Libor + 850bp

It's done. The US government is bailing out AIG to the tune of $85 billion. But boy is it an expensive loan:

Interest will accrue on the outstanding balance at the three-month London interbank offered rate plus 8.5 percentage points.

If everything goes according to plan, the outstanding balance will decline dramatically over the two-year life of the loan as AIG sells off assets. But to a first approximation, let's just assume the $85 billion is repaid at maturity, and that 3-month libor stays at its current level of 2.81%. Then the interest rate on the loan will be 11.31%, and the total interest paid over two years will be over $19 billion. It's kinda an open question here who's bailing out whom.

To put that in perspective, total US corporate income taxes in fiscal 2006 totaled $380 billion -- which means that the government's interest payments from AIG will account for about 2.5% of all US corporate tax revenues over the next two years.

Assuming, of course, that AIG doesn't default. But it won't: it's now owned by the US government, and entities owned by the US government don't default.

This is basically the same thing as we saw with Fannie and Freddie: shareholders get diluted, bondholders get bailed out, systemic risk is averted. But with AIG, Treasury is making the company pay through the nose for the privilege of being bailed out. It didn't need to do so: it could have just bought an 80% stake for a nominal sum, and made it clear that it guaranteed AIG's debt. No big $85 billion headline figure, but the same practical result. The reason for the $85 billion loan is not that AIG needs the money -- it doesn't, now that it has an implicit government guarantee. Rather, it ensures that AIG ends up paying a lot of interest back to Treasury.

This is something which, frankly, only a lame-duck executive could pull off. It's easy to foresee the screaming headlines tomorrow: the US government spending $85 billion, or $850 per American household, on bailing out Wall Street fat cats. No politician wants to see that. But Paulson isn't a politician, and the president isn't worrying about being re-elected. So they can do it. I don't like it, necessarily, but at least we averted a counterparty-risk meltdown.

Update: Aha. It's not actually a loan of $85 billion, it's authorization "to lend up to $85 billion" -- it's a liquidity facility more than an actual loan. So total interest could be much, much lower than the numbers above, if AIG doesn't find itself in need of the cash.