The latest rescue of American International Group Inc. illustrates the difficulties the government faces in trying to carve up large, systemically important institutions at a time when buyers are scarce and the few there are will only pay fire-sale prices.
It's a conundrum that at least partially explains why the government is not moving to seize control of the nation's top banks. In a speech Monday, Federal Deposit Insurance Corp. Chairman Sheila Bair confronted the question head-on.
"If more direct intervention to take over a large financial group is needed, that will present significant challenges," she told the Institute of International Bankers. "The main hurdle is that there's no clear process for resolving a large financial holding company with multiple affiliates. We have a process for dealing with large banks, but not financial conglomerates."
AIG is definitely the latter, and is now on its fourth government bailout. And though each time the government has gained more control over the insurance giant, the terms also have gotten more lenient.
Among other things, the restructured loan gives AIG an additional $30 billion from the Troubled Asset Relief Program, raising its total to $70 billion, or 10% of the total rescue fund. But crucial to Monday's announcement were two provisions that amount to an easing of the government's conditions on the loans.
AIG won a break on interest payments; the new loan removes the floor on the London interbank offered rate AIG was paying.
Perhaps more important for AIG's capital-building efforts, the Treasury Department is converting its shares in the company from cumulative preferred to noncumulative preferred. The move gives AIG's board of directors more discretion on whether to pay dividends to the government.
The AIG moves may be a precursor to future action at Citigroup Inc., which has received $45 billion from Tarp and will convert some of the government's preferred equity stake to common shares. AIG does not have to pay a dividend, but Citi still must pay an 8% dividend rate.
Some observers said if the dividend hurts Citi, it, too, should be relieved of having to pay it. While politically unpopular, punishing banks that need help does not further government efforts, they said. "I don't think we ought to be trying to punish them," said Robert Clarke, a former comptroller of the currency who is now a partner at Bracewell & Giuliani LLP. "If it takes better terms" to revive Citi," then that's what you ought to do."
Paul Miller, the managing director of Friedman Billings Ramsey & Co., agreed that the government should stop expecting dividend payments from Citi and other struggling institutions.
"We need to start getting over the fact of punishing people," he said. "We need to fix the system. … We need to get the money into the system."
Other large institutions that have received a bailout, such as Fannie Mae and Freddie Mac, are also paying dividends to the government.
But Joseph Mason, a professor at Louisiana State University, said eliminating the dividend will not dramatically improve struggling banks.
"Those kind of changes affect the bottom line only in a marginal way," he said. "Tweaking in that direction just makes it more of a subsidy."
Some also said that easing the terms on AIG and Citi only punts the work of breaking up the firms further down the road.
"That would just be part of this creeping nationalism," said Cornelius Hurley, the director of the Morin Center for Banking and Financial Law at the Boston University School of Law. "That's the problem as I see it. The incrementalism just isn't working."
Under the AIG deal, the government also appears to be exerting more power—though not full control—over two individual units, another step it could imitate in Citi's case.
The AIG deal gives the Federal Reserve Bank of New York a preferred interest in special-purpose vehicles that will hold all of the common stock of American Life Insurance Co. and American International Assurance Co. Ltd.
The administration emphasized that AIG will maintain control of those large subsidiaries, but the New York Fed does have "governance rights."
That means the Fed could veto decisions made by the subsidiaries and must also be consulted during big decisions, such as a significant asset sale. It is unclear whether the Fed could make a similar play for some of Citi's subsidiaries, but Mason said the move marks a "resurgence" in the central bank's role in bailouts.
Speaking to reporters Monday, Comptroller of the Currency John Dugan dismissed questions of whether AIG could prove a model for Citi or others.
"I don't see the AIG situation as a template for the banks," he said.
But others argue the government should at least step up efforts to assert more control at Citi. The government already owns 79.9% of AIG, giving it tremendous clout over the firm's activities.
The government currently holds a 36% stake in Citi, and until its ownership expands, observers say it will be difficult to achieve the goal of breaking up the firm.
"It does seem to be a franchise that's being dismantled," said Richard Herring, a professor at the University of Pennsylvania's Wharton School, "and whether it's better to see it happen kind of piecemeal like this or whether it would be better off with knowing about the losses and have it well capitalized, I think it's pretty clearly more preferable to make a clean break of things."
But that break cannot come while management and shareholders remain in place, observers said. "As long as you have equity holders and have management told they are in control of this company, it's going to be difficult to break them up," said Joshua Rosner, the managing director of the research firm Graham Fisher & Co., "which is why I think a government-run resolution will be the least costly and the most effective approach."
As for the government seizing control of Citi directly, however, Bair appeared to say that was off the table.
"Based on where we stand today, I would be surprised if the FDIC had to step in as conservator or receiver of a large, systemically important institution," she said.
Despite the implications for Citi, some see the revised AIG bailout as the latest one-off policy decision from the government, which has jumped from crisis to crisis over the past year.
"They're dealing with these situations in a very ad hoc manner," said Bert Ely, an independent consultant in Alexandria, Va. "It's like they'll almost do anything within reason to deal with these situations."
Boston University's Hurley agreed.
"The connection here would be that the largesse of the Treasury … seems to be unlimited," he said.
Emily Flitter and Cheyenne Hopkins contributed to this story.
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