The Fed’s Bail-out of AIG and Shareholder Equity

Elizabeth Nowicki —  18 September 2008

The Federal Reserve Bank of New York’s announcement of an $85 billion bail-out of AIG came as a shock to many of us, and the precise terms of the lending agreement underlying the bail-out are still unclear.

In an e-mail to the BIZLAW listserv, Professor Bainbridge rightly queried how AIG could have offered the Fed secured status for the credit facility given the likelihood that some of AIG’s existing debt instruments have debt-related covenants or are secured by the same assets the Fed is using.  Elliott Manning, Tom Joo, Steven Davidoff, and myself all chimed in, and it is not clear we have a final answer, but it is likely that either (a) such covenants do not exist in the older debt instruments (they obviously do not exist in the 2007 unsecured subordinated debt, but I have not seen the documents for the older secured debt), (b) if these covenants do, they can be waived, and (c) if they cannot be waived, AIG can violate the covenants with a slim likelihood of being sued by priority debt-holders as suing AIG would essentially amount to nudging them toward insolvency.  If any of our readers have thoughts on this topic, please post them.

Another issue, and the more interesting issue in my view (and perhaps in David Zaring’s view), regarding the Fed bail-out of AIG involves the equity stake in AIG that the Fed claims to be getting in return for the $85 B credit facility.  The Fed’s press release says “The [$85B] loan is collateralized by all the assets of AIG, and of its primary non-regulated subsidiaries…. The U.S. government will receive a 79.9 percent equity interest in AIG.”  This equity interest, I am told, takes the form of warrants given to the government, and one commenter on Zaring’s post states that the equity interest is contingent, only to be taken if AIG defaults.

I am unclear as to how AIG can issue an 80% equity stake without the approval of their existing shareholders whose interests will thereby be severely diluted.  Surely AIG does not have 80% of their authorized, issued, and outstanding common stock on hand to use.  Where, then, do they get the authority to issue that much new stock without shareholder approval, … unless the stock is of a different class and the press release is simply conveniently omitting that important fact?

One response to The Fed’s Bail-out of AIG and Shareholder Equity


    If the equity interest in “contingent” this means they have issued a “convertible”.

    This is actually less good than a straight-up bond as if AIG go bankrupt the government will own 80% of a worthless business instead of being a creditor.

    I suppose there is no big issue about the other shareholders for that reason. Perhaps they will have to approve it unless they have already given authority to issue convertibles? But they would be fools not to.