Bloomberg—The Federal Reserve Bank of New York’s role in the $182.3 billion rescue of American International Group Inc. is ending on a high.

The central bank is planning to sell $3.4 billion in toxic mortgage debt today that it inherited four years ago when it bailed out AIG, once the world’s largest insurer. The assets are the last batch from its Maiden Lane III LLC portfolio created to purchase $62.1 billion of collateralized debt obligations tied to risky residential- and commercial-mortgage securities that helped sink AIG when property markets tumbled.

Demand for subprime mortgage debt and CDOs has jumped this year as the housing recovery strengthened and the Fed extended programs to keep borrowing costs low. AIG has received more than $6 billion in proceeds through July from the auctions and may get another $1.9 billion this month, helping Chief Executive Officer Robert Benmosche, 68, buy back shares from majority owner the U.S. Treasury Department. The insurer is now entitled to receive one-third of the proceeds from sales since the central bank fully recovered its investment in June and AIG’s equity contribution was repaid last month.

“People will debate forever if the bailouts worked and how they should have happened, but you can say the Treasury has been a good owner of AIG,” Josh Stirling, an analyst at Sanford C. Bernstein & Co. said in a telephone interview. “These auctions are good for the Treasury because the Fed selling its interest in Maiden Lane III has allowed AIG to raise liquidity, with which it can support the Treasury by buying back stock.”

Joe Norton, an AIG spokesman declined to comment.

Treasury Stake

AIG’s rescue in 2008 swelled to include a $60 billion credit line from the New York Fed, as much as $52.5 billion for two Maiden Lane programs and a Treasury investment of up to $69.8 billion. The Treasury has since cut its stake in AIG to 53 percent from 92 percent by selling shares, the credit line has been repaid and Maiden Lane II, created to buy about $39 billion in residential-mortgage securities was unwound earlier this year through asset sales.

Maiden Lane III was created to purchase CDOs to cancel credit-default swaps that AIG had sold to protect counterparties against losses, sparing firms including Societe Generale SA and Goldman Sachs Group Inc. from damages and sparking criticism from lawmakers who called it a “backdoor bailout” of banks.

The debt was purchased at about half its face value, reflecting markdowns AIG had already taken. AIG’s counterparties were permitted to keep about $35 billion in collateral payments the insurer had already posted, meaning they received face value for the assets, according to a 2010 report by the Office of the Special Inspector General for the Troubled Asset Relief Program.

Rescue Measures

The rescue was among measures the U.S. government and central bank undertook in 2008 to try and thwart the deepest financial crisis since the Great Depression. In total, they spent, lent or committed as much as $12.8 trillion, including the Troubled Asset Relief Program to bolster banks and automakers.

“It was an unprecedented time and the Fed used unprecedented tools,” said Bryan Whalen, co-head of mortgage bonds at Los Angeles-based TCW Group Inc. which oversees about $130 billion. “In hindsight some worked really well, some really didn’t. This is one that worked fairly well.”

The Fed removed distressed assets from the market when prices were tumbling and sold them when the market was able to absorb them, said Whalen. The process could have been improved, he said.

Property Stabilizing

Last year, when the Fed began trying to sell the holdings, it invited more than 40 broker-dealers to take part in a series of auctions. It switched to a less open process this year after traders blamed the regular, more public disposals for damaging prices. It later resumed a process more similar to its original program.

Hedge funds and insurers including AIG have snapped up non- government backed mortgage debt this year betting the housing and commercial property markets are stabilizing.

Sales of previously owned homes rose to an annual pace of 4.47 million last month, up from 4.37 million in June, the National Association of Realtors reported yesterday. Home prices have risen for three straight months since February after dropping more than 35 percent from the 2006 peak, according to an S&P/Case Shiller index.

“Trends in economic data indicate the worst of the housing crisis may be past,” Joshua Anderson, a portfolio manager at the Newport Beach, California-based Pacific Investment Management Co., the world’s largest bond manager, and Emmanuel Sharef, a structured credit analyst, wrote in a commentary posted on its website this week. “PIMCO believes that over the coming years, housing related assets have the potential to outperform the conservative assumptions embedded in their current market valuations.”

Bond Prices

Typical prices for the most-senior bonds tied to option adjustable-rate mortgages, a type of non-agency debt, soared to 62 cents on the dollar last week, from 49 cents in November, according to Barclays Plc data.

AIG has already purchased $7.1 billion this year in mortgage-related securities from Maiden Lane III auctions as part of a plan to increase investment yields, the company said Aug. 2. It reported its third straight quarterly profit this month with net income of $2.33 billion.

Its shares rose 0.3 percent to $33.66 at 10:11 a.m. in New York Trading. They’d returned 45 percent this year through yesterday, the biggest gain among 22 companies in the Standard & Poor’s 500 Insurance Index.

The Fed’s sale of Maiden Lane III will help to support prices of non-agency debt, according to Whalen.

“Last fall we were all very concerned about legacy supply pushing prices down and Maiden Lane portfolios were a big part of that legacy supply,” he said. “Now it looks like it’s all going to be moved and it’s not going to lower prices, we’re actually going to see prices rise into the sale.”

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