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3 Lessons from the AIG Bailout

Rick Newman

A lot of people thought this day would never arrive, but the U.S. government is finally poised to extricate itself from the ugliest bailout of the 2008 financial crisis.

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The Treasury Department says it plans to sell its last remaining shares in AIG, the insurance giant that would have imploded in the fall of 2008 without a federal takeover. Washington essentially nationalized AIG at one of the diciest moments of the financial panic, out of fear that AIG's collapse would have taken much of the financial system with it. The government ultimately committed $182 billion to AIG, making it the largest bailout of any single company. The highly unpopular General Motors bailout, at about $52 billion, cost less than one-third what the feds provided to AIG.

Treasury expects the government to earn a net profit of $22.7 billion on the AIG bailout, once it sells its remaining shares. That amounts to roughly a 3 percent annual return, which is better than the current interest rate on a 30-year Treasury bond.

The government doesn't invest in failing companies to make a profit, of course, but to stabilize the economy--which, theoretically, is in the interest of every taxpayer. The AIG bailout, however, was fraught with fumbles and political miscalculations. Looking back, here are three key lessons about how to approach a huge, failing company like AIG.

The government has enormous financial power. In normal times, there are often investors willing to buy distressed companies at a discount, because they can turn a sizable profit by turning the company around. But nobody had the resources or the gumption to take on AIG in 2008, which is why the government stepped in. The government's power comes not just from its vast resources and its ability to print money, but also from the fact that it can hold assets as long as necessary--even for decades, if called for. That was a major factor allowing AIG to sell assets, revamp its finances and stabilize itself.

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One of AIG's most valuable assets, for instance, is its aircraft-leasing arm, which it considered selling in 2008 to raise desperately needed cash. But that would have been a horrible time to sell, since it was extremely hard if not impossible for buyers to raise money, and any buyer would have been able to command a fire-sale price from a distressed seller. The federal lifeline allowed AIG to wait for more favorable conditions, and AIG recently agreed to sell the aircraft unit to a Chinese outfit for a healthy $5.5 billion. The feds also helped AIG by purchasing two huge portfolios of AIG "toxic assets" such as derivatives linked to troubled mortgages, which virtually nobody would have touched during the 2008 meltdown. The government made a profit on those, too, by selling them for more than it paid, once the economy recovered. The broader point is that the government can be a very effective buyer of last resort with no net loss of taxpayer money.

Transparency is vital. Perhaps the most controversial element of the AIG bailout was the discovery in 2009 that $62 billion in taxpayer funds disbursed to AIG ultimately went to big banks that had contracts with AIG, including Goldman Sachs, Merrill Lynch, Bank of America and even a few foreign firms. The transactions were complicated, but the feds essentially redeemed AIG trading partners at 100 cents on the dollar, when those same partners would have gotten a fraction of that amount if AIG had declared bankruptcy. Worse, the government never publicized the pass-through bailouts, creating the horrible impression that Washington was simply funneling taxpayer money to Wall Street, like an inverse Robin Hood.

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The rationale for those redemptions may have been logical, because they upheld the integrity of the financial system (or at least what was left of it), as well as the sanctity of legal contracts. But it's hard to imagine a worse way to dispense taxpayer dollars. The fact that it was done with no public notice generated legitimate outrage. If there's ever another such bailout, provisions such as this ought to be vetted at Congressional hearings and approved only if politicians can convincingly explain them to voters.

Taxpayer protections need to be institutionalized at the outset. The other outrage of the AIG bailout was the plan for AIG to pay $165 million in bonuses to senior executives--including many of the traders who caused the very problem that brought AIG to its knees--after the government had gotten involved. In retrospect, the bailout should have included provisions at the outset that prohibited such bonuses, or financed them from private money, or made them contingent upon the ultimate recovery of the company. As it was, the executives were legally due their bonuses because of past obligations they had already fulfilled. That made taxpayers party to a crazy incentive system and once again created the impression that the U.S. government was rewarding outlandish behavior.

The irony of the Wall Street bailouts is that they essentially worked, by stabilizing the financial system and setting the stage for the economic recovery we're now in. Without them, we could easily still be mired in a depression, with the unemployment rate well above 10 percent. But the bailouts also severed the trust many Americans have in their government and left the impression that politicians and bankers merely take care of each other, with no regard for the little guy. If there's even another bailout on the scale of AIG, taxpayers need to come first.

Rick Newman is the author of Rebounders: How Winners Pivot From Setback To Success. Follow him on Twitter: @rickjnewman.

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