throughout the spring and summer say he was unwilling to accept the rapidly falling valuation of his firm.

``Dick was so proud of Lehman that he was slow to recognize that others didn't share that belief,'' said George L. Ball, chairman of Houston-based investment firm Sanders Morris Harris Group Inc. and a friend of Fuld's."

Sounds here like Fuld couldn't differentiate between perception and reality. It's Proustian, frankly. The problem you project onto others is actually your own.

"Even interested parties figured the price would keep coming down, as real estate valuations fell and Lehman got more desperate for cash. The Bear Stearns precedent, in which the government stepped in to facilitate a deal, also gave prospective buyers a reason to wait."

Absolute gold. I've been waiting for it. Waiting for government intervention. Got it!

"Meanwhile, worried that his lieutenants wouldn't be able to fetch a fair price from an investor, Fuld was pursuing another strategy. The plan his associates devised would offload Lehman's toxic commercial-mortgage portfolio to an independent company, codenamed Spinco. The new company's stock would be owned by Lehman shareholders, and its startup capital would be provided by the firm. While Lehman would have to raise fresh capital to replace what it transferred to Spinco, investors would be buying into an investment bank with a scrubbed balance sheet. "

I might work this into a novel.

"The cost of insuring Lehman's debt surged by almost 200 basis points after the KDB news, rising to 500, still not as high as where Bear Stearns's credit-default swaps were trading before its collapse. (A basis point equals one-hundredth of a percentage point.)

That caused Lehman's hedge fund clients to pull out, and short-term creditors cut lending lines. New York-based JPMorgan, Lehman's clearing agent for trades, demanded additional powers to seize cash and collateral in the firm's accounts."

It does appear that he's sitting on a weaker and weaker hand. Perhaps he playing a game none of us understand.

"The next day, Sept. 10, Fuld pre-announced quarterly results -- a $3.9 billion loss, after $5.6 billion of writedowns. He also said Lehman would auction off a majority stake in its asset-management division, and he revealed his Spinco plan. He was still talking defiantly.

``We have a long track record of pulling together when times are tough,'' Fuld said on a conference call with investors. ``We are on track to put these last two quarters behind us.''

Once again, Fuld was a step behind events. Before the day was out, Moody's Investors Service said it was reviewing Lehman's credit ratings and that it would downgrade the firm unless it made a deal with a strategic partner. Lehman's shares fell another 42 percent the next day to $4.22."

Perception and reality again. This article is making him sound like King Lear.

"As things were spinning out of control, Fuld turned to the federal regulators with whom he had been talking since the demise of Bear Stearns.

He had approached Timothy F. Geithner, 47, president of the Federal Reserve Bank of New York, in July to see whether Lehman might become a bank-holding company, which would allow it to widen its funding base."

Now he's an alchemist.

"Meanwhile, Paulson was putting out the word there would be no more federal bailouts, that the government couldn't rescue every failing investment bank. "

Note to Paulson. Moral hazard only works when you enforce it from the beginning. If you don't, then your actions seem fickle and arbitary.

"When asked why AIG was saved and Lehman wasn't, he leaned into a microphone, scowled and slowly replied: ``Until the day they put me in the ground, I will wonder.''

I told you we'd learn a lot if we'd just listen. Fuld was right, and is just saying what I said people would say once you've ignored moral hazard. Actions are as important as words.

"At that point, the only way to save the deal would have been for U.S. regulators to make the temporary debt guarantee. They didn't. Paulson, who told the New York Times he didn't have the authority to rescue Lehman, didn't answer questions about Sunday's events submitted by Bloomberg. Nor did Geithner. "

What's he going to say? I'm an ass. He's too rich to admit that to himself.

"Fuld thought Paulson was in his corner, he told a person familiar with events, even as the Treasury secretary publicly resisted spending taxpayer money to help Lehman. Fuld was stunned, the person says, when Paulson didn't throw him a lifeline at the end.

It was McDade who called Fuld from the Fed meeting on Sunday afternoon, not Paulson. Far from helping Lehman, Paulson, Geithner and other officials, including SEC Chairman Christopher Cox, began pressing Lehman to declare bankruptcy. McDade told them that would have serious repercussions for other firms. Wall Street executives gathered at the Fed said a bankruptcy wouldn't be the end of the world. Goldman Sachs and Morgan Stanley both had war rooms with charts detailing Lehman's subsidiaries and their exposure to each one, and they thought their potential losses would be limited.

No one, not even Lehman, knew what furies the firm's failure was about to unleash."

He misheard Paulson, who told him to go sit in the corner. Mythology talk. That's bad as well.

"The end came at about 2 a.m. Sept. 15, when Fuld, out of running room, filed for bankruptcy. That day the Standard & Poor's 500 Index had its biggest daily drop since the September 2001 terrorist attacks, and bank-lending rates soared. Paulson, who was poised to let AIG fail, quickly re-thought the wisdom of that decision and approved an $85 billion bailout. He and Bernanke also went to Congress to push for a $700 billion federal bailout to buy bad assets from troubled banks.

Only Lehman ended up in the wrong place at the wrong time.

Fuld was hard-pressed to explain his fate when he appeared in front of Waxman's committee on Oct. 6. To many of the congressmen's hostile questions and accusations, he had no answers. ``I wake up every single night,'' Fuld said, ``thinking, `What could I have done differently?'''

It might have ended differently had Fuld not risked so much on mortgage-backed securities. It might have ended differently had Fuld been willing to acknowledge Lehman's falling valuations. It might have ended differently if Fuld had made a deal in June, or July, or August.

That would have required acknowledging that time had run out on Wall Street's over-leveraged, overpaid gilded age. Instead, in his stubbornness and isolation, Dick Fuld failed to save the firm he lived for."

He walked out into cold evening air, bumped into a man carrying a bag of groceries, and quickly apologized. The cars and buses roared past him, ignoring the dimensions of the harm his failings would cause to the world's financial system. A beautiful middle aged woman smiled at him, something that would usually cheer him up, but not today.

"Why did I risk so much on mortgage-backed securities?", he asked aloud to passing pedestrians, none of whom responded, either because they didn't know or didn't care. "Was is simply a matter of using the name 'Spinco'?", he mused. "Could it all boil down to choosing a laughable name sounding like one of the Marx Brothers?"

Time for me to end this narrative before I actually start writing a novel based on it.

“We have more capital so we don’t have to sell good assets in bad markets,”

From the FT, I actually understand what Liddy of AIG is saying:

"Mr Liddy said that with the new plan, the authorities wanted to avoid a repeat of the credit markets paralysis that followed the collapse of investment bank Lehman Brothers, which went bankrupt just before the first rescue of AIG.

“The collapse of Lehman caused the credit markets to freeze up. Had AIG gone, it would have been even more significant,” Mr Liddy said.

Mr Liddy pledged to press on with a wide-ranging programme of asset sales aimed at raising funds to repay the $100bn in capital injected by the government.

He said the extension of the duration of the main government loan from two to five years and the cutting of the loan’s value from $85bn to $60bn would ensure AIG did not have to dispose of businesses at fire-sale prices.

“We have more capital so we don’t have to sell good assets in bad markets,” he said. AIG has not announced a single major disposal so far, partly because potential buyers have not been able to get funding."

Okay. I agree that Lehman was a big mistake, so Liddy is correct. I also understand the plan; namely, keep going until these tanked assets appreciate. Theoretically, the government could buy these assets cheaply and sell them for more later on. The theory is plain enough, but what about the execution?

The problem is that we have no clear idea of how much these assets will cost, or what we'll sell them for or when. And, if these terms need to be eased now, we, the taxpayers, should get substantially more later.

What is also clear is that AIG needs to be broken up into an entity that cannot demand a bailout on the supposed threat to the system. The problem of the free market model here is that an individual company can cause a tremendous ripple through our financial system if it gets too large. No point in debating that anymore. From my perspective, Lehman proved this.

Casey Mulligan claims that this can all be cleaned up by the DOJ enforcing anti-trust legislation. I suppose, in theory, it could, were there a DOJ that had the competence, resources, and laws, to do this. But one point needs to be made: Laws are no different than regulations. Oddly, they are both enforced by human agents. If regulators are suspect, surely anyone working in our legal system is. Both enforce rules. Period. It's preposterous to claim that we need a legal system to enforce contracts, but no regulations because it involves rules and regulators. A system of contracts is a set of rules enforced by human agents after being constructed by human agents. That's what a system of regulations are. Both limit and enforce human behavior.

Why am I going on about this? Because there is a concerted effort to reify and abstract this crisis that will lead to nothing good coming out of it. To the extent that human agents are left out of these explanations, we won't understand what has happened or how to keep it from happening again.

Listen to Mr. Liddy. He's telling it like it is, no matter how much we dislike hearing it. Listen to the agents involved in this crisis. They'll tell us what we need to hear, even when they're trying not to, if we are merely alert to the grammar and vocabulary that they employ.

“It is not exactly a bailout,” he said in a conference call this morning."

The bailout, excuse me, investment that just keeps giving. Floyd Norris in the NY Times:

"Why do people insist on saying things that are obviously untrue?

Edward M. Liddy, the chief executive of A.I.G., says the latest bailout is just a normal transaction.

“It is not exactly a bailout,” he said in a conference call this morning.

“The terms of the relation are commercial in nature,” he said, adding that everything was being done at “market interest rates.”

Does he want us to believe that there was anyone in the private sector that would have financed A.I.G. on these terms? Does he really think we will believe there is anyone in the private sector who would have financed this company on any terms?

It is sad to see that the plan is for A.I.G. to stay in business forever. This is a company that should be wound down. Instead, it appears that the government will remain an investor for years and years, helping one insurance company compete with others that are not government-subsidized."

I'm very weary. AIG forever. God spare us.

Floyd Norris again. I wonder how he's feeling:

"The most interesting part of the American International Group bailout today is the securities lending part, which I will get to later. It is happening because A.I.G. gambled with collateral that it was expected to put in safe investments. Having lost the gamble, it turns to Uncle Sam."

This is so important to me but it's not getting noticed. AIG only made these risky investments because it believed that the government would intervene if these investments backfired. Either the FED or government could not let AIG go down, and it looks like they were right. When Liddy says that it's not a bailout, he's right. It's collecting on the implicit government guarantees that it always expected. It's the governments job, according to AIG, to help them when they invest poorly. We taxpayer's just don't get it. That's our system. Listen carefully: We've had a system of implicit and explicit government guarantees to intervene in a finacial crisis. And here's the thing: A guarantee is a guarantee. The system of investments and banking is based upon these guarantees. If we don't change them, it always will.

"But the rest of the paragraph is misleading or wrong. The inability of company executives to answer the question is appalling. This deal will appeal to everyone in the market. It is only the government that is at risk...

The government will get just one percentage point over Libor on its investment, although it will be repaid first, if all goes well. If somehow there are profits, the government gets two-thirds, and A.I.G. the rest.

If there are losses, A.I.G. will take the first $5 billion, and the government the rest.

For A.I.G., this limits the possible losses from the venture...

A.I.G. guaranteed they would pay off. This makes good on the guarantee, courtesy of the taxpayers...

Again, all will make money if the market price is low enough. They will lose if it is not low enough to cope with future defaults.

Much will depend on whether the market values are fair or not. A.I.G. will calculate them, under government oversight."

This is all self-explanatory. My brother couldn't give me this deal.

More from Alea:

"AIG announced agreements with the U.S. Treasury and the Federal Reserve to establish a durable capital structure for AIG, and facilities designed to resolve the liquidity issues AIG has experienced in its credit default swap portfolio and its U.S. securities lending program."

I'm collecting a scrapbook on this debacle.

From Interfluidity:

"What kind of society is compatible with an economy managed by a cadre of large, politically connected firms whose operations and those of the state are intimately connected, and which cannot be permitted to fail since that would bring "chaos"? Friedman would have remembered. "Mussolini-style corporatism" can't be quarantined at the corner of Liberty Street and Maiden Lane. Trillion dollar bail-outs represent claims on scarce resources. If times get hard, the idea of scarcity will become a lot less abstract. The state will be called upon to enforce "property rights", including rights to the property that the state is right now giving away (and which in turn are being given away to the truly deserving). First there are economic emergency measures. Later there may be emergency measures of a different sort. Mixing my libertarians, there is more than one road to serfdom.

It is so odd, how we are becoming inured to these sums, $150 billion for AIG, $140B in tax breaks to encourage consolidation into bigger and more dangerous banks, the hundreds of billions in equity infusions under the modified TARP plan, etc. The Fed's balance sheet has expanded by more than a trillion dollars over the course of several weeks, almost all of which is used to offer one form or another of covert subsidy to financial firms. A bit hyperbolically, I thought, I once compared the scale of the Fed's interventions to the direct cost of the Iraq War. Now that seems quaint. The scale of the government's response to the financial crisis now completely dwarfs the direct costs of that war, as well as any plausible estimates of the indirect (financial) costs. (Obviously, the real costs of war are not financial, and run much deeper than our economic problems. I hope the comparison doesn't seem flip.)

Of course, we are constantly told, all of this is an "investment", no money has been spent, the taxpayer may even turn a profit.

That's an argument that sounds reasonable only until you give it a moment's thought. Nearly all "government spending" (outside of entitlement transfers) is investment. When we build schools, run head start programs, buy fighter jets, and fund our court system, that is not "consumption". We don't do those things because we enjoy them, but because they create ongoing payoffs that we believe outweigh the opportunity cost of our funds."

He seems to be missing the point. This catastrophe is a once in our lifetime investment opportunity for the taxpayers. What about guarantees is hard to get through our heads?

"That cost may be quite large. A commonly held view is that yes, the Fed's interventions are extraordinarily expansionary, and yes that could lead to inflation sometime far in the future. But for now we have D-leveraging, D-flation, D-pression to worry about. The Fed retains its traditional tools to fight inflation with, when the time comes. It will be able to sell Treasury bonds for cash and "mop up" all this "liquidity" it has "injected" into "the system".

But wait. The Fed doesn't hold very many Treasury securities any more (see Kady Liang). It would have to sell off some of the other stuff. Maybe we get lucky, and by the time we need to fight inflation, all those "money good" CDOs turn marketable again. Maybe not, though, and then the Fed will have little choice but to tolerate a great inflation or watch its own balance sheet implode. When the inflation comes, bright investment bankers will have already converted the bonuses we paid them into real property. It will be ordinary savers, and especially workers without bargaining power, who will be stiffed with the bill.

I think either a great inflation or a catastrophic deflation are pretty much unavoidable. It's the distributional effects that have me white hot with rage. We are sowing the seeds of inflation by making those most deserving of catastrophe whole, while doing nothing for those whose wages may soon achieve purchasing power parity with the emerging world. I'm actually cool with inflation — hey, all my money's in gold. A sharp inflation would be a kind of large-scale Chapter 11, a systemic debt-to-equity cramdown, debtholders get their claims devalued but the firm's nation's economic life goes on. However, inflation is a wealth transfer, and we should be conscious of from whom and to whom. For every dollar of Federal largesse that goes into the Wall Street bonus pool, three dollars should go into extremely generous unemployment benefits, paid sabbaticals for workers to return to school and retool, anything and everything to give people bargaining power to negotiate higher wages without all the hassle a union. Let's pass the "Take this job and shove it act of 2009".

Because the only thing worse than a great inflation with a wage/price spiral is a great inflation without one."

Great to know.

Justin Fox adds to the fun:

"The original AIG loan was arranged in a couple of days as markets shuddered after Lehman Brothers' bankruptcy. Its terms were meant to be pretty draconian, incentivizing the company to break up and sell off its parts to quickly repay the loan. Funny thing, though: In the middle of a financial crisis people don't want to pay top dollar for financial companies, even pretty good ones like AIG's insurance subsidiaries. Plus, it turns out it wasn't just AIG's derivatives-trading arm, AIG Financial Products, doing dumb stuff. The WSJ reports that AIG's securities-lending business took the collateral put up by short sellers that borrowed securities from it, and put it into mortgage securities that now it can't sell. Smart!

The government's dilemma is that the people at AIG responsible for this mess really do deserve to be tarred and feathered, or maybe drawn and quartered. There's ample reason to be punitive. But once they made the decision that AIG was too systematically important to fail--and I'm not saying that was the wrong decision--the Fed and Treasury needed to structure their bailout in a way that allowed AIG to survive, at least until the financial situation improved dramatically. They didn't do that the first time around, which is why they had to restructure the deal on Sunday."

I agree that it seems that way, but I go with Buiter.