Why Would Treasury Cut AIG’s Interest Payments?

The WSJ’s latest AIG story has set off Joe Wiesenthal’s bullshit detector — and mine, too. It’s headlined "U.S. Weighs Options to Ease Strain on AIG", and it seems to be an attempt to jawbone Treasury into reducing the punitive rates at which it’s lending to the troubled insurer.

But the stated reasons for Treasury doing such a thing don’t make sense:

People close to the insurer complain that the terms of AIG’s loans are onerous compared with the 5% interest charged by the government to banks and other financial institutions under the $700 billion Troubled Asset Relief Program.

AIG officials hope these factors will help persuade the government to change its loan terms, since the government would have the most to lose as both AIG’s creditor and controlling shareholder.

The idea here is that if Treasury charges AIG a lower interest rate, then AIG will have more money left over for shareholders, and will be less likely to default on its obligations.

But as the sole reason why AIG hasn’t gone bust, Treasury has no reason to let AIG’s minority shareholders benefit from its largesse. And it doesn’t really matter how much Treasury charges on its loans to AIG, since the money’s just going around in circles anyway.

The fact is that the US government isn’t going to lose anything as AIG’s creditor, because the US government isn’t going to let AIG default on its obligations. So long as you have an unlimited source of liquidity, you never need to default, no matter how insolvent you might be. So the US has no worries on the creditor front.

And the government is a very special kind of shareholder, because it’s effectively getting a monster dividend in the form of high interest payments, which isn’t available to AIG’s other shareholders. Besides, the cost basis of the US goverment’s shareholding is effectively zero, which means it can’t lose money there, either.

So I’m having difficulty seeing any upside, as far as Treasury is concerned, in bringing down the interest rate it’s charging AIG for its billions. Of course, if AIG can raise that sort of money elsewhere at a lower rate, then it should be able to do so — but it can’t. Treasury holds all the cards, here, so I do wonder why it’s at all amenable to this idea.

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