Wednesday, December 30th, 2009
How can you turn debt into equity?
Jmat81 asked:
Recently, I have heard some economists discussing the bailout the government is proposing. They have suggested that the bailout is not the best way to proceed as it is “rewarding” the wrong people, the bank owners and debt holders. They would prefer to see, as at some naive level I would, those who caused the problems be held accountable. They suggest that this could be done by converting their debt to equity…evidently this is similar to what was done for AIG. I was wondering if someone could explain this in more lay terms.
Recently, I have heard some economists discussing the bailout the government is proposing. They have suggested that the bailout is not the best way to proceed as it is “rewarding” the wrong people, the bank owners and debt holders. They would prefer to see, as at some naive level I would, those who caused the problems be held accountable. They suggest that this could be done by converting their debt to equity…evidently this is similar to what was done for AIG. I was wondering if someone could explain this in more lay terms.
December 30th, 2009 at 4:13 am
Basically, what the government did in the AIG case was extend a line of credit to AIG in exchange for an equity (ownership) interest in the company. By accepting the Line of Credit, AIG gave the government an ownership stake of almost 80 percent of the company. As the company gets sold off (which is the aim of the AIG bailout), the government will be paid back with the proceeds plus interest – in other words, the government makes a profit and by avoiding a distress sale, possibly other equity owners may see some pay back that might not have otherwise happened under fire sale conditions or a complete shutdown.