American capitalism new lifeline and source of survival – US government bailouts

Discussion in 'Economics' started by SouthAmerica, Sep 14, 2008.

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    “Fed’s $85 Billion Loan Rescues Insurere”
    U.S. to Get Control of the Troubled Giant A.I.G.
    By Edmund L. Andrews, Michael J. de la Merced and Mary Williams Walsh
    The New York Times - September 17, 2008

    WASHINGTON — Fearing a financial crisis worldwide, the Federal Reserve reversed course on Tuesday and agreed to an $85 billion bailout that would give the government control of the troubled insurance giant American International Group..

    The decision, only two weeks after the Treasury took over the federally chartered mortgage finance companies Fannie Mae and Freddie Mac, is the most radical intervention in private business in the central bank’s history.

    With time running out after A.I.G. failed to get a bank loan to avoid bankruptcy, Treasury Secretary Henry M. Paulson Jr. and the Fed chairman, Ben Bernanke, convened a meeting with House and Senate leaders on Capitol Hill about 6:30 p.m. Tuesday to explain the rescue plan. They emerged just after 7:30 p.m. with Mr. Paulson and Mr. Bernanke looking grim, but with top lawmakers initially expressing support for the plan. But the bailout is likely to prove controversial, because it effectively puts taxpayer money at risk while protecting bad investments made by A.I.G. and other institutions it does business with.

    What frightened Fed and Treasury officials was not simply the prospect of another giant corporate bankruptcy, but A.I.G.’s role as an enormous provider of esoteric financial insurance contracts to investors who bought complex debt securities. They effectively required A.I.G. to cover losses suffered by the buyers in the event the securities defaulted. It meant A.I.G. was potentially on the hook for billions of dollars’ worth of risky securities that were once considered safe.

    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, and that in turn would have reduced their own capital and the value of their own debt. Small investors, including anyone who owned money market funds with A.I.G. securities, could have been hurt, too. And some insurance policy holders were worried, even though they have some protections.

    ...Financial markets, which on Monday had plunged over worries about A.I.G.’s possible collapse and the bankruptcy of Lehman Brothers, 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. Asian stock markets opened with strong gains on Wednesday morning, but the rally lost steam as worries returned about the extent of harm to the global financial system.

    Still, the move will likely start an intense political debate during the presidential election campaign over who is to blame for the financial crisis that prompted the rescue.

    ...A major concern is that the A.I.G. rescue won’t be the last. At Tuesday night’s meeting. lawmakers asked if there was any way of knowing if this would be the final major government intervention. Mr. Bernanke and Mr. Paulson said there was not. Indeed, the markets remain worried about the financial condition of major regional banks as well as that of Washington Mutual, the nation’s largest thrift.

    The decision was a remarkable turnaround by the Bush administration and Mr. Paulson, who had flatly refused over the weekend to risk taxpayer money to prevent the collapse of Lehman Brothers or the distressed sale of Merrill Lynch to Bank of America.

    Earlier this year, the government bailed out another investment bank, Bear Stearns, by engineering a sale to JPMorgan Chase that left taxpayers on the hook for up to $29 billion of bad investments by Bear Stearns. The government hoped at the time that this unusual step would both calm markets and lead to a recovery by the financial system. But critics warned at the time that it would only encourage others to seek bailouts, and the eventual costs to the government would be staggering.

    The decision to rescue A.I.G. came on the same day that the Fed decided to leave its benchmark interest rate unchanged at 2 percent, turning aside hopes by many on Wall Street that the Fed would try to shore up confidence by cutting rates once again. Fed and Treasury officials initially turned a cold shoulder to A.I.G. when company executives pleaded on Sunday night for the Fed to provide a $40 billion bridge loan to stave off a crippling downgrade of its credit ratings as a result of investment losses that totalled tens of billions of dollars.

    But government officials reluctantly backed away from their tough-minded approach after a failed attempt to line up private financing with help from JPMorgan Chase and Goldman Sachs, which told federal officials they simply could not raise the money given both the general turmoil in credit markets and the specific fears of problems with A.I.G. The complexity of A.I.G.’s business, and the fact that it does business with thousands of companies around the globe, make its survival crucial at a time when there is stress throughout the financial system worldwide.

    “It’s the interconnectedness and the fear of the unknown,” said Roger Altman, a former Treasury official under President Bill Clinton. “The prospect of the world’s largest insurer failing, together with the interconnectedness and the uncertainty about the collateral damage — that’s why it’s scaring people so much.”

    Under the plan, the Fed will make a two-year loan to A.I.G. of up to $85 billion and, in return, will receive warrants that can be converted into common stock giving the government nearly 80 percent ownership of the insurer, if the existing shareholders approve. All of the company’s assets are being pledged to secure the loan.

    Existing stockholders have already seen the value of their stock drop more than 90 percent in the last year. Now they will suffer even more, although they will not be totally wiped out. The Fed was advised by Morgan Stanley, and A.I.G. by the Blackstone Group. Fed staffers said that they expected A.I.G. would repay the loan before it comes due in two years, either through the sales of assets or through operations.

    Asked why Lehman was allowed to fail, but A.I.G. was not, a Fed staffer said the markets were more prepared for the failure of an investment bank.

    Robert B. Willumstad, who became A.I.G.’s chief executive in June, will be succeeded by Edward M. Liddy, the former chairman of the Allstate Corporation. Under the terms of his employment contract with A.I.G., Mr. Willumstad could receive an exit package worth as much as $8.7 million if his removal is determined to be “without cause,” according to an analysis by James F. Reda and Associates.

    A.I.G. is a sprawling empire built by Maurice R. Greenberg, who acquired hundreds of businesses all over the world until he was ousted amid an accounting scandal in 2005. Many of A.I.G.’s subsidiaries wrote insurance of various types. Others made home loans and leased aircraft. The diverse array of companies were more valuable under a single corporate parent like A.I.G., because their business cycles offset each other, giving A.I.G. a relatively smooth stream of revenue and income.

    After Mr. Greenberg’s departure, A.I.G. restated its books over a five-year period and instituted conservative new accounting policies. But before the company could really rebuild itself, it became embroiled in the mortgage crisis. Some of its insurance companies ended up with mortgage-backed securities on their books, but the real trouble involved the insurance that its financial products unit offered investors for complex debt securities.

    Its stock tumbled faster this year as first the debt securities lost value, and then the insurance contracts, called credit default swaps, came under a cloud.

    The Fed’s extraordinary rescue of A.I.G. underscores how much fear remains about the destructive potential of the complex financial instruments, like credit default swaps, that brought A.I.G. to its knees. The market for such instruments has exploded in recent years, but it is almost entirely unregulated. When A.I.G. began to teeter in the last few days, it became clear that if it defaulted on its commitments under the swaps, it could set off a devastating chain reaction through the financial system.

    “We are witnessing a rather unique event in the history of the United States,” said Suresh Sundaresan, the Chase Manhattan Bank professor of economics and finance at Columbia University. He thought the near brush with catastrophe would bring about an acceleration of efforts within the Treasury and the Fed to put safety controls on the use of credit default swaps.

    “They’re going to tighten the screws and say, ‘We want some safeguards on this market,’ ” he said of the Fed and the Treasury.

    The swaps are not securities and are not regulated by the Securities and Exchange Commission. And while they perform the same function as an insurance policy, they are not insurance in the conventional sense, so insurance regulators do not monitor them either.

    That situation set the stage for deep losses for all the countless investors and other entities that had entered into A.I.G.’s swap contracts. Of the $441 billion in credit default swaps that A.I.G. listed at midyear, more than three-quarters were held by European banks.

    “Suddenly banks would be holding a lot of bondlike instruments that were no longer insured,” Mr. Sundaresan said. “They would have to mark them down. And when they marked them down, they would require more capital. And then they would have to go out and raise capital in these markets, which is very difficult.”

    Source: http://www.nytimes.com/2008/09/17/business/17insure.html?

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    #21     Sep 17, 2008
  2. Agreed, it is what everyone needs whether they understand it or not.
    It produces a far more comfortable and dignified lifestyle for everyone.

    However greed being greed, once a few have now had a good taste at the trough there will be no going back.

    The trick (now proven) is to keep the results of failure so large that central govs must step in a socialise the losses.

    regards
    f9
     
    #22     Sep 17, 2008
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    September 17,2008

    SouthAmerica: The coming days it will give a good opportunity for Ben Bernanke to go on a shopping spree since there are a lot of bargains out there and the Fed could add many more collapsing institutions to its fast growing portfolio of junk.

    Which companies are next in line on the pipeline for a quick US government bailout?

    WaMu
    Morgan Stanley
    Citi Group
    Bank of America
    GM
    Ford
    Most US airlines
    A few insurance companies
    The Hedge Funds Ben Bernanke should not have any use for these guys - and Private equity firms also he should let them go down in flames.

    The mutual funds all they have to do is sell their investments to cover the massive amount of redemptions on their funds.

    After this financial meltdown is over the federal government will be the proud owner of lots of new pension funds from companies that have gone belly up.

    At this point I am not sure if it is a good idea for the China Investment fund to offer about $ 10 billion dollars to buy the carcass of Goldman Sachs during the financial meltdown.

    By the way, the financial implosion that is underway is making trillions of US dollars in market cap to go up in smoke.

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    #23     Sep 17, 2008