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FINANCIAL SYSTEM IN CRISIS: BAILOUTS

Business unusual: U.S. takeovers raise myriad questions

September 21, 2008|Jim Puzzanghera | Times Staff Writer

WASHINGTON — Uncle Sam is turning into Uncle CEO. But will the new corporate suit be a good fit?

By agreeing to bail out insurance giant American International Group Inc. and mortgage lenders Fannie Mae and Freddie Mac, the federal government has put itself in the unprecedented position of running huge private companies. In the case of American International Group, or AIG, the government is now the majority shareholder, acquiring 80% of the company in exchange for lending it as much as $85 billion over two years to keep the business out of bankruptcy as it is dismantled.

But some lawmakers and financial experts wonder whether U.S. officials are up to the task of directing large corporations through such turbulent times. AIG, for instance, has 116,000 employees and does business in about 100 countries. Fannie Mae and Freddie Mac together hold or guarantee $5.4 trillion of mortgages, about half of the nation's home loans.

"The government does not have a core competency to run an insurance company of the magnitude of an AIG," said David M. Walker, former head of the Government Accountability Office, the congressional watchdog agency. "It's clearly not going to be able to effectively manage AIG and do what needs to be done."

Top Bush administration officials say they authorized the controversial bailouts to prevent corporate failures that could have crippled the U.S. economy. But many details about how the government will run the companies, and for how long, are still being worked out.

Some critics of the bailouts are heartened that federal officials moved quickly to place seasoned, private-sector executives into key leadership positions at the companies. For example, Edward M. Liddy, former chairman and chief executive of Allstate Corp., was installed as the new head of AIG and told employees that he didn't think the government intended to "hamstring" the company.

Yet questions remain about what influence federal officials such as Treasury Secretary Henry M. Paulson -- who reportedly sought the ouster of AIG Chief Executive Robert Willumstad as a condition of the bailout -- will exert over the companies, and what role politics might play in their operation.

"When you have these things going on behind closed doors, it's a little disconcerting," said Dean Baker, co-director of the Center for Economic and Policy Research, a left-leaning think tank in Washington. "When you do have sell-offs of the parts of AIG, we want to make sure that is done on a fair-market basis. You don't want to have sweetheart deals."

Still, given the dire financial problems faced by AIG, Fannie Mae and Freddie Mac, Baker said, it won't be difficult for the federal government to improve on their management.

"It's hard to see how they could do worse," he said.

The history of federal bailouts has been generally good, said Benton E. Gup, a finance professor at the University of Alabama and editor of the 2003 book "Too Big to Fail: Policies and Practices in Government Bailouts." The government even turned a $313-million profit on stock options it received when it provided $1.5 billion in loan guarantees to automaker Chrysler Corp. in 1980, he noted.

In those bailouts, however, the government did not take control of the companies. It simply provided guarantees for loans. The Federal Reserve and Treasury did the same thing in March when they authorized $29 billion in loan guarantees to JPMorgan Chase & Co. to facilitate its purchase of struggling brokerage Bear Stearns Cos.

But the bailouts of AIG, Fannie Mae and Freddie Mac are new territory, fueled by an attempt to avoid a global financial disaster.

"They are not taking over because they believe they can manage them better, but rather because it's a way to provide a government guarantee," said Pablo Spiller, a professor of business and technology at UC Berkeley. "This is the biggest financial crisis in the last 80 years."

The subprime mortgage mess crippled Fannie Mae and Freddie Mac, private companies known as government-sponsored enterprises because they were originally chartered by the federal government. Many investors believed the companies -- which buy mortgages from savings and loans, banks and other lenders to generate more cash for those lenders to make more home loans -- had the implicit financial backing of Washington.

Two weeks ago, the federal government seized control of the companies. The Treasury Department plans to buy as much as $100 billion in stock in each, expand their portfolios of mortgages and mortgage-backed securities until 2010, then slowly reduce their holdings.

To do that, the government placed Fannie Mae and Freddie Mac into a conservatorship run by the Federal Housing Finance Agency, a body created by Congress this summer. Paulson said having a government-appointed conservator was the only way he would commit taxpayer money to the bailout.

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