The Big Picture Web Publication

AIG the world's biggest insurer. AN uncontrolled bankruptcy would have dramatically exacerbated the current recession -- possibly turning it into a depression;

2) The NY based firm was also a huge Credit Default Swap insurer/underwriter. The tems of CDS require collateral to be posted, depending upon such factors as credit rating and credit spreads;As home prices fell, spreads widened, and companies went down, AIG's collateral requirements went up significantly.

3) Hence, this is more of a liquidity problem than an actual insolvency. This is the first bailout that adhered to Walter Bagehot's dictum "Central Banks should lend freely at a penalty rate;"

4) Moral Hazard, successfully avoided in the Lehman Brothers bankruptcy, was put aside given the massive size of AIG -- if any firm was TBTF -- too big to fail -- it is AIG.

The Federal Reserve released:

The Federal Reserve Board on Tuesday, with the full support of the Treasury Department, authorized the Federal Reserve Bank of New York to lend up to $85 billion to the American International Group (AIG) under section 13(3) of the Federal Reserve Act. The secured loan has terms and conditions designed to protect the interests of the U.S. government and taxpayers.

The Board determined that, in current circumstances, a disorderly failure of AIG could add to already significant levels of financial market fragility and lead to substantially higher borrowing costs, reduced household wealth, and materially weaker economic performance.

The purpose of this liquidity facility is to assist AIG in meeting its obligations as they come due. This loan will facilitate a process under which AIG will sell certain of its businesses in an orderly manner, with the least possible disruption to the overall economy.

The AIG facility has a 24-month term. Interest will accrue on the outstanding balance at a rate of three-month Libor plus 850 basis points. AIG will be permitted to draw up to $85 billion under the facility.

The interests of taxpayers are protected by key terms of the loan. The loan is collateralized by all the assets of AIG, and of its primary non-regulated subsidiaries. These assets include the stock of substantially all of the regulated subsidiaries. The loan is expected to be repaid from the proceeds of the sale of the firm’s assets. The U.S. government will receive a 79.9 percent equity interest in AIG and has the right to veto the payment of dividends to common and preferred shareholders.

Here's a few excerpts from major media --

Bloomberg:

The U.S. government agreed to lend as much as $85 billion to American International Group Inc. in exchange for a 79.9 percent stake to save the country's biggest insurer from collapse.

The Federal Reserve determined that, in current circumstances, a disorderly failure of AIG could add to already significant levels of financial market fragility and lead to substantially higher borrowing costs, reduced household wealth and materially weaker economic performance, the Fed said.

The agreement, supported by the Treasury Department, will keep New York-based AIG in business, averting a failure that could have threatened more financial companies and added to chaos in world markets. Losses industrywide could have totaled $180 billion if AIG collapsed, according to RBC Capital Markets. AIG needed the loan after its credit ratings were cut and shares plunged 79 percent since Sept. 11.

WSJ:

That the government would prop up AIG financially offers a stark indication of the breadth of the insurer's role in the global economy. If it were to have trouble meeting its obligations, the potential domino effect could reach around the world.

For one thing, banks and mutual funds are major holders off AIG's debt and could take a hit if the insurer were to default. In addition, AIG was a major seller of "credit-default swaps," essentially, insurance against default on assets tied to corporate debt and mortgage securities. Weakness at AIG could force financial institutions in the U.S., Europe and Asia that bought these swaps to take write-downs or losses.

AIG's millions of insurance policyholders appear to be considerably less at risk. That's because of how the company is structured and regulated. Its insurance policies are issued by separate subsidiaries of AIG, highly regulated units that have assets available to pay claims. In the U.S., those assets can't be shifted out of the subsidiaries without regulatory approval, and insurance is also regulated strictly abroad.

NYT:

If A.I.G. had collapsed - and been unable to pay all of its insurance claims - institutional investors around the world would have been instantly forced to reappraise the value of those securities, which in turn would have reduced their own capital and the value of their own debt.

"It would have been a chain reaction," said Uwe Reinhardt, a professor of economics at Princeton University. "The spillover effects could have been incredible."

Financial markets, which on Monday had plunged over worries about A.I.G.’s possible collapse, reacted with relief to the news of the bailout. In anticipation of a deal, stocks rose about 1 percent in the United States on Tuesday and were up about 2 percent in early trading in Asian markets Wednesday morning.

To give you an idea of how interconnected AIG is with the rest of the financial universe, Bloomberg reports that Lehman Brothers Holdings Inc.'s London landlord, Songbird Estates Plc, said rent payments on the bank's offices in the Canary Wharf financial district are insured by American International Group Inc.

The AIG news is unprecedented, and will likely dominate tomorrow's trading. Futures are up only now down modestly.

Tuesday, September 16, 2008 | 10:48 PM

Fed News Flow & Wrap Up

Got back long after the FOMC news was released. As we expected yesterday, the Fed disappointed the perma-bulls and left rates unchanged. Here's what grabbed my eye between meeting. While I am gorging on yet another slab of marbled red meat, I won't leave you with nothing to read.

Here is some interesting news flow surrounding the Fed decision, AIG and other, behind the scenes actions:

Surprise! Fed stays on hold, keeps neutral bias (MarketWatch)

Parsing the Fed: New Risks, Same Rate (WSJ)

Fed to futures market: Thanks but no thanks (Rosenberg/Merrill Lynch)

Bloomberg headline: US Considering AIG "Conservatorship"

Fed Said to Reverse Stance, Consider AIG Loan Package (Bloomberg)

Today's WTF headline: JPMorgan Gave Lehman $138 Billion After Bankruptcy(Bloomberg)

The Crisis of Confidence and the Banks (The Institutional Risk Analyst)

Geithner Skips FOMC Meeting to Stay in New York (for AIG ?) (Real Time Economics)

The End of Dissent: Fisher Joins the Majority (WSJ)

Barclays to acquire Lehman capital markets (MarketWatch)

AIG-LEH-Federal Reserve and asymmetric information (Kotok/Cumberland)

Money fund breaks a buck: Reserve Primary Money Fund Falls Below $1 a Share(Bloomberg)

Shattering the Glass-Steagall: The rise of the commercial banks. (Slate)

Greenspan: Economy in 'once-in-a-century' crisis (CNN/Money)

Why the Fed couldn’t lower rates (iTulip)

A Sense That Wall St.’s Boom Times Are Over (NYT) Do ya think ?

Bail-out or bust? (Economist)

McCain Calls Wall Street Reckless, Obama Hits McCain (Bloomberg)

Investment Banks, By the Numbers (Marketbeat)

Any notice? Russia fell 20% overnight

Lastly, the always objective, neutral and disinterested Hank Greenberg:

It is in America’s interest to save AIG (Real Time Economics)

Tuesday, September 16, 2008 | 07:30 PM

US Considering AIG "Conservatorship"

Bloomberg:

Excerpt:

The U.S. Treasury is considering taking over American International Group Inc. under a conservatorship as one option to address the insurer's crisis, according to two people briefed on the discussions.

Executives from AIG, bankers and Treasury and Federal Reserve officials are meeting today on the company's situation at the New York Fed. A number of options are under being discussed to fill a shortfall of $75 billion to $100 billion in funding, one of the people said. The talks are continuing, he said.

Goldman Sachs Group Inc. and JPMorgan Chase & Co., which have been leading efforts to find a private-sector solution, informed the Fed that such an effort would be difficult, the person said. Under another option, the Fed would extend a loan to New York-based AIG, according to a person informed of the matter.

Source:

Treasury Said to Be Considering AIG Conservatorship

Craig Torres and Elizabeth Hester

Bloomberg, Sept. 16 2008

A Disastrous Rate Cut ?

Monday, September 15, 2008 | 12:00 PM

Why on earth the FOMC would want to undo any of the work by Treasury with a rate cut? The whole idea of letting Lehman die is to reintroduce the concept of risk and eliminate some of the Moral Hazard fostered by prior bailouts.

The current market bet is that a 25 or even 50 basis cut may occur at tomorrow's Fed meeting.

That would be ill advised.

We have survived the initial impact caused by the collapse of Lehman Brothers (LEH). AIG is certainly in trouble, as are Wachovia (WB) and Washington Mutual (WM) and others.

The Fed would be well served, with rates now at 2%, to keep some powder try for the latter innings of this crisis.

Unless we are looking to emulate Japan's 15 year recession, a ZIRP/pushing on a string policy would not be advantageous.

Monday, September 15, 2008

The Terrible Lessons of Bear Stearns

As Lehman Brothers (LEH) turns into a single digit financial midget on its way to zero, as Washington Mutual (WM) works its way towards a buck, as Wachovia (WB) drops more than 80% over a year, as Fannie Mae (FNM) and Freddie Mac (FRE) become divisions of the United States of America, and are now priced in pennies, as AIG continues to plummet -- we need to reflect upon the ongoing lessons learned from all these interventions by Treasury, Congress and the Federal Reserve.

The lesson from the Bear Stearns' bailout -- $29 Billion in Federal Reserve bad paper guarantees -- are quite stark:

Go Big: Don't just risk your company, risk the entire world of Finance. Modest incompetence is insufficient -- if you merely destroy your own company, you won't get rescued. You have to threaten to bring down the entire global financial system. The fear and disruption caused by a Bear collapse is why it was saved. (AIG has the right idea on this)

If you cant Go Big, Go First: Had Lehman collapsed before Bear, then the same fear and loathing of the impact to the system might have worked to their advantage. But having been through this once before, the sting is somewhat lessened -- especially for a smaller, lets interconnected firm like LEH (in the dot com days, we called this "First mover advantage!").

Threaten your counter-parties: Bear Stearns had about 9 trillion in its derivatives book, of which 40% was held by JPMorgan (JPM). Some people have argued that the Bear bailout was actually a preventative rescue of JPMorgan. Its a good strategy if your goal is a bailout -- risk bringing down someone much bigger than yourself.

Risk an important part of the economy: If your book of derivatives is limited to some obscure and irrelevant portion of the economy, you will not get saved. On the other hand, AIG's CDS might threaten much of the financial system. Mortgages are important, credit cards and auto loans are too -- but securitized widget inventory is not. To use a dirty word, Lehman's exposure is "contained," AIG's was not.

Balance Sheets Matter: Focus on the media, complain about short sellers, obsess about PR. These are the hallmarks of a failing strategy -- and a grand waste of time. Why? Its call insolvency. ALL THAT MATTERS IS THE FIRMS' BALANCE SHEET. Lehman's liabilities exceed its assets, and they are now toast. Merrill Lynch got a lot of the junk off of its books, and got a takeover at 70% premium to its closing price. And Credit Suisse, who dumped much of its bad paper many quarters ago, is in a better tactical position than most of its peers.

Unintended Consequences lurk everywhere: When the Fed opened up the liquidity spigots via its alphabet soup of lending facilities, the fear was of the inflationary impacts. But the bigger issue should have been Complacency. The Dick Fulds of the world said after Bear, these new facilities "put the liquidity issue to rest." Lehman got complacent once liquidity was no longer an issue -- perhaps they acted to slowly to resolve their insolvency issue in time.

Unfortunately, Moral Hazard has created terrible lessons in 2008 -- via Bear Stearns (BSC), Lehman (LEH), Fannie Mae (FNM) and Freddie Mac (FRE).

Don Drapkin of Lazard states two things: "The Merrill Lynch deal is terrific for the market, and comes out in favor of the short selling rule, blasts ending the uptick rule." Dylan asks him about leverage, and he says "We have a sound financial system."

Wow, totally empty apohorisms, zeroi value added. Thanks for nothing, Don.

Gasparino redeems himself, discusses Fuld's (now obviously) false statements, saying Lehman's capital is sufficient

Maria Bartiroma says Paulson did not pressure MER into a sale; Merrill BoD voted unanimously for the deal. Maria says AIG and LEH frightened MER into selling itself tonite; Private Wealth Business retains the Merrill Lynch name.

Maria says there was a heavy short interest in MER at $15, but that makes no sense to me

Vince Farrell is accentuating the positive

Federal Reserve Board announces several initiatives to provide additional support to financial markets, including enhancements to its existing liquidity facilities

Still waiting for a Treasury Press Release;

SEC: Statement Regarding Recent Market Events and Lehman Brothers

Fox, meet henhouse: Dylan Ratigan essentially calls Harvey Pitt a corporate tool. Pitt, who actually is a corporate tool, fails to acknowledge the slur. Back when Harvey Pitt was SEC chair, he said the markets were a better regulator of companies than the SEC. For a smart guy, he is a total idiot.

Pitt is discussing competition.

Understated headline of the night: Financial-Sector Distress Likely to Hold Back Stocks (WSJ)

David Kotok says "Look out below."

Lehman Said to Prepare Bankruptcy as Buyers Withdraw (Bloomberg)

Nouriel Roubini says all independent B/Ds are toast, they are highly leveraged, and their business model is fundamentally flawed. Financials facing a "disaster"; bankruptcies, Broker-dealers "are going to disappear."

Its a fundamental, radical change on Wall Street. Expects WaMu to go under, says AIG is in trouble.

AIG CEO turned down PE money, and turns to the Fed. (The currently cannot tap the Fed). AIG Scrambles to Raise Cash, Talks to Fed

U.S. Opts to Avoid Lehman Rescue

CNBC reports that the Fed told Merrill Lynch to "Sell it self" and MER has been shopping itself for a few days.

FT: Hubris - is thy name Richard Fuld?

Oil is under $100; trading at 99 change.

Fed Plans Expanded Lending Facilities

WSJ reporting Bank America/Merrill deal is done at roughly $44 billion.

The Lehman panel itself is an incompetent parade of horribles, and none of them have any business being there. Harvey "make the SEC toothless" Pitt, Bill "thanks-for-the-bailout" Gross, and Charlies "Dick-Fuld-is-AWESOME" Gasparino.

Love it that they brought on Bill Gross and Harvey Pitt to discuss LEH - the irony’s exquisite. Not to mention Gasparino, but that’s just icing on the cake. (I contacted CNBC earlier and offered my services)

Vince Farrell says Bank of America is not stupid. He's wrong, their management has made some rather stupid moves -- how about their purchase of Countrywide? That was $4 billion worth of dumb.

Special Fed rules for taking even junkier paper; Cramer talking up Nasdaq, and he is a buyer not a seller. Harvey Pitt blames short seller. He is as clueless a pundit as he was a SEC Chair.

CNBC Live show with Dylan Ratigan is now beginning.

Lacker & Plosser: No Deal! (at least none funded by US) Friday, September 12, 2008 | 09:28 AM

Richmond Fed President Jeffrey Lacker and his Philadelphia counterpart Charles Plosser raised concerns about moral hazard in June, urging that lines be set for any central bank intervention. U.S. regulators reluctant to backstop another investment bank may point to the fact that speculation about Lehman's potential failure hasn't generated as much concern among investors as Bear Stearns's implosion.

Lawrence Meyer:

What would be best is to alter the precedent with Bear Stearns, said former Fed governor Laurence Meyer, who is now vice chairman of Macroeconomic Advisers LLC, an economic forecasting firm in Washington.

CNBC:

Sources says no government money in resolution of Lehman's situation; Two things will make this deal different: 1) the market has been aware of the situation and has had time to prepare; 2)Fed's primary dealer credit facility now exists to allow for orderly process

"Each crisis has been followed by a bigger crisis..."

Wednesday, September 10, 2008 | 11:30 AM

On Monday, we looked at Weekend Bailouts and Subsequent Market Reactions. CitiFX took a closer look at the data, and they confirm our prior position: Namely, that "Support levels were eventually breached and the market trended lower."

CitiFX Technicals adds:

As the market falls aggressively, we find that there are further developments from authorities that act as ST supports for the Dow. But the real concern is that each crisis has been followed by a bigger crisis and this just does not feel like the "capitulation blow out"