Q&A: Bailout Becomes Magnet For Other Industries

After reporting a huge loss of $29 billion for the quarter, Fannie Mae says its might need more financial assistance beyond the $100 billion the government said it would provide. Meanwhile, insurance giant American International Group is poised to get a revamped bailout package worth more than $150 billion.

What's new this time around for AIG is that the relief package includes funds drawn from the $700 billion bailout package administered by the Treasury Department. Previously, the government had said the $700 billion was reserved for financial companies. And now there's talk of extending that bailout to the Big Three automakers.

That has taxpayers asking whether the government's bailout efforts can really work, and where they end. Here, a look at some of the issues involved.

What kind of help has Fannie Mae already gotten, and why might it need more?

When the government took over Fannie Mae in September, the Treasury Department committed to providing the mortgage finance giant with up to $100 billion of cash in exchange for preferred stock. So far, Fannie hasn't tapped these funds yet, according to the Treasury, but it warns that it will need access to this money — and much, much more — if it becomes insolvent.

The company's financial position has deteriorated along with the economy, creating a bleaker outlook than when the government first took over Fannie two months ago. "There were holes in their balance sheet that we did not know the dimensions of," says Vincent Reinhart, resident scholar at the American Enterprise Institute.

On Monday we learned that the Treasury Department agreed to restructure AIG's assistance package. What's different?

The new assistance program for AIG involves dipping into the $700 billion bailout plan that Congress approved. Previously, only banks and financial services companies were eligible for a share of the pie. The Federal Reserve will also make loans to AIG as part of the new plan at a lower interest rate than the previous loans, and the company will have five years to back the money, instead of two.

The restructured assistance for AIG also addresses the actual purchase of troubled assets, which was not part of the original rescue plan for the company. The Treasury Department has yet to buy any assets for its Troubled Asset Relief Program, or TARP, which was established to help thaw credit markets by buying financial companies' toxic assets. Instead, the Treasury has used the funds to inject cash into firms.

Catherine Mann, a professor of international economics and finance at Brandeis University's International Business School, says that "any resolution of this financial mess" for AIG and other financial institutions requires three components: the flow of money through the system, equity injections and the determination of price — what assets are actually worth. But so far, she says, we've seen no action on the pricing front.

Without a means to price assets, it's next to impossible for companies to value what they have on their books — and for the markets to return to good health.

Critics note that under the terms of the new AIG rescue package, the government — and taxpayers — will get a lower return because part of the restructuring involved cutting the interest rate terms. What's more, Reinhart says, the government is increasing its exposure to risk.

The original goal was "to have us in and out of AIG as quickly as possible," says Jonathan GS Koppell, an associate professor of politics and management at the Yale School of Management.

In mid-September, the Federal Reserve made an $85 billion loan to AIG to prevent its failure. The loan was made in exchange for a 79.9 percent equity stake in the company. The Fed said the two-year loan, with an interest rate based on the three-month LIBOR plus 850 basis points, was designed in part to give AIG some breathing room to be able to sell some of its businesses "in an orderly manner." The expectation was that proceeds from the sale of some of AIG's assets would enable the company to repay the loan. Under the new plan, the government would instead be paid back based on the appreciation of its stake in the overall company.

In early October, the government gave AIG a second loan for $37.8 billion.

But AIG is not a bank, so how come it qualifies for the cash injection?

The decision to keep AIG afloat was based largely on the fact that it was the largest global insurer, with more than $1 trillion in assets. The company insured financial instruments related to the U.S. housing market, and it was "hit squarely between the eyes by the housing finance meltdown," Morningstar senior equity analyst Bill Bergman says in a research note. Bergman says the biggest source of loss and concern was the credit default swaps the company wrote. But even now, AIG still has one of the largest balance sheets in the business.

With markets deteriorating around the company and mounting losses, counterparties — that is, the other companies participating in financial transactions with AIG — have demanded more collateral.

Well, if AIG qualifies for a bailout, why not Detroit?

The Treasury's bailout program was originally designed to assist financial services companies, which held toxic mortgage-backed securities that were at the heart of the financial crisis. The government expanded the reach of the program by offering assistance to banks of all sizes.

"The Treasury is just drifting," says Reinhart. "It didn't have a set of principles by which to guide its decision. What that means is they've had a very hard time drawing lines, and therefore, it has sort of invited firms to encroach."

Now, Detroit's Big Three automakers — General Motors, Ford and Chrysler — are lobbying for $25 billion in loans to help them survive. That's in addition to the $25 billion that Congress approved in September as funding to help the U.S. auto industry develop fuel-efficient technology.

So far, the Treasury Department has given this request a thumbs down, pitching it back into the lap of Congress. Congressional Democrats and President-elect Obama have urged the White House to allocate bailout funds for the companies.

Part of the rationale for extending the assistance is the specter of massive job losses: According to recent estimates from the Center for Automotive Research, the failure of the Big Three could result in nearly 3 million lost jobs in the first year, not just for the automakers but for parts manufacturers, dealers, related industries and in the general economy.

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