AIG bailout. Where did the money come from

[a_unique_person]

The miracle happens when the Fed loans it to someone. Up until that, it's just paper (or electronic blips).

The vast majority of wealth these days is just variations in the magnetic field on the surface of a metal disk.

 

[PaKu]

Francesca: "The money is at risk (to the taxpayer) but said taxpayer could end up making a profit, having bought the company for free."

But right before THAT happens there will be a sudden urge for "deregulation" of big old evil govn't right?

 

[PaKu]

allow me a dumb question:
what is going to happen with all the people that defaulted on their mortgage (the sub-prime thing, the start of the problem so to speak)?
Are the Feds going after them?
Is the government going to end up with a LOT of houses?

 

[Francesca R]

That's what I thought. However, other posters, particularly Francesca, seemed to think that was not the case. She said that the loan couldn't be written off. Those posters seemed to think that taxpayers were "on the hook" for the money. i.e. taxpayers would have to repay it.

That was contrary to my understanding of things. If AIG defaults, and if the sale of its assets doesn't cover the outstanding debt, my understanding was simply that now there were more dollars in the world, and the US dollar would take an inflation hit.

It seems to me that you and Francesca are not saying the same thing.

Can anyone enlighten me about whether Francesca and Gazpacho really are in agreement here, and I'm not understanding things? Also, if they really are different, who's right?

Please understand that the government is (as of last Wednesday) the majority 80% owner of AIG. If a nationalised company defaults to its creditors it is a *government* default. That is not going to happen in the USA. Therefore the government will give good value to the loan principal and interest if it cannot be covered by AIG's trading operations, or by selling AIG's assets if it was to experience liquidation now or in the future before the government had disposed of its stake.

That means that the government would need to raise USD85 billion. And it would do that by increasing borrowing, raising tax or selling something else it owns. There are no other ways.

ETA--Even if the government did sell its equity interest, I think it is still the case that the government guarantees any loan from a Fed System Bank, yes. (I could be wrong but I don't think so)

 

[Francesca R]

allow me a dumb question:
what is going to happen with all the people that defaulted on their mortgage (the sub-prime thing, the start of the problem so to speak)?
Are the Feds going after them?
Is the government going to end up with a LOT of houses?

No. Existing laws provide for commercial mortgage banks to recover their debts (and a previous stimulus package in Q1 of this year was unveiled to try to alleviate those foreclosure events).

AIG did not make mortgage loans as far as I know. Their investment banking unit owned a lot of the rubbish those were packaged into. The securities AIG holds benefit from recovery of defaulted underlying morgages but AIG as principal owner does not have the ability to directly grab houses.

 

[plumjam]

To cut a long story short: when capitalism ****s up, socialism comes to the rescue.

 

[69dodge]

The miracle happens when the Fed loans it to someone. Up until that, it's just paper (or electronic blips).

When it gets repaid to the Fed, the money vanishes. Dollar bills held by the Fed are just paper.

The only way to get currency into circulation is by borrowing it?

I have a $20 bill in my wallet. It's mine. I don't owe it to anybody. How did that happen?

What if everyone decided to repay all their loans and not take out any new ones? It sounds like this would be impossible if I want to keep my $20 bill.

I think you're right, but it seems very strange.

 

[Meadmaker]

allow me a dumb question:
what is going to happen with all the people that defaulted on their mortgage (the sub-prime thing, the start of the problem so to speak)?
Are the Feds going after them?
Is the government going to end up with a LOT of houses?

I don't think there are any dumb questions in this mess, because the web has become so tangled that no one knows where the money is going. Oddly enough, though, everyone thought that their little piece of the pie was perfectly safe and there was no risk involved. This turned out to be hogwash. That being said, let me see if I can answer your question, and someone can correct me if I'm wrong.

The short answer is no, but it's not easy to see why the short answer is no.

Let's start when you buy a house. You take out a loan from a bank. If you don't pay back the loan, the bank takes your house and sells it. Easy. At least, that's the way it used to work.

Now, however, it doesn't work that way in an awful lot of cases. You buy a house. You take out a loan from the bank. Then, the bank sells your loan to someone else. The bank continues to service that loan. i.e. it still collects the payments. However, it sends the money from your payments to whoever bought the loan. The people who did buy the loan then took your loan, plus a whole lot of other loans, and put them together in a big bundle called a "mortgage backed security". The ultimate person getting the money you pay on your loan is not the bank, nor even the enitity to whom the bank sold the interest in your mortgage, but rather the people who bought the bonds that were backed with your mortgage. The owner of your mortgage takes your payments and uses it to pay interest on the bonds they issued.

Now, suppose you default. What happens? Part of "servicing" your loan includes foreclosing. The bank, who is still servicing your loan, takes your house and sells it. They send the money to the people who bought your mortgage, and they distribute it, just as they would a regular payment. Except...oops....the amount they got from selling your house isn't as much as you were paying in payments. The bond owners don't get as much money as they expected. In fact, they actually may lose money.

Well, we can't have that. The government isn't proposing to get involved in the actual buying, selling, or foreclosing on real houses, so they won't end up with your house. They are bailing out the mortgage backed securities, not the mortgages.

 

[Gazpacho]

ETA--Even if the government did sell its equity interest, I think it is still the case that the government guarantees any loan from a Fed System Bank, yes. (I could be wrong but I don't think so)

You're saying that if AIG defaulted to the Fed, then the Treasury would be responsible for repaying the Fed what AIG borrowed? That seems kind of pointless, as the Fed has no particular need for the money.

 

[Francesca R]

You're saying that if AIG defaulted to the Fed, then the Treasury would be responsible for repaying the Fed what AIG borrowed? That seems kind of pointless, as the Fed has no particular need for the money.

I am almost certain that is what would happen. Has a Federal Reserve Bank ever written off a loan?

 

[Skeptic Ginger]

allow me a dumb question:
what is going to happen with all the people that defaulted on their mortgage (the sub-prime thing, the start of the problem so to speak)?
Are the Feds going after them?
Is the government going to end up with a LOT of houses?

I would like someone to tell me why the lending institutions stuck with any pending foreclosures didn't just renegotiate these loans once it was recognized foreclosure was not going to result in recovery of the lent capital?

Except, I realize now this is probably the wrong thread for my post so never mind.

 

[gtc]

I would like someone to tell me why the lending institutions stuck with any pending foreclosures didn't just renegotiate these loans once it was recognized foreclosure was not going to result in recovery of the lent capital?

Except, I realize now this is probably the wrong thread for my post so never mind.

The bottom line answer has to be that the lenders either have to do it that way or they thought they would get a better return that way.

This article from wikipedia might help but there seems to be a lot of variation from state to state.

My understanding is that in Australia they would try to restructure the loans first of all, but negative equity (where the loan is worth more than the house) has been very rare and it is harder to walk away from a mortgage.

 

[Meadmaker]

The bottom line answer has to be that the lenders either have to do it that way or they thought they would get a better return that way.

There's another reason. Who holds the mortgage? First, the bank makes the loan. Then, they sell it to someone else. Then Fannie Mae or Freddie Mac ends up with it and bundles it into a mortgage backed security sold to investors. Meanwhile, the bank is the servicer of the loan, responsible for looking after the interests of the owners, which is...who exactly? I guess Fannie Mae or Freddie Mac...sort of? The bank can't renegotiate the loan because they don't own it any more. They have no interest in renegotiating the loan.

 

[gtc]

There's another reason. Who holds the mortgage? First, the bank makes the loan. Then, they sell it to someone else. Then Fannie Mae or Freddie Mac ends up with it and bundles it into a mortgage backed security sold to investors. Meanwhile, the bank is the servicer of the loan, responsible for looking after the interests of the owners, which is...who exactly? I guess Fannie Mae or Freddie Mac...sort of? The bank can't renegotiate the loan because they don't own it any more. They have no interest in renegotiating the loan.

You are right; I was simplifying the situation as to who is the ultimate 'lender'. There would be contractual terms which specify what is done in the event that the borrower falls behind. It wouldn't surprise me if the number of institutions who have an interest in the loan means that the terms are less flexible than they might be if the loan stayed on the books of the originating institution.

 

[a_unique_person]

The amount is added to the current account deficit for the country.

 

[Francesca R]

I would like someone to tell me why the lending institutions stuck with any pending foreclosures didn't just renegotiate these loans once it was recognized foreclosure was not going to result in recovery of the lent capital?

They make a commercial decision that the recovery under renegotiated terms (net of the cost of doing that) will be less than the recovery from foreclosure.

 

[Meadmaker]

The problem was that companies that did have reserves and in assets, still need cash to function. The expected short term loans just weren't available any more. This has led to companies that deserved to die ending up in trouble, but also companies that were more conservatively running ending up in trouble, too, even though in normal times they would have been managing quite comfortably.

AIG seems to be in the latter category.

As I've read up on this, I think I've come to realize that AIG was not in the latter category. It seems to me they were in the former category.

It seems to me that they got into a whole heap of trouble becasue they sold a lot of insurance policies that paid off if mortgage backed securities lost money. This wasn't some sort of short term credit crisis. This company sold a lot of insurance that they can't pay on.

That, in and of itself, wouldn't be a huge, huge, problem, except that all those companies that bought the insurance figured that they didn't have to worry so much about their mortgage backed securities losing money, because, after all, they were insured. So, what do you do if the insurance company goes bankrupt. Uhhh...it looks like you lost money after all.

So, AIG is in real trouble, not because of some hiccup in the short term credit market, but because they sold insurance that they can't cover. At least, that's what it seems to me.

And, as I asked in a new thread, just what is a "58 trillion dollar market" anyway?

 

[a_unique_person]

As I've read up on this, I think I've come to realize that AIG was not in the latter category. It seems to me they were in the former category.

Fool me once, shame on umm, fool me twice, um err, you know.

 

[Puppycow]

Turns out taxpayers made an $18 billion (with a 'b') profit on the AIG bailout:

Fed turns AIG bailout into $18 billion profit

NEW YORK (CNNMoney) -- The Federal Reserve finally has wiped its hands clean of AIG and turned a nearly $18 billion profit for taxpayers in the process.

Now it's up to the Treasury Department to sell the rest of the U.S. government's stake in the insurance giant.

So we loaned AIG money, and we got all of our money back, plus $18 billion in interest.

Does this change anyone's mind?

ETA:
Oh, and one more thing:

That said, the U.S. government is not entirely free of AIG. The Treasury Department still owns $29 billion, or roughly 53% of AIG's common stock.

The Treasury Department has said it too expects to make a profit on that investment, as it sells the shares over time.

So actually it's $18 billion plus whatever profit Treasury makes when it sells its shares.