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AIG Bailout Details Don't Tell the Full Story

Updated from Monday, March 16

The public outcry over American International Group's (AIG - Get Report) bailout and bonus fiasco has heated up measurably, but it may only have just begun.

AIG on Sunday evening released a detailed list of payouts made to trading partners, or counterparties, after months of lawmaker demands. Congressional leaders wanted information about who was benefitting from the $170 billion in public money that has so far been extended to prop up the sinking insurer.

The list, however, only relates to Sept. 16 through Dec. 31. The government has since extended additional support to AIG, and the counterparty payments do not mean that all related positions have been closed out.

A big chunk of AIG's payments, $22.4 billion of $118.4 billion, was made to dozens of financial firms which bought credit default swaps from the insurer. CDS insure counterparties against major losses on debt investments. As the value of those investments declined, AIG was obligated to provide collateral payments to the firms that purchased CDS.

But many of those underlying credit assets exist in frozen markets where valuations are subjective at best. The government's initial Troubled Asset Relief Program was scrapped because the Treasury and Federal Reserve could not figure out how to set prices for those assets. Paying too much would cause major losses for taxpayers, but paying too little could send financial firms with major exposure into bankruptcy.

The government abandoned its initial strategy of buying the toxic assets, but in its bailout of AIG it provided the insurer with cash it needed for what it called "severe valuation losses." It should come as no surprise that AIG became a conduit to funnel the cash to its top trading partners. After all, in announcing AIG's first bailout on Sept. 16, the Federal Reserve said it was extending an $85 billion loan to prevent "a disorderly failure" and "to assist AIG in meeting its obligations as they come due."

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