Chris Whalen On The Zombie IPO: Is American International Group the "Blood Doll" of Wall Street?

Zombie IPO: Is American International Group the "Blood Doll" of Wall Street?
The Institutional Risk Analyst
January 25, 2011

"It was against this background of exploding prices and a multiplying issue of national and local currency that the fourth London conference provided the curtain raiser to 1923, the year of the wheelbarrow."

Adam Fergusson
When Money Dies
(1975) London: William Kimber & Co. Ltd.

"The sixth phase of the depression began with the inauguration of the New Deal. The rest of the world turned to recovery in July, 1932, and only the United States marched in the opposite direction with the election of 1932. If the New Dealers had carried on our policies instead of deliberately wrecking them and then trying to make America over into a collectivist system, we should have made complete recovery in eighteen months after 1932, as did all the dozen other nations with a free economy. We continued in the sixth phase of the depression until war intervened in 1941."

Herbert Hoover
The Great Depression
(1952) New York: Macmillan

In this issue of The Institutional Risk Analyst, we return to the zombie dance party to check in on the queen of the prom, American International Group ("AIG"). First a question: Vampires are all the rage now in popular culture, so allow us to offer a macabre metaphor for AIG. Do you know what a "blood doll" is? A girl who craves to be the regular victim of or willing donor to a vampire. But hold that thought.

This week in The IRA Advisory Service, we report on our latest channel research and reaffirm the outlook on Bank of America ("BAC"/Q3 2010 Stress Rating: "C") and CapitalOne Financial ("COF"/Q3 2010 Stress Rating: "C"). We also talk about our forward outlook for revenue and earnings for the US banking industry in 2011. For more information, please visit our Advisory Service home page.

In one of his most recent Pickin Nits blog posts , IRA CEO Dennis Santiago describes some of the factors impacting our forward analysis, both in terms of aggregate industry data and his observations from the banking channel on the west coast. Suffice to say that while the inhabitants of Washington & Wall Street see economic recovery and blue skies ahead, this built on the shaky foundation of zero interest rates, the view from Main Street is falling asset prices, financial restructuring and fiscal constraint.

Last week saw a number of important developments in Washington. General Electric CEO Jeffrey Immelt and Bill Daley were appointed as economic advisor and chief of staff at the White House, respectively, a move that signals the mutation of Barack Obama from Euro-socialist to center-right Republican. Think of the betrayal of conservative values by Richard Nixon in reverse and you've got the scale of the political transformation now underway at 1600 Pennsylvania Avenue.

With President Obama taking orders directly from former JPMorgan ("JPM"/Q3 2010 Stress Rating: "C") investment banker and Chicago fixer Bill Daley, there seems little reason for Treasury Secretary Timothy Geithner to remain at Treasury as the guardian of Wall Street. In historical terms, Geithner is the third protector of the big banks at Treasury after Hank Paulson (2006-2008) and Robert Rubin (1995-1999). Part of the duty of protector, to be fair, was also carried out by Bill "NYSE" Donaldson (2003-2005) and Chris "XBRL" Cox (2005-2009) during their respective tenures as SEC Chairmen.

With the announcement that JPM banker Bill Daley, the youngest son of the late Mayor John Daley, would become White House concierge, having Geithner at Treasury now seems like overkill in terms of protecting the largest banks' political interests. Perhaps that is why Geithner is so focused on selling the remaining stakes in various parastatal entities acquired under his watch.

The Treasury just announced an offering to sell part of its stake in AIG, the troubled insurance giant that has been propped up at public expense since the Fed under Geithner bailed out Goldman Sachs ("GS"/Q3 2010 Stress Rating: "A+"), Deutsche Bank ("DB"/Q3 2010 Stress Rating: "A") and a number of other OTC derivatives dealers who were habitually sucking the insurers blood. News reports indicate that AIG chose BAC, DB, GS, and JPM to manage the sale of the government's 92 percent stake in the insurer -- many of the same firms that caused AIG's failure.

Following our suggestion of over a year ago, Treasury Secretary Tim Geithner has finally taken the Federal Reserve Bank of New York out of its involuntary equity stake in AIG. Indeed, Treasury is disposing of stakes in zombie companies at a brisk clip, including Ally Financial (Q3 2010 Stress Rating: "A+") and Citigroup ("C"/Q3 2010 Stress Rating: "C"). We applaud Secretary Geithner's industry; selling these public stakes in private firms is precisely the right policy, but it would have been better had the investments not occurred at all.

Geithner apparently now intends to offload the government's position in AIG onto the public, declare success and ride off into the sunset -- and hopefully back to the private sector. But the real question is whether or not there is anything left at AIG for public investors to buy. After selling most of the prime assets to repay the Fed and Treasury, AIG still looks insolvent to us. In fact, given that the most problematic liabilities of AIG were not reduced at all by the asset sales to date, the financial viability of AIG is arguably less certain than ever before.

A report published over the Christmas holiday by Bloomberg News, "AIG Didn't Report $18.7 Billion of Guarantees, Pennsylvania Regulator Says," illustrates the scale of the fraud and malfeasance seemingly still running rife at the government-owned AIG: "National Union Fire Insurance Co. ("NUFIC") of Pittsburgh and American Home Assurance Co., which issued the guarantees to bolster other AIG units, had contingent liabilities tied to the promises of $157 billion on Dec. 31, 2008, compared with the $138.3 billion disclosed at the time, Robert Pratter, the state's acting insurance commissioner, said today in a report. AIG was instructed by the regulator to limit or end its intra-group guarantees, according to the report," Bloomberg News reports. You always read the holiday news clips.

The regulatory order to end intra-group guarantees by the insurance units of AIG is the key factoid for investors who want to understand the value proposition here. For years, AIG has used what seems to be a Ponzi scheme of credit-default swaps, side letters and overt reinsurance claims to generate revenue, but all the while concealing the true nature of the total liabilities facing the company. See our earlier comment: ("AIG: Before Credit Default Swaps, There Was Reinsurance," April 2, 2009)

While the AIG guarantees on mortgage securities issued by firms such as AMBAC Financial Group (See "An A.I.G. Lesson From Wisconsin," Reuters, 3/25/10) might be sufficient by themselves to kill the company, the internal guarantees between American Home Assurance ("AHA") and other units of AIG are far larger. AIG takes the position that these guarantees, which are visible in the statutory reporting for the regulated insurers, are unlikely to be paid out, but the scale of the portfolio and the lack of reserves supporting it beg the question. AHA has issued unconditional guarantees to other units covering "all present and future liabilities of any kind" And here's the best part: the shell parent company of the AIG group is the guarantor for AHA. The snake eats its own tail in public, yet the banksters have no problem finding sufficient numbers of credulous investors to subscribe to an offering of shares.

Likewise NUFIC has issued unconditional guarantees of performance to affiliated companies within AIG. Again, the AIG parent company is the guarantor for these obligations by NUFIC. The guarantees include $21 billion in obligations issued by American International Assurance (Bermuda) and $6 billion in potential claims exposure written by American International Life Assurance (New York). The total capital surplus backing these potential claims is $2 billion. In all, NUFIC has issued $40 billion unconditional guarantees of performance backed by just $6 billion in capital surplus. Did we mention that NUFIC has over a $1 billion of its meager capital surplus tied up in real estate partnerships with other AIG companies?

Next Question: Quiet Periods and the Securities Act of 1933

Putting aside the financial condition of AIG for a moment, let's now consider the spectacle of the Treasury draining AIG of assets to repay the bailout funds and then selling what remains to the investing public in a share offering. In his zealous advocacy of the financial interest of the American people, Geithner makes a lie of his previous sworn protestations that he is not an investment banker. Oh, our boy Timothy is a master of the universe all right, a regular Jedi warriror, but one who serves the Dark Side. And like his peers at GS and JPM, skirting a few securities laws along the way to cashing in at the great casino called Wall Street is not a problem.

Apparently Geithner is so excited about the AIG stock offering that he commanded his direct reports at the Treasury to put on a full-court press in the media, demanding positive press stories about AIG. Yet despite his intensity and supposed intellect, Geithner remains ignorant of many aspects of finance and law that bear directly on his responsibilities as chief fiscal officer of the US, especially when it comes to selling stock in zombie banks and other companies. Whether the beneficiary of the share sale is a private individual or the US Treasury matters not, according to the lawyers we consulted.

First and foremost, somebody needs to gently remind Secretary Geithner that he and the members of the Treasury staff are subject to the Securities Act of 1933 just like everyone else. Now that Treasury has announced its intention to sell shares in AIG and other companies, making any statements about AIG and/or its financial condition, or encouraging members of the media to write positive stories about the company, appears to be a violation of the law. And yet thus is precisely what has been going on for at least a month, according to several news organizations contacted by The IRA.

Jake Siewart, counselor to the Treasury Secretary since June 2009, apparently has been communicating with members of the media and the public regarding the offering of AIG shares. Since the decision to sell the shares was made well before the holidays, the communications of Siewart regarding the AIG offering, including both verbal and email communications to members of the media, are arguably a willful violation of the 1933 Act.

We contacted AIG yesterday and asked whether they were aware that employees of the Treasury are contacting members of the public and also the media regarding the upcoming sale of stock in AIG. We asked if such contacts were not a violation of the Securities Act of 1933 and FINRA regulations. We reminded them that sellers of securities are prohibited from making any statements regarding the offering except via a written prospectus. Also, none of the personnel at Treasury who have been making these solicitations regarding the AIG equity offering are registered with FINRA.

AIG officials did not reply directly to written questions from The IRA seeking comment on the activities of Treasury officials. About an hour after we sent our email to AIG, however, we heard from several senior lawyers from the Treasury. They assured us that all Treasury officials were aware of the law and the specific requirements regarding a public offering of securities.

When we asked, hypothetically you understand, whether Tim Geithner calling Arthur Sulzberger or other senior managers at the New York Times and demanding favorable coverage of AIG in front of an offering would be a violation of the law, they reiterated that all Treasury officials are doing their utmost to comply with the securities laws. We are delighted to hear it. But still, we understand from several members of the media that Siewart, the former and last press secretary for President Bill Clinton, has been offering to arrange interviews with AIG management and senior Treasury officials. Again, if these allegations are true, Mr. Siewart's actions look an awful lot like conditioning the market in advance of a securities offering.

The recent Goldman Sachs fiasco involving FaceBook, where those special masters of the universe did not seem to understand that doing a private placement for a prominent internet company is pretty nigh impossible, the Treasury's handling of the sale of shares in AIG and other zombie companies seems to confirm that none of these people know their business -- or care. In both cases, the elementary legal requirements of executing a public offering of securities in the US seems to have escaped the notice of the responsible adults at the Treasury and GS. Does anyone at the White House know or give a damn?

Next time that Timothy Geithner testifies under oath that he is not an investment banker, don't you believe him. Secretary Geithner is showing all of the guile and duplicity needed to become a very successful bankster when he leaves the Treasury. The AIG IPO will leave enough value on the table to attract the flies to the sugar, but the ultimate fate of AIG as a going concern will be somebody else's problem.

Yesterday's closing price for AIG was $43, but the close at the start of 2008 at the post-split equivalent price was over $1,400. Got that? Some value creation, eh? There is little uncertainty on the "true" current value, notes one former AIG official. The value could be quite high, if AIG were run proficiently or sold in an orderly manner -- after a restructuring, he offers.

But AIG now is appropriately a $43 stock because it is badly run, with political rather than economic goals. Our guess is that the real value of the ongoing business is about $30, after franchise damage and recent asset stripping. But as discussed above, that theoretical $30 is the net of $40 worth of assets with $10 in excess liabilities. Again, Geithner's refusal to restructure AIG, as with the zombie banks, simply kicks the can down the road. The market understands that politicos and hacks led by Secretary Geithner are at this moment parsing the $40 and will gladly sell it for less than half, in order to declare victory. That's apparently the reason for Hank Greenberg's recent protest in the Wall Street Journal.

Which brings us back to the concept of the "blood doll," the source of subsidy for the real zombie banks of Wall Street. As we discribed in 2009, AIG was the blood doll of GS, DB, et al. The firm was not a move-mover, but a chump, run by and for the largest New York dealers banks who suggested strategies and trades. And now we see that AIG was kept alive not to save the global financial system from meltdown, but rather as as a future blood doll for those bankers prescient enough to own senior Fed and Treasury officials. Some of the same banks that caused the collapse of AIG and the subsequent looting of the Fed are now acting as underwriters in an offering that nobody should touch. But no one says a word, either in Washington or on Wall Street, because in both venues the truth is a matter of perspective.


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