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Did the Government Profit From AIG? That's the Wrong Question

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The Treasury Department announced this week it would sell $18 billion worth of AIG shares at $32.50 and the applause started almost immediately. Treasury said taxpayers would see a "positive return" from the investment in AIG, a nonbank financial services firm so systemically important we gave them more than $182 billion to survive.

This is Treasury's biggest dump of AIG shares since the crisis forced a rescue of the insurer in 2008 and supplemental support in 2009. Taxpayers owned almost 80% of AIG in exchange for all that cash.

It can never be proven that the crisis bailouts saved us from financial Armageddon. That's the logical fallacy of asserting a claim with no way to disprove the opposite. So saying we made a profit on the deal is the next best thing. The New York Times' Andrew Ross Sorkin claims, if you combine Treasury actions and "positive returns" on Federal Reserve activities, the Treasury is now "on a path to actually turn a profit." That's where the debate starts.

Former Special Inspector General for the Troubled Asset Relief Program Neil Barofsky says, "Not so fast."  I agree. If your intention is to try to prove or disprove the government PR claims that the taxpayer has made an accounting profit on any of the bailouts, or even broken even, you must remember this: That's not why the government supposedly did what they did. And on the two counts of failing to unfreeze credit and failing to help homeowners – how the bailouts were justified to Congress – the government is guilty.

Treasury never uses the term "profit," even in press releases. The term it does use, "positive return," is a non-Generally Accepted Accounting Principles metric. Treasury has sunk to the level of a social commerce IPO like Groupon, whose infamous Consolidated Segment Operating Income (CSOI) – which was slammed by the Securities and Exchange Commission – glossed over losses to convince investors there was a gain instead.

Combining numbers from the Fed's AIG investment with Treasury's has two big problems. The first is that each entity tracked the value of their AIG investments differently. The second is that you can't assume the numbers published by the Treasury have received the same level of independent scrutiny by independent outside auditors as the Fed's.

Treasury uses a government version of GAAP to prepare its annual reports. The Treasury's caveat: "The statements should be read with the realization that they are for a component of the U.S. Government, a sovereign entity."

Treasury uses Statement on Federal Financial Accounting Standards No. 2 to account for equity investments which requires measurement at the net present value of estimated future cash flows. AIG common stock is held on an "available-for-sale" basis and Treasury records it at fair value using models to calibrate to market prices of similar securities. Modeling the value of Treasury's investment in AIG preferred shares is imperfect since no other asset like it exists.

The Fed's caveat is stronger: "Decisions regarding securities and foreign currency transactions, including their purchase and sale, are motivated by monetary policy objectives rather than profit." At the Fed, these investments are recorded at cost on a settlement-date basis rather than the trade-date basis required by GAAP. The Fed records them at amortized cost rather than fair value.

Barofsky told Sorkin "it's just not accurate" for Sorkin or anyone else to accept Treasury's view of profitability because "they mixed the pot. The Fed's cost basis is zero and they essentially gifted the shares to Treasury."

Another big difference between the Treasury and the Fed is the level of independent scrutiny of any published numbers. The Fed's numbers are audited by Deloitte. That's the firm that also vouched for the solvency of Bear Stearns, Washington Mutual, Royal Bank of Scotland and Merrill Lynch before all ceased to exist as independent companies.

The Treasury is audited by KPMG. However, KPMG does not audit the numbers for the TARP department, Treasury's Office of Financial Stability. KPMG depends on the Government  Accountability Office to do that. "Our opinion," says KPMG in Treasury's 2011 Agency Fiscal Report, "insofar as it relates to the amounts included for IRS and OFS, is based solely on the reports of the other auditor."

The GAO's most recent audit report says OFS still hasn't completely fixed a repeat significant deficiency in internal controls over their financial reporting. The problems include a significant, but not material, incorrect amounts and inconsistent disclosures in OFS's draft financial statements that OFS did not detect, and instances where OFS's accounting and financial reporting procedures were not complete or effectively implemented.

In October 2010, the Congressional Oversight Panel issued a report on Treasury's use of contractors to support OFS and TARP. The largest contractor is PricewaterhouseCoopers, the global accounting and consulting firm and the auditor of AIG since 1980. Did PwC help OFS prepare the status report on the government's "positive return" from the bailout of AIG?  If so, that would be a serious conflict of interest. A Treasury spokesperson did not respond to my inquiry by press time.

My caveat? Don't believe the hype.

Francine McKenna writes the blog re: The Auditors, about the Big Four accounting firms. She worked in consulting, professional services, accounting and financial management for more than 25 years.

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Comments (11)
I believe that the evidence exists to support a belief that the primary purpose of TARP and AIG was to unfreeze the credit markets. Now a presentable case can be made that AIG should have not been protected and the bankruptcy process used to work things through. But protecting the functioning of the credit allocation system was a complete success as all types of credit lines continued to be honored immediately upon these rescues and no one can say that would have been the case if everyone was passing through Chapter 11. I have no idea where GDP would have gone if banks could not have funded lines of credit in October 2008. I have no idea what would have happened if they could not fund credit card purchases or honored a previously committed mortgage. We were facing a complete shutdown of all the credit markets and if that had happened, it is certain that there would have been more businesses filing for Chapter 11, individuals filing for bankruptcy and unemployment would have been much higher than 11% or whatever it's peak was.
Posted by Tom White | Friday, September 14 2012 at 12:27PM ET
This is " any way the author chooses to present the stastics she chooses". like Barofsky she has "an axe to grind", therefore the program cannot be a sucess & of course since there was no armageddon, how do we know it ever was in the first place? This is nothing but sophistory of the poorest quality!
Posted by kinpowell | Friday, September 14 2012 at 12:28PM ET
The real question ought to be, given what the Treasury knew at the time, was the AIG bailout justifiable. While I'm not sure it really produced any measurable positive effects or saved us from a meltdown, perhaps there was some emotional or political value along the lines of "see, we are doing something so the financial markets should feel better."
Posted by GEIII | Friday, September 14 2012 at 12:30PM ET
Even if the numbers are slightly skewed, looks like the administration was able to make the best of a very bad situation, and regardless of party or pursuasion, that good for America and we should rally behind that apparent outcome(and learn from our mistakes of course to avoid history repeating itself yet again.
Posted by Nick Lamjeff | Friday, September 14 2012 at 12:52PM ET
I agree with Barofsky's take in his excellent book Bailout: the Treasury Department did not protect the American taxpayer in the AIG mess. It paid face value to terminate the CDSs, when it could have forced the giant bank counterparties, including Societe Generale and Goldman Sachs and UBS, to take significant haircuts.

This was just another backdoor bailout.
Posted by masaccio | Friday, September 14 2012 at 1:55PM ET
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