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Feb 18

AIG, GMAC and Citi: Lessons in moral hazard

Posted by MQuinn in Riskmoral hazardGMACCitigroupBanksbailoutsAIG


There are plenty of examples of how the bank bailout has propped up some extremely unhealthy companies not only through capital infusions but also through the implicit guarantee of future bailouts.

But the current affairs of three bailout recipients -- and three companies that many would argue should have been allowed to fail -- might be the most egregious examples.

The biggest bailout recipient, American International Group, has been acting for a while as if it's not 80 percent owned by the U.S. government.

But Thursday's news from the Financial Times that the insurer has shelved plans to sell off its entire derivatives portfolio and keep up to $500 billion in positions is the biggest nose thumbing to date.

The original plan, devised under then chief executive Edward Liddy, was to sell off all the positions and close down the AIG Financial Products group as soon as possible. But now it will retain derivatives with a notional value of between $300 billion and $500 billion - or between 15 and 25 per cent of the derivatives portfolio's original size. AIG is hoping to avoid a fire sale and "reap the benefits of rallying credit markets," the FT reported.

That's got to be the real kicker considering playing a booming market was what got AIG in trouble in the first place. I guess the music won't stop this time - and even if it does, everyone knows Uncle Sam is waiting in the wings with enough money to get the band going again.

AIG insists the financial products division will be shut down by yearend, but what exactly has it done to this point to show it's acting in good faith?

Next up is GMAC, the beyond-troubled mortgage and auto lender. Fresh off a fourth quarter net loss of $5 billion and full-year loss of over $10 billion, GMAC was able to sell $2 billion in unsecured notes due in 2015 last week.

This is particularly noteworthy because, as Gimme Credit analyst Kathleen Shanley pointed out in a research note Thursday, "GMAC was the only bank covered by last year's stress tests that wasn't able to raise capital in the private markets to cover its deficit."

But make no mistake: despite this bondholder vote of confidence, GMAC is in disastrous shape. Its equity declined to $20.8 billion at yearend, from $24.9 billion at the end of the third quarter. Its Tier 1 common capital ratio dropped to 4.8 percent, from 6.1 percent at the end of September.

So what would attract investors? The fact that the U.S. now owns 56 percent of the company's common equity, plus convertible and trust preferred securities, following a $3.8 billion capital infusion at the end of December, of course.

Shanley wrote: "Holders of short-term GMAC paper face relatively low risk, since it is unlikely that the government will remove support precipitously, given how much cash has already been invested in propping up the company."

Finally, there's Citigroup, which has curiously found itself the center of hedge fund investor attention. Bloomberg reported Wednesday: "Firms run by John Paulson, Eric Mindich and George Soros purchased almost half a billion shares in Citigroup Inc. last quarter as more than 120 hedge funds said they bought stock in the bank."

I must have missed the good news in the bank's $7.6 billion fourth quarter loss. But as an trader over at Seeking Alpha put it: "I still have no idea how to analyze Citigroup (does it still have those infamous off balance sheet accounts, a la Enron?). But since the government says Citi is a cockroach that cannot be allowed to die, the investment community seems happy to pile on."

If that isn't the definition of moral hazard, then I don't know what is.

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