September 16 in business history: a rollup the bankers took, a peg defended for a day, and 79.9 percent of AIG
Three September 16 decisions — General Motors' incorporation in 1908, Britain's exit from the exchange-rate mechanism in 1992, and the Federal Reserve's loan to AIG in 2008 — show who ends up setting the date on which a commitment comes due.
The number attached to a decision is the part its author controls. The date that number comes due is usually set by somebody else — a lender, a market, or the counterparty on the other side of the contract. Three commitments dated September 16 show how that division of labour works in practice: a holding company chartered in 1908 that bought its rivals with its own securities and was handed to its bankers two years later; a currency fixed at 2.95 deutsche marks in 1990 and given up in one afternoon in 1992; and a guarantee called within hours in 2008, at a cost of 79.9 percent of the company that wrote it.
General Motors: a rollup paid for with its own paper
On September 16, 1908, William Crapo Durant incorporated General Motors in New Jersey 1. The company began as a holding company for Buick, which Durant had managed since 1904, and for Oldsmobile 2. Durant had already built the Durant-Dort Carriage Company from a $2,000 investment into a $2 million business, the largest vehicle manufacturer in the United States, and by 1908 Buick's output exceeded Ford's and Cadillac's combined 2.
The shape of the company was a compromise. A consolidation of Ford, REO, Maxwell-Briscoe and Buick, organised under the sponsorship of the financier J.P. Morgan, collapsed when Henry Ford insisted on being paid in cash. Durant went ahead with a holding company that left its parts largely alone, against Benjamin Briscoe's preference for merging them completely. "Durant is for states' rights," Briscoe said. "I am for a union." 1
Durant then bought faster than his balance sheet could fund. General Motors' own history counts 22 companies purchased within sixteen months of incorporation, among them Cadillac, Oakland (later Pontiac) and McLaughlin of Canada; several turned out to be worthless. Other accounts of the same two years count 30 companies, including 11 automakers 12. The Detroit Historical Society records the debt this left behind: $15 million incurred through the acquisitions 3.
The bill arrived in 1910. The market for large cars dried up as buyers moved to Ford's Model T, and General Motors was offering 21 models built by 10 independent divisions, few of them profitable 2. To borrow the money that would keep the company afloat, Durant accepted bankers' control of it for the five-year term of the loan, from September 26, 1910 23.
He bought his way back in. Durant founded Chevrolet in 1911, and by 1916 Chevrolet held a controlling interest in General Motors, which returned him to the presidency 2. The second exit was his own doing: when the post-war boom ended in 1920 and stocks lost a quarter of their value, he bought General Motors shares on margin and lost $90 million in six months, accepting a rescue that required him to resign 2. Alfred Sloan's structure of centralised control over decentralised divisions, and the market share it produced, came after he was gone; General Motors passed Ford in sales by the late 1920s 3.
Decision mirror: A consolidator spends its own securities and borrows against them, and the lender who fills the gap takes the equity when the gap opens. In October 2019, SoftBank committed more than $10 billion to WeWork and finished with 80 percent of the company, having valued it at $8 billion in the deal against a $47 billion valuation in January; the founder left the board with a $685 million side payment, a $500 million loan and a $185 million consulting fee 4. The terms of a rescue are written by whoever can still write a cheque.
Sterling: a price the state promised to hold
Britain joined the Exchange Rate Mechanism in October 1990 with sterling fixed at DM 2.95, a rate the currency sat pinned against through 1991 and 1992 while German reunification kept Bundesbank interest rates high 5.
The pressure broke on September 16, 1992, a day after the Bundesbank's president, Helmut Schlesinger, spoke publicly of the need for a "wider-ranging realignment" of currencies and traders read an imminent devaluation 5. By mid-morning the Bank of England was buying £2 billion of sterling an hour 5. At 11 a.m. the base rate went from 10 to 12 percent; that afternoon it was raised again, to 15 percent 56. At 7.40 p.m. the Chancellor, Norman Lamont, announced that Britain was suspending its membership of the mechanism with immediate effect, and the second rate rise was revoked 6.
The defending side's bill came in two versions. The City estimated that about £10 billion of Britain's reserves had been spent, roughly 40 percent of them, and sterling closed in New York at DM 2.69 — nine pfennigs below its former permitted floor 6. The Treasury's later estimate of the losses on the day's trading was £3.3 billion, and the Bank of England records the episode as having cost the Treasury over £3 billion, with the next day's 15 percent rate rise cancelled 57. On the other side of the trade, George Soros's Quantum Fund, which had sold sterling short, was reported to have made about $1 billion 8.
What the surrender bought is the part that matters for anyone holding a fixed price. The peg was replaced by an inflation target; in October 1992 the Chancellor asked the Bank of England to publish a regular report on progress against it, and the first Inflation Report appeared in February 1993 7. The economy grew through the rest of the decade, and the day acquired a second name — White Wednesday 5.
Decision mirror: The Swiss National Bank shows what the same decision looks like when the defender picks the day. On January 15, 2015, it discontinued its CHF 1.20 floor against the euro with immediate effect and cut its policy rate to −0.75 percent 9. The euro fell from 1.20 francs to 0.8052 before recovering to 1.04, Swiss shares closed 9 percent lower, and the watchmaker Swatch lost 15 percent of its market value in a day 10. Both central banks paid; one chose the timing and the other had it chosen for it.
AIG: a guarantee called by a ratings line
The Federal Reserve Board released its decision at 9.00 p.m. Eastern on September 16, 2008, with the Treasury's support: the Federal Reserve Bank of New York was authorised to lend up to $85 billion to the American International Group under section 13(3) of the Federal Reserve Act 11. The terms were a 24-month secured loan at three-month Libor plus 850 basis points, collateralised by all the assets of AIG and its primary non-regulated subsidiaries, including the stock of substantially all of its regulated insurance subsidiaries. In exchange, the United States received a 79.9 percent equity interest in the company and the right to veto dividends on its common and preferred shares; the loan was expected to be repaid out of the sale of AIG's businesses 11.
The trigger was a contract term. AIG had $1 trillion of consolidated assets at mid-2008 and had sold credit default swap protection through AIG Financial Products, an unregulated unit 1213. All three ratings agencies cut AIG's rating on September 15, and the downgrades triggered an additional round of cash collateral calls on those swaps — collateral AIG could not post 14. The New York Fed's general counsel later testified that a further downgrade would have "immediately triggered billions of dollars of additional liquidity demands related to AIG FP's business" 13.
Two restructurings followed the $85 billion announcement. On November 10, 2008, the Treasury bought $40 billion of AIG preferred stock with money from the Troubled Asset Relief Program, the Fed's facility was cut from $85 billion to $60 billion, its term extended to five years and its rate reduced to Libor plus 300 basis points 12. A second restructuring on March 2, 2009 added a Treasury equity facility of up to about $30 billion, reduced the Fed's outstanding balance by about $26 billion in exchange for preferred interests in two life insurance subsidiaries, and cut total available credit to $35 billion 12.
The company's own results show what those contracts had done to it. AIG reported a fourth-quarter 2008 net loss of $61.7 billion, or $22.95 a share, and a full-year loss of $99.3 billion, or $37.84 a share 15. The Federal Reserve and the Treasury's combined maximum commitment peaked at $182.3 billion; by December 11, 2012, when the Treasury sold its last AIG shares, it reported a positive return of $22.7 billion across the programmes — $17.7 billion to the Fed and $5.0 billion to the Treasury — with AIG's size cut nearly in half and the derivatives unit's legacy exposure down more than 93 percent 16. Against that, AIG's shareholders gave up 79.9 percent of the company for the timetable 11.
Decision mirror: Collateral clauses are what turn a price move into a cash call on somebody else's schedule. In September 2022, after the UK's fiscal statement of September 23, the yield on 30-year gilts rose 130 basis points in three days of trading, levered liability-driven investment funds faced margin calls faster than they could recapitalise, and the Bank of England opened a temporary gilt purchase facility on September 28, buying £19.3 billion over the following two weeks and unwinding the whole position by January 2023 17.
The diligence test
Four questions to run against a commitment of your own this week:
- What is the commitment made of? General Motors paid for 22 companies with its own securities and a $15 million debt, and the debt decided who ran the company.
- Who holds the trigger? AIG's guarantees came due on a ratings downgrade; sterling's floor came due on the Bundesbank's next sentence about realignment. Name the event that starts your clock, and who controls it.
- What does one more day of defence cost? The Bank of England spent about £2 billion an hour on September 16, 1992, and the Treasury's later estimate of the day's losses was £3.3 billion. Put an hourly price on holding your position.
- Who ends up owning it? The United States took 79.9 percent of AIG for the timetable it provided, and SoftBank took 80 percent of WeWork for the cheque it wrote. Model the cap table that survives the rescue.
References
- 1
- 2
- 3Detroit Historical Society: General Motors
detroithistorical.org
- 4
- 5Econlib: Wednesday, Black and White
econlib.org
- 6The Guardian: Pound drops out of ERM, 17 September 1992
theguardian.com
- 7Bank of England: Our history
bankofengland.co.uk
- 8Investopedia: George Soros and Black Wednesday
investopedia.com
- 9
- 10
- 11Federal Reserve: $85 billion credit facility for AIG, 16 September 2008
federalreserve.gov
- 12
- 13
- 14Financial Crisis Inquiry Commission: September 2008, the bailout of AIG
fcic-static.law.stanford.edu
- 15AIG: Reports Fourth Quarter and Full Year 2008 Loss, 2 March 2009
fraser.stlouisfed.org
- 16
- 17
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