The Treasury Department has restructured the AIG bailout in an attempt to buy more time for the company to unwind their CDS business. The plan has the Treasury using the TARP to buy preferred stock and also to purchase some of the bad assets from AIG. The magnitude of the losses at AIG are just now becoming known and the numbers are frankly staggering (via WSJ):

The insurer swung to a net loss of $24.47 billion, or $9.05 a share, in the third quarter, compared with net income of $3.09 billion, or $1.19 a share, a year earlier. Excluding capital losses, the red ink amounted to $9.24 billion, or $3.42 a share.

Revenue declined 97% to $898 million from $29.84 billion in the third quarter 2007.

 

The latest results included $7.05 billion in unrealized losses at AIG Financial Products, the source of the credit-default swaps and $18.31 billion in investment write-downs, of which $11.7 billion was from AIG’s securities-lending program. That effort, which caused major problems for AIG as the stock market swooned in recent months, is being winded down.

AIG’s general insurance business swung to a loss on $1.39 billion in catastrophe losses, primarily related to hurricanes Gustav and Ike, falling investment income and increased losses at United Guaranty. General insurance net premiums dipped 0.8% to $11.73 billion. Life-insurance and retirement-services profits were more than halved by weak partnership and mutual-fund results.

The new Treasury deal is concentrated on getting the CDS business under control.

Under the revised deal, AIG is expected to transfer the troubled holdings into two separate entities.

The first such vehicle is to be capitalized with $30 billion from the government and $5 billion from AIG. That money will be used to acquire the underlying securities with a face value of $70 billion that AIG agreed to insure with the credit default swaps. These securities, known as collateralized debt obligations, are thinly traded investments that include pools of loans. The vehicle will seek to acquire the securities from their trading partners on the CDS contracts for about 50 cents on the dollar.

The securities in question don’t account for all of AIG’s credit default swap exposure but are connected to the most troubled assets. The government may be betting that its involvement will encourage AIG’s trading partners to sell the securities tied to the CDS contracts to the new entity.

snip

A second vehicle would be set up to solve the liquidity problems in AIG’s securities-lending business. The business involves lending out securities to short sellers or others and investing the collateral for gains.

AIG has labored to unload illiquid assets in order to give back the collateral it accepted. AIG’s exposure to the securities-lending market forced it to seek a $37.8 billion loan from the government to cover its commitments.

Under the new plan, the government is expected to inject $22.5 billion into the securities lending vehicle, with AIG providing an additional $1 billion. The entity would then buy the illiquid securities the AIG unit holds, known as residential mortgage-backed securities, for about 50 cents on the dollar. AIG would use the proceeds to shut down the $37.8 billion lending facility which it has not yet fully tapped.

I don’t know where they got the 50 cent price; it appears to be a guess based on wishful thinking. While AIG will take the first tranch of losses, the taxpayer is probably going to get hosed on this deal. No one knows what these securities are worth and chances are that Treasury will end up paying too much.

What I can’t figure out is how AIG got this deep into this mess. How many CDS did they think they could write? Apparently a lot. And in what did they invest the proceeds of the securities lending business? CDOs? Auction rates? I don’t know but the securities lending business is not a high risk business normally. You just collect a fee for lending the securities and then invest in something safe to make a little extra return. You don’t invest in illiquid securities. Amazing…