Did AIG pay its debt, or just disguise it?

How do you make $25 billion in debt to the American people disappear overnight? Ask the American International Group, better known as AIG. Just days ago, AIG owed the Federal Reserve Board of New York's credit facility $42 billion, and that was before interest and fees.  Now with a little accounting magic and without paying a dime, that debt has been slashed to a mere $17 billion. 

 
How was this done?   AIG has two newly formed subsidiaries: American International Assurance (AIA) and American Life Insurance Company (Alico). With what appears to be sleight-of-hand, AIG has exchanged the preferred equity interest in the two companies for debt of $25 billion. The common shares of the two companies will still be held by AIG, while the parent company decides how the stock will be sold.  AIG's press release which announced the transactions stated that this move furthers their goal of positioning AIA and Alico either for third party sale or an Initial Public Offering.   The decision of how to sell the common stock will depend on market conditions at the time, and the customary regulatory approvals that apply.
 
AIG's Chief Executive Officer, Bob Benmosche said in the press release, "Today's announcement that we reduced our debt to the Federal Reserve Board of New York by $25 billion sends a clear message to taxpayers: AIG continues to make good on its commitment to pay the American people back.  Moreover these transactions position AIA and Alico, two terrific, unique international life insurance businesses, for the future."
 
The Reserve Board credit facility trust was created in September 2008, with the extension of $85 billion in credit to AIG.  When AIG's debt is fully repaid, the credit facility will continue to hold the majority – 79.8 percent – of the company's preferred stock. From the initiation of that debt to the end of September, 2009, AIG has recognized $11.7 billion in amortization expenses and expects to recognize another $5.7 billion in 2009's fourth quarter (which includes $5.2 billion in accelerated amortization related to the AIA and Alico transactions).
 
"We continue to focus on stabilizing and strengthening our businesses, but expect continued volatility in reported results in the coming quarters," says Benmosche, "due in part to charges related to ongoing restructuring activities, such as the previously announced loss that we expect to recognize in the upcoming quarter related to our announced agreement to sell our Taiwan based life insurer, Nan Shan."

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