AIG in talks with U.S. for more funds, GM thinks bankruptcy may cost more than government aid

CNN Money reports that AIG is in talks to seek additional funds from the US Treasury. AIG is essentially nationalized. It has a loan on fairly strict terms from the US Treasury. It has already sought two rounds of funding. In addition to giving the US government an 80% ownership stake, the first loan carried terms that basically meant AIG would have to sell off a large proportion, and possibly most, of its assets to pay off the Treasury. The terms were made somewhat less stringent, if I recall correctly, in round 2, because AIG was having trouble selling assets.

AIG is systemically important. Putting AIG into liquidation could cause damage to other financial firms for various reasons. AIG was a trading counterparty for various instruments, for example. The US is not likely to let it fail, which would strain the credit markets probably beyond relief. However, I believe that round 3 should mean the company is formally put into conservatorship and forced to run off existing business. That's essentially a controlled liquidation. Equity and debt owners, aside from the US government, should be given whatever is left after all the dust settles. I'm not sure if that's legally possible, but I think that outcome ensures the least amount of injustice. Disclosure: I used to own AIG stock. Obviously I lost money on that.

Next, GM and Chryslersaid several days ago that a new loan from the US government would save it. They claimed it would be cheaper than the company going into bankruptcy.

If the company were liquidated, the effects would be disastrous. I don't see any reason to disagree over that. Jobs would be lost, supply chain companies would go under. Assuming Ford did not also go under, their supply chain would be severely disrupted. GM and/or Chrsyler could reorganize in bankruptcy, but GM claims it would need $100 billion in debtor in possession (DIP) financing from the US government to make it out of bankruptcy.

DIP financing means the government gives them a loan when in bankruptcy to get them out. The government is first creditor, meaning that if they fail, the government gets paid first. In a chapter 11 reorganization, the bankruptcy court has authority to renegotiate by fiat just about all of the company's labor, supplier and creditor contracts. Given how some parties won't budge otherwise, some folks have said that maybe GM should just file. Others have said that it's going to be very costly to the government and that buyers won't buy cars from an automaker in bankruptcy.

However, a different NYT article quotes a New York University business professor who said he thought GM would only need $50bn in DIP financing. He said that the companies could be overstating the potential cost as a scare tactic.

In both these cases, the US government must weigh the damage caused by letting the automakers liquidate with the cost of propping them up. A CNN Money article contends that there is no easy way to fix Detroit's troubles. Aside from letting them reorganize in bankruptcy or loaning them whatever funds they need (which are likely to be far more than the companies claim), one other choice is to let Chrysler die and prop GM and/or Ford up, or force Chrysler to merge with GM. Another option I can think of is the one I suggested for AIG: put them into conservatorship. Prop them up temporarily and liquidate them as the economy recovers.

Edit: Across the pond, the UK is facing a similar situation with the Royal Bank of Scotland, which made too many aggressive acquisitions in the good years.