The $85 Billion Check

Ottorock asks a question:

When a gov’t cuts an $85Bn cheque, where do the funds come from?

John Jansen hazards a guess at the answer:

If the Federal Reserve Bank of New York plans to write an $85 billion check to AIG , then Treasury market participants should duck for cover. They will likely raise the money by selling Treasury debt from the System Open Market Account. I have no idea how they would do that but it would be the largest such sale of securities since the dawn of human history.

The real answer, however, is that there won’t be any $85 billion check. AIG will draw down this liquidity facility only as and when it needs to, and indeed there’s a substantial chance that now the liquidity facility exists, it won’t get used at all.

At Libor + 850bp, the funds in the liquidity facility are very expensive, and AIG will tap them only as a last resort. What’s more, it’s now owned by the government, which means that it almost certainly won’t default. (The Germans call this Anstaltslast.) As a result, AIG can probably find cheaper private funding elsewhere.

In other words, the headline cost of this bailout is $85 billion. But the practical cost might well be zero — and the government’s getting 79.9% of the world’s largest insurer, to boot.

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