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The Government Bails Out AIG: Was It Worth It?

This is 3 of 3 in our AIG Series. Check out "AIG on the Brink: Was a Bailout Necessary to Save the Financial System?" for the first article and "AIG: The Center of a Financial Apocalypse" for the second article.

AIG became the locus of a financial collapse due to its runaway financial products division and its one-sided stance on the enduring health of the mortgage market. Regardless of the causes for AIG’s evaporating liquidity and imprudent business practices, the disastrous effects of a collapse could be foreseen. Allowing the collapse of what became a focal point in not only the financial system but also the U.S. economy would have led to a freezing of credit and a total erosion of trust in counterparties throughout the financial system. The Treasury’s and Fed’s intervention was needed in order to avoid outright depression and the ramifications that come from such economic conditions: the rise of demagogues, the blaming of groups for hardships, the collapse of social and economic order; and the flaring of tensions leading to war.


The implementation of TARP and the Fed’s programs went fairly well, especially considering the dire circumstances of a decaying financial system and a deteriorating real economy. As Treasury Secretary at the time Hank Paulson put it, a “bazooka” in the form of an unquestionably massive financial reserve to provide capital injections into financial institutions was needed in conjunction with the Fed’s programs in order to restore financial order.

The objectives of TARP and the Fed’s programs were achieved and the financial system and U.S. economy lived to see another day. However, the Treasury’s and Fed’s hastily needed actions were undoubtedly a consequence of implicit government guarantees and bred moral hazard. Perhaps the reasons that Lehman Brothers was allowed to fail while AIG was not are that Lehman was not such a focal point and not on the opposite end of a trade versus the whole financial system. AIG effectively became a “financial octopus” with its poisonous tentacles latched on to other major financial institutions.



From a financial perspective, the 10-year Treasury yield averaged 3.75% between September 2008 and October 2008. As the government was already running a deficit, it is safe to assume that the funds used in the bailout were borrowed funds and would require a rate of return in excess of 3.75% to turn a real profit. Given the $22.7 billion profit on the $182.3 billion total investment, the compounding return is about 3% over a four year period – less than the 3.75% Treasury hurdle rate. Similarly, the 5-year Treasury yield between those two months averaged 2.81%, which makes the bailout a little more palatable. The 10-year is more applicable in this instance due to the uncertainty surrounding the bailout and the general belief that the funds could indeed be tied up for close to a decade.

Still, the cost to the taxpayer was minimal compared to the cost of financial ruin and economic collapse. Moreover, these calculations are crude and do not consider the timing of all the cash flows; they are used to give an approximation of the profitability of the government's intervention. The results could be better or worse considering many factors.

> Part 1: "AIG on the Brink: Was a Bailout Necessary to Save the Financial System?"
> Part 2: "AIG: The Center of a Financial Apocalypse"
> Part 3: "The Government Bails Out AIG: Was It Worth It?"

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