By David Cho, Binyamin Appelbaum and Zachary A. Goldfarb
Washington Post Staff Writers
Saturday, October 25, 2008
The Treasury Department is dramatically expanding the scope of its bailout of the financial system with a plan to take ownership stakes in the nation's insurance companies, signaling new concerns about a sector of the economy whose troubles until now have been overshadowed by the banking industry, government and industry sources said.
Insurers, including The Hartford, Prudential and MetLife, have pushed the Bush administration to include them in the plan. Many firms have taken losses from mortgage-related securities and other investments and are struggling to replenish their coffers.
Government officials worry that the collapse of a major insurer could further destabilize the financial system because of the crucial role the companies play in backstopping a wide range of financial transactions, although the direct impact on holders of car, life and other insurance policies would be modest, industry officials said.
The new initiative underscores the growing range of problems that Treasury is scrambling to address with the $700 billion allocated by Congress this month. The shape of the plan has changed repeatedly since Treasury Secretary Henry M. Paulson Jr. introduced it last month as an effort to rescue banks by buying their troubled mortgage-related assets. That original mandate has now been pushed aside by a plan to take equity stakes in banks and insurance companies, and other businesses are lobbying to be included.
The government has been forced to expand the plan partly because the federal guarantees previously given some institutions, such as banks, have put other companies and financial sectors at a disadvantage, making them less attractive to uneasy investors.
The government's power to choose winners and losers in the crisis was illustrated yesterday when the Cleveland-based bank National City was forced to sell itself when regulators turned down its request for a Treasury investment after deciding the firm was too weak to save, according to people familiar with the matter. Instead, the Treasury gave $7.7 billion to PNC Financial Services Group to help buy National City. It did not require that the money be used for new lending, the stated purpose of the government plan. PNC, which has a major presence in the Washington region, would become the fifth-largest bank in the country by deposits.
Treasury officials yesterday backed away from plans to publicize a new round of investments in about 20 large regional banks over concerns that firms not on the list would be perceived as unhealthy and punished by investors. Capital One of McLean, SunTrust of Atlanta and KeyCorp of Cleveland are among the banks that will receive government funding, according to people familiar with the matter. Other banks are now free to make their own announcements, as PNC did yesterday.
The cost of saving the country's largest insurer continues to rise. Senior managers at troubled insurance giant American International Group warned the Federal Reserve yesterday that the company would probably need more taxpayer money than the $123 billion in rescue loans the government has provided, according to two sources familiar with the private talks.
AIG is having a painful time trying to pay off bad bets it made guaranteeing other companies' risky mortgage investments, which have lost much of their value. Five weeks after the government launched an unprecedented bailout to save the private company from bankruptcy, AIG has so far burned through $90.3 billion of government credit.
The troubles at AIG highlight the difficulty of rescuing insurance companies after they begin to unravel. Each week, AIG has faced multimillion-dollar collateral calls to pay off the mortgages and other assets it guaranteed, sources said. The calls were triggered largely because AIG's credit rating was sharply downgraded. The Federal Reserve Bank of New York and AIG declined to comment yesterday on the talks or to characterize AIG's situation.
"In light of worldwide economic and financial conditions, we are in constant conversations with the Federal Reserve," said AIG spokesman Joseph Norton, who offered no further comment.
The move to rescue other insurers raises questions about how much the government will need to spend to prop up the insurance sector and which part of the nation's financial system might need help next.
"The big problem is whether the resources they've got available are sufficient as they expand to more and more sectors," said Roberton Williams, a budget expert at the Urban Institute. "Now that they're going to expand to certain insurance institutions, is there enough money to cover that? And what would be the next domino to fall?"
If an insurer filed for bankruptcy protection, the direct impact on most consumers would probably be minimal. Most policies, such as car and home insurance, would be transferred to another company. But in many states, the cash value of life insurance policies and a widely held retirement insurance product called a fixed annuity is guaranteed only up to $100,000.
The Emergency Economic Stabilization Act, approved by Congress and signed into law Oct. 3, permits Paulson to invest in any financial institution, including insurance companies. But when Treasury drafted rules for spending the first $250 billion to recapitalize banks, the program was limited to banks and bank holding companies. In order to buy stock in insurance companies, Treasury officials would have to redraft the rules for the program or create a new one.
Insurers lobbied federal officials for inclusion in the program, arguing in part that it would "level the playing field" between banks and insurance firms. An industry trade group and several insurance companies have met with Treasury officials to discuss participation, industry sources said.
Several insurers yesterday emphasized that their industry is less vulnerable to the mortgage-backed securities and other complex investments that have damaged the balance sheets of some banks.
A recent report by Goldman Sachs noted that many insurers are struggling to raise enough capital to keep their credit ratings and meet regulatory requirements. Several major companies report earnings next week, putting their problems on public display.
"These people are not in the same precarious position as AIG, but it would still be prudent for some of them to take on additional capital," Donn Vickrey of Gradient Analytics said. "Given how large the losses are and how long they've been building, they're running out of time."
Treasury officials said yesterday that insurance companies organized as thrift holding companies are already eligible to receive federal money. That list includes most of the largest insurance companies.
Industry sources said that the Treasury has formed a team to examine how it can help insurance companies that have no federal regulator. Many of these companies are subject to oversight by state authorities.
"The life insurance industry is pleased to learn the Treasury Department is considering the inclusion of the life insurance industry in its Capital Purchase Program," said Frank Keating, president and chief executive of the American Council of Life Insurers.
MBIA and Ambac, the country's largest bond insurers, are among those most at risk. Executives from the two companies met Tuesday in New York with their regulators to discuss options for winning help from the government, including getting capital injections. The day before the meeting, New York State Insurance Superintendent Eric Dinallo said bond insurers may need as much as $20 billion from federal coffers.
Several economists said they were not surprised that Treasury has turned its attention to insurance companies, which are as likely as banks to be heavily leveraged and exposed to the fallout from rampant foreclosures on residential mortgages.
"It's the financial system in general" that's in trouble, said Alex J. Pollock, a former banker and resident fellow at the American Enterprise Institute. "Insurance companies are very important suppliers of credit to the rest of the economy and the rest of the financial system."
Yesterday, the Financial Services Roundtable, a trade association for the largest financial firms, sent a letter to the Treasury urging the government to consider investments in a broader range of companies, including broker dealers, automobile companies, and foreign banks and insurance firms.
Yet progress on the Treasury program remains halting. The roughly 20 regional banks joining it would be added to nine of the largest American banks, including Bank of America, Citigroup and J.P. Morgan Chase, which were forced to accept $125 billion in funding last week. But the Treasury has yet to give federal money to any of the banks because of legal wrangling over the details of the investment agreements.
Assistant Treasury Secretary Neel Kashkari, the official responsible for the program, said in testimony before Congress this week that the next round of banks probably wouldn't get funding for "a few weeks."
Banks that accept government investments must agree in return to issue to the government shares of preferred stock, which pay annual interest of 5 percent, and warrants for shares of common stock, which allow the government to profit as the company's share price rises. Banks also must accept limits on executive compensation and cannot raise dividends without permission.
The PNC deal is the latest mega-merger orchestrated by the government to save a troubled bank. Previous rescues included Washington Mutual and Wachovia. Like Wells Fargo, which bought Wachovia, PNC will benefit from a recent rule change that allows it to use National City's losses to shelter income from taxes.
PNC has been relatively untouched by the mortgage crisis. But the meltdown has caused deep losses for National City. PNC said it expects it could book $19.9 billion in losses, representing 17.5 percent of National City's loan portfolio.
Staff writers Carol D. Leonnig, Lori Montgomery and Peter Whoriskey contributed to this report.