On the eve of the Treasury Department’s sale of its massive position in American International Group (AIG), one group of people has reason to be livid. It is made up of those who held AIG shares on Sept. 16, 2008, because on that day, their property rights were violated egregiously.
At AIG’s current share price, the U.S. government has an unrealized capital gain of more than $40 billion on its initial 79.9 percent holding in the company. For perspective, consider that Congress is debating spending cuts in the ballpark of $50 billion to $100 billion. Federal need for the stash notwithstanding, before Congress blows the whole wad, I suggest legislators consider how the loot was acquired. Part, if not all, of this gain rightfully belongs to dispossessed shareholders.
Without question, it was a magnificent investment. Warren Buffetthimself would be impressed. Although I normally could appreciate the beauty of such a sublimely executed trade, I must withhold my applause this time. Ask yourself this: For this tremendous capital gain, what percentage return did our government achieve? Don’t strain; it’s a trick question. Calculating a rate of return requires dividing gains by the initial investment, but you may remember from grade school that it is impossible to divide any number by zero, which is what the government paid to shareholders for their respective stakes in AIG.
It was claimed that this stake was just compensation for granting AIG access to Federal Reserve lines of credit necessary to keep it afloat. There are at least two major problems with this claim. First, lenders’ compensation typically is denominated in an appropriate interest rate. Since when does lending money permit a lender to take ownership of property unless a loan is in default? Second, if only as a pedagogical matter, I would like to see the calculation behind the government’s 79.9 percent figure. Pricing models are certainly important in the study of finance - and if my students are reading this, yes, it will be on the exam - but they provide only subjective estimates. Specifically, they are subjective estimates of where the public buying and selling of something might be at some point in the future. Any price arrived at by calculation, even by Mr. Buffett, is an educated guess.
However, without needing calculation, there is one way to know exactly a stock’s correct price. I typically ask this on the first day of the semester: If a stock opens at $50, trades up to $55 by noon, then slides down to $49 before closing at $51, what was the correct price of the stock? Answers I commonly get are the day’s opening price, closing price or average price for the day. All are understandable but incomplete. The best answer is that every traded price is the correct price. After all, who has any say about the correctness of a price other than those voluntarily buying or sellingat a particular moment? Because AIG stock did trade on Sept.16, 2008, we know its correct price at any time that day. And it was never zero. So why did shareholders receive zero for their seized property? Was zero dollars just compensation for 80 percent of the company?
If I had been a shareholder and the matter had been put to a vote (which it wasn’t) I well may have voted against letting the government in on such terms and taken my chances. That might have contributed to the company’s demise, but surely that would have been my right, the ramifications notwithstanding. Similarly, the right to destroy my house is mine, not the government‘s, despite its concern for my neighborhood’s property values.
Shylock, the usuriousMerchant of Venice, seems a model of charity in comparison to the feds. All he demanded from poor Antonio was 1 pound of flesh. Assuming the fictitious Antonio was an average man of about 150 pounds, this would represent a diminution to his (human) capital of only about 0.66 percent, and Antonio actually did default on his bond. AIG did not welsh or even have the chance to welsh on its credit, but the feds carted off 80 percent of the company anyway without compensating the existing owners. The U.S. government, normally the arbiter and enforcer of the rules of play, in this case took an active role in the playing of the game, unsurprisingly winning it handily. Just imagine another game in which the refereeing official also gets a point total. Picture it: Nationals 10, Yankees 5, Umpires 879.
With the initial public-offering proceeds, Congress will have the opportunity to rectify this travesty. It is known who the shareholders of record were on that fateful day. When considering the disposition of the capital gains, Congress must remember their forfeiture. That sounds more like just compensation to me.
Michael Justin Lee worked in the George W. Bush administration at the Department of Labor and teaches at the University of Maryland’s Robert H. Smith School of Business.
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