The government's decision to rescue AIG during the financial crisis

Aspiring Intern

Current PAC-10 Consulting Management

REF.: The AIG Rescue

As the global financial crisis began to unveil, all of the financial institutions with positions on the market that exposed them to the crash began to feel under pressure. AIG was one such company, where a combination of credit swaps and other esoteric financial instruments weakened its position and its capacity to remain competitive on the market in the face of the financial losses such instruments generated. As of the that point, the U.S. Administration, usually in the form of the Federal Reserve or the Treasury Department, intervened with significant bailouts for many of these companies, including AIG, which received $85 billion in exchange for a 79.9% stake in the company

This memo will aim to briefly analyze the pros and cons of the governmental intervention, briefly analyze the future implications of this intervention and determine whether or not this was a correct action by the government.

Cons of the governmental intervention

The rescue of the AIG is done with the taxpayers' money. The legitimate question that arises is to what degree the rescue of AIG works to the best interest of the taxpayers who have paid for this. At the same time, some of these funds were used to pay for the salaries and benefits of some of the executives who had gotten the company in this situation initially.

The governmental intervention in the case of the AIG affects the overall competitiveness on the financial markets, as there are numerous other financial institutions that have not received federal funds and have either left the business or were forced to file for bankruptcy.

The AIG rescue means an increased governmental intervention on the market, not necessarily in the regulatory way it should be done. This can affects the market's functionality in the long-term.

Future implications of the intervention

There are several implications of the governmental intervention in the case of AIG. On one hand, there continues to be a divergent approach in terms of the way the AIG management receives payment for its services. Initially, the executives' salaries and bonuses were substantially decreased, but there have been different signs lately that this trend is likely to stop and that representatives of the government, notably Kenneth Feinberg, in charge with regulating these issues, tend to believe that a substantial decrease will create problems in terms of AIG's capacity to pay its debt to the government. Notably, in his opinion, decreasing the pay of executives too much would impact the employee retention levels for AIG

However, restating the executive pay at the levels before the financial crisis is likely to have a negative impact on the perception of the taxpayers. Indeed, the overall perception among them is that their money is being used not necessarily to revive the company itself, but rather to sustain levels of payment that can no longer be justified and explained.

The other implication in the future is that the government will need to define (or rather redefine) its level of involvement and implication. The Americanism liberalism has always been characterized by a lack of governmental involvement on the markets. In other words, the market could regulate itself and the government would only implement a limited set of regulations to ensure that the market could function properly.

With the financial crisis, the need for governmental involvement became more apparent. However, one can decide whether this should come in the form of direct investment in companies (which would mean that, in the case of AIG, the government becomes a part owner in the company) or through better regulations that could ensure failures such as the financial crisis do not occur again. Nevertheless, the problem that remained after AIG was the question as to how much the government should be involved in the markets. In the case of AIG and, in general, on the insurance and financial markets, the answer would be obvious after the financial crisis: the government would actually own parts of different financial institutions and companies. Unfortunately, this would make it both a regulator and a participant on the market.

Final analysis and recommendations

The final analysis and recommendations should decide on whether the implication of the government in rescuing AIG was correct, as well as on what should the government do in the future. In the opinion of the writer of this memorandum, the government was correct to intervene financially and bail out AIG. However, at the same time, it is necessary for this to be a temporally limited action: at some point in the short-term, the government should sell its participation back to the original stakeholders and resume its role as regulator on the market. At the same time, in order to ensure that such crisis could be avoided in the future, the government should also expand the regulatory framework and ensure that the rules are better implemented and better respected.

In the short and medium term, the government should ensure the appropriate balance between the executives' pay and the need to maintain the competitiveness of AIG on the labor market and its capacity to continue to attract new talents.