Wednesday, October 22, 2008

The Activist Entrepreneur: Varieties of Nationalization

This is part two in a series of posts chronicling the activist investing efforts of Hank Greenberg at AIG. This blog entry is written by Chris Faille, a writer (formerly with Reuters’ HedgeWorld) and regular contributing expert to our blog. Chris’ blog on the struggles for corporate control can be found at:

The Federal Reserve last month offered AIG a loan of $85 billion. As I noted in the first part of this series, there were significant strings attached. AIG agreed to pay 8.5% over three-month LIBOR, an initial gross commitment fee of 2% of the total loan facility, and an 8.5% fee on undrawn amounts. Also – the kicker – the Fed received a 79.9% stake in the insurer.

The same authorities raised the stakes on October 8, offering a separate line of credit of up to $37.8 billion. This gave AIG a cushion of close to $123 billion. In the punchline of an old joke, “…pretty soon you’re talking about real money.”

Yet the insurer is working through that cash at a steady clip, meeting collateral calls and unwinding its positions on derivatives tied to bad mortgage debts. Even more worrisome, it hasn’t yet managed to arrange any of the asset sales on which its survival certainly depends.

Meanwhile, it has provided the usual diverting let-them-eat-cake story: that now-infamous $440,000 post-rescue weekend at a California spa for (according to the initial reports) certain of its executives. AIG denied one aspect of this report: it has said that the event was for independent agents that bring in a lot of business, not for headquarters execs. Nonetheless, the late night comics had their fodder.

In the midst of the mess, Maurice (“Hank”) Greenberg has put forward his own plan to save the giant insurance company he led for more than four decades. He calls the Fed loan, its terms, and the anticipated asset sales all a “lose/lose plan.” He proposes that the deal be re-negotiated, and that the Fed receive instead non-voting preferred stock with a dividend of about 5.5% and a 10 year right of redemption. (link to Greenberg's letter)

Nationalization by Foreigners
Nationalization looks rather different when it comes from your own government. The partial takeover of AIG that we have seen over the last month reminds me, though, of some observations in a recent book about AIG, and Greenberg’s large place in its history. The book, written by Ron Shelp, a former AIG troubleshooter, with assistance from journalist Al Ehrbar, is fittingly titled Fallen Giant (2006).

It devotes considerable attention to the issue of nationalization, attention that carries an ironic charge now.

When other U.S. companies suffered from nationalization policies in non-U.S. countries, they’ve generally lost the value of the tangible assets in the companies concerned – in Cuba or India, to take just two instances. A U.S. company that lost the value of a nationalized steel plant or automobile assembly line in such a place was assured of the sympathy, and perhaps of the effective assistance, of the U.S. State Department. AIG executives have often had reason to be envious of that.

AIG’s business (as Cornelius Starr himself put it after Castro took over in Cuba) isn’t anything as tangible as a steel plant. It’s “a guarantee, a piece of paper.” Valuing that piece of paper, and determining the compensation appropriate after nationalization, is a tricky matter.

It wasn’t until the 1970s that a considerable lobbying push developed to have the government recognize services, including insurance products, as items of trade on a par with tangible goods. When such a movement did develop, AIG played a big part in it, and Hank Greenberg chaired the trade association that resulted, the Coalition of Service Industries.

This push for parity of treatment for intangibles got underway too late, though, to have an impact on the wording of The Trade Act of 1974. One crucial provision of that law, section 301, gave the executive branch the authority to retaliate against a foreign country that discriminates against U.S. commerce. The discrimination, of course, need not go as far as Castroite nationalization to invoke 301, although that’s a paradigm case.

By 1984 the CSI had made its point, and the law was amended that year to include service industries within the scope of 301.

Shelp and Ehrbar write, “AIG’s worldwide reputation had been substantially enhanced by the very visible leadership it had given to advancing this issue.”

Nationalization at Home
Greenberg, in recent testimony prepared for the House Committee on Oversight, also spoke of this issue. “During my tenure there, AIG opened markets for U.S. businesses all over the world, and contributed significantly to U.S. gross domestic product. For more than three decades, it stood at the vanguard of the movement to liberalize the global trade in services.”

Now that the threat of nationalization has arisen from within the U.S. political system, with some assistance from the state of New York and more assistance from the political tone-deafness of AIG’s leadership, neither the State Department nor the trade officials in the Commerce Department will do it any good.

Furthermore, and unfortunately, Greenberg’s alternative plan is a non-starter. The Fed isn’t obliged to respond to an SEC filing, and of course aren’t likely to “surrender their bond” (if the Shakespearean phrase be allowed) in return for anything less than they were able to exact at the moment of crisis.

But Greenberg has left us that testimony to the House Oversight Committee, and in that he has given us the best account yet of what happened, of how “the risk controls my team and I put in place were weakened or eliminated after my retirement.”

That subject will occupy us in the next installment of this series.

This entry was posted by Chris Faille who is a journalist covering activist investing issues and a regular contributor to our blog.