Tuesday, September 16, 2008

AIG Aftermath

Things are moving quickly now. CNBC and Bloomberg are both reporting there's now a Fannie/Freddie style Fed conservator/takeover bid in the works where the government will end up running AIG.

American International Group may work out some kind of deal with the Federal Reserve to shore up its finances by the end of the day, CNBC has learned.

Under pressure from New York Governor David Paterson and AIG policyholders, the Federal Reserve is considering reversing its decision on Monday and providing some kind of financial aid to the troubled insurer.

Bloomberg reported late Tuesday that the Fed was considering some kind of conservatorship for AIG, which sent the firm's shares down in after-hours trading.

The Fed met with the company's advisers throughout the day and came to a better understanding of what is needed to help the company through its current crisis, people familiar with the negotiations said.

These people said there is hope that a Fed-funded plan could be reached by the day's end.

This goes FAR beyond a bailout. This is the complete Fannie and Freddie package, complete with stockholders getting wiped out as the debt is dumped on them.

As a result AIG is now trading under half of its closing value of $3.75 this afternoon, it's down to $1.80 a share and falling in after hours trading as of 5:30 PM.

If this falls through it's over, but if a conservatorship happens...then what? We've already nationalized the mortgage industry. We're well on the way to nationalizing the investment industry as well...and then the banks themselves are quite possibly next.

This is insanity. You can't buy the entire industry. Observe Bank of America snapping up everything it can get its hands on: it's going for Too Big To Fail. Look for more massive consolidation in the financials.

Today was the ultimate Dead Cat Bounce for the Dow.

There Is Win. There Is Awesome.

And there is this story.

Anyway: A wonderful lady picked him up at a bar, and she went to his hotel room, and she slipped him a mickey. When he woke up, his entire ridiculous jewel-encrusted ultra-tacky wardrobe was stolen — “$120,000 in money, jewelry and other belongings,” according to the Pioneer Press. Ha, it costs $120,000 to look like that? Who knew!

It was the night of Sarah Palin’s big dumb speech at the RNC. This guy, Gabriel Schwartz — “a single attorney and a fixture in Colorado Republican politics,” according to the Pioneer Press — was staying in Minneapolis at the fancy Hotel Ivy. He reportedly took this girl back to his $319-per-night room and she told him to get undressed while she made the drinks. This is a wonderful scene from some James M. Cain book, but rather than wearing a salesman’s suit, the mark is dressed like some castout from the Village People or the Stray Cats or god knows what.

“Victim reported suspect made victim drinks, told him to get undressed, which is the last thing he remembers,” a police narrative said. “Upon waking, victim discovered money, jewelry gone; total loss over $120K.”

A police report notes the crime occurred between 4:22 and 5:46 a.m., and Palmer said investigators believe Schwartz had been drugged, although he declined to discuss details.

Aside from the watch, ring, necklace, earrings and belt, Schwartz also reported a $1,000 purse or wallet, a $1,500 cell phone, $500 in cash and a couple of rings worth $50 had been taken.

Ha ha ha ha ha ha ha ha ha ha. We salute you, wonderful girl thief of Minneapolis. You are America’s Real Hero. Everything about you is a delicious testament to the American Dream … the American Dream of duping a vulgarian lawyer.

The only thing that would make this better is an anonymous donation of $120,000 to Obama's campaign. Oh my my my my my. There is karma in the universe after all.

If McSame Has Lost These Guys...

...then he's screwed. Observe.

Fork, meet John Sidney McSame The Third. John Sidney McSame The Third, meet done.

When Traversing Roads On Your Steam Velocipede...

While supplies last. (h/t AmericaBlog)

Documenting The Atrocities

Another liveblog of the markets today.

9:35 AM -- Five minutes in. AIG is already at less than two dollars, Dow down 125.

9:45 AM -- Some fighting back. AIG hovering around $2.50, Dow down 70.

9:50 AM -- Goldman Sachs missed its earning target by about 70%. Stock down 10%. AIG still hovering around $2.50, Dow off 60 points.

10:20 AM -- AIG and Dow still hovering, but WaMu is actually up about 10 cents.

10:30 AM -- AIG struggling up to $3. Dow treading water. Rumors of a Fed rate cut are limiting the damage.

10:45 AM -- AIG still at $3, Dow still slightly down, just treading water until the Fed decides on a rate cut now later today. Anything less than a half point cut will cause the market to drop like a stone.

11:00 AM -- News breaking that the Fed is meeting to discuss AIG, a Fed bailout is now "back on the table." AIG stock is climbing to $4 a share and threatening to break into positive territory.

11:05 AM -- Dow back above 11,000 mark. Investors are "confident the Fed will take significant action today."

11:20 AM -- Moral Hazard clause in action. Many talking heads are saying if AIG doesn't get a substantial taxpayer bailout that it's over, and that the Fed has no choice. More treading water, Dow slightly under 11k.

11:30 AM -- Dow back down 50, AIG back down 2 bucks to under $2.50, back to where we were at 10.

11:35 AM -- Market is depressed back to the 10 AM level doldrums because the private sector solution to AIG's money problems is now "definitely dead". It's a Fed bailout or bust now.

12:00 PM -- Dow up 20, AIG back close to $3. Still treading water until a rate cut/bailout decision is made. McSame says "taxpayers should not be on the hook" for AIG. For the first time in years I agree with the guy. Go figure.

12:35 PM -- Dow and AIG are still treading water. Nobody wants to make a move right now until the rate cut/bailout situation is resolved.

1:15 PM -- Dow's up 70 or so, AIG above $3, but still down a third for the day. Obama's planning to give a big speech on the economy today in Golden, CO.

1:25 PM -- WaMu is up 10% on news of a possible deal with JP Morgan Chase.

2:00 PM -- Former AIG CEO Hank Greenburg is leading a group of investors who may be making a play to buy out AIG in a proxy fight. Could this be the white knight? Does it even matter if the white knight arrives when there's an army of problems waiting? AIG still floating around $3.

2:15 PM -- NO RATE CUT. Dow is dropping, AIG down to $2.50, no word on an AIG bailout yet.

3:25 PM -- Dow up substantially, up 150. AIG above $4 now, once again threatening to go into positive territory.

3:35 PM -- Reality rears its ugly head. AIG down 30% again at $3.25, Dow up 70.

3:40 PM -- Bloomberg is reporting the Fed is now officially considering making a deal to save AIG later today, reversing its stance. Happy markets, yay capitalism.

3:45 PM -- Word is Lehman's core business has just been bought by Barclays, and that's got the market juiced in the final 15 along with the possible Fed bailout.

4:00 PM -- Final score, Dow up 141, AIG down to $3.75. Street is licking its chops waiting on the details of the "bridge loan to nowhere". The Street has now "factored in" AIG getting $70-$90 billion dollars before the market opens tomorrow from the Fed.

We'll see how that goes.

Global No-Confidence Vote: Deal Or No Deal Part 2

September 15, 2008...Black Monday...was just the beginning, folks. The Dow may have lost 500 points, but the S&P lost 4.71%, an even worse day on the broader markets. And once again, I cannot stress enough that Lehman Bros. was not the real problem.

It was just one more domino in the chain, one more player in the great game of Deal Or No Deal. Lehman Bros. got No Deal...and the global markets are in freefall as a result.

But today could be worse. Today's Deal or No Deal contestant is the largest insurance company in the world, American International Group or AIG. It's time to play the game.

And AIG is in serious, serious trouble.

American International Group Inc. fell 38 percent in early New York trading after the insurer's credit ratings were cut, threatening efforts to raise funds to keep the company afloat and roiling global financial markets.

S&P lowered AIG's long-term counterparty rating three grades to A- because of ``reduced flexibility in meeting additional collateral needs and concerns over increasing residential mortgage-related losses,'' the rating company said yesterday. Moody's cut AIG's senior unsecured debt two grades to A2. Fitch Ratings lowered its assessment to A from AA-.

The downgrade of AIG is the latest tremor to shake the global financial industry, less than a day after Lehman Brothers Holdings Inc. filed for Chapter 11 bankruptcy protection and Merrill Lynch & Co. sold itself to Bank of America Corp. for about $50 billion. Stock markets from Tokyo to London tumbled as investors weighed the impact of a potential collapse of the largest U.S. insurer by assets.

``There's a systemic risk if AIG isn't saved,'' Benoit de Broissia, an equity analyst at Richelieu Finance in Paris, said in a Bloomberg Television interview. Richelieu has about $6.2 billion under management.

I've been talking about systemic risk in the Global No-Confidence Vote series for months now. Systemic risk is just that: a risk that threatens the entire system. Fannie and Freddie going under was the ultimate systemic risk. The Fed had no choice but to save it. But AIG poses a large systemic risk as well. What do I mean by systemic?

Take a look at the aftermath of Hurricane Ike as an example. Millions of Americans got a harsh lesson in systemic risk this weekend, including myself. Recovery efforts are needed from Houston to Detroit, power outages, gas shortages, food and water interruptions, critical supply problems. Here in the Cincy area there are still hundreds of thousands without power, even with power crews being called in from other states.

Now imagine a hurricane so bad that the entire lower 48 was hit with 75 MPH+ winds that caused damage, power outages, and supply interruptions across the entire country at the same time. All states would need their power crews. All power companies would be facing angry customers. Getting supplies into areas would be nearly impossible because they would be needed everywhere. All Governors would be scrambling for Federal emergency assistance. FEMA would be overloaded.

Supplies of food, water, and gas would dwindle to nothing. There would be no easy way to get supplies back in. Tens of millions of Americans would have to fend for themselves. The system would break down. The threat would be systemic. We would degenerate into riots, martial law, and chaos after only a few weeks. It would take months to get the system back up again...if it was even able to come back up at all.

That is the level of risk an AIG collapse would pose to the entire global financial system. How bad would it be?

This bad.

When Lehman Brothers filed for bankruptcy on Monday, it became the latest but surely not the last victim of the subprime mortgage collapse. Lehman owned more than $600 billion in assets. Financial institutions around the world have already reported more than half a trillion dollars of mortgage-related losses and that figure will most likely double or triple before the crisis exhausts itself.

But there is a bigger potential failure lurking: the American International Group, the insurance giant. It poses a much larger threat to the financial system than Lehman Brothers ever did because it plays an integral role in several key markets: credit derivatives, mortgages, corporate loans and hedge funds.

Late Monday, A.I.G. was downgraded by the major credit rating agencies (which inexplicably still retain an enormous amount of power in the marketplace despite having gutted their credibility with unreliable ratings for mortgage-backed securities during the housing boom). This credit downgrade could require A.I.G. to post billions of dollars of additional collateral for its mortgage derivative contracts.

Fat chance. That's collateral A.I.G. does not have. There is therefore a substantial possibility that A.I.G. will be unable to meet its obligations and be forced into liquidation. A side effect: Its collapse would be as close to an extinction-level event as the financial markets have seen since the Great Depression.

A.I.G. does business with virtually every financial institution in the world. Most important, it is a central player in the unregulated, Brobdingnagian credit default swap market that is reported to be at least $60 trillion in size.

Nobody knows this market's real size, or who owes what to whom, because there is no central clearinghouse or regulator for it. Credit default swaps are a type of credit insurance contract in which one party pays another party to protect it from the risk of default on a particular debt instrument. If that debt instrument (a bond, a bank loan, a mortgage) defaults, the insurer compensates the insured for his loss. The insurer (which could be a bank, an investment bank or a hedge fund) is required to post collateral to support its payment obligation, but in the insane credit environment that preceded the credit crisis, this collateral deposit was generally too small.

As a result, the credit default market is best described as an insurance market where many of the individual trades are undercapitalized. But even worse, many of the insurers are grossly undercapitalized. In one case in the New York courts, the Swiss banking giant UBS is suing a hedge fund that said it would insure nearly $1.5 billion in bonds but was unable to do so. No wonder -- the hedge fund had only $200 million in assets.

If A.I.G. collapsed, its hundreds of billions of dollars of mortgage-related assets would be added to those being sold by other financial institutions. This would just depress values further. The counterparties around the world to A.I.G.'s credit default swaps may be unable to collect on their trades. As a large hedge-fund investor, A.I.G. would suddenly become a large redeemer from hedge funds, forcing fund managers to sell positions and probably driving down prices in the world's financial markets. More failures, particularly of hedge funds, could follow.

Regulators knew that if Lehman went down, the world wouldn't end. But Wall Street isn't remotely prepared for the inestimable damage the financial system would suffer if A.I.G. collapsed.

AIG's collapse could very well be a systemic risk problem...a problem that risks the end of the current global financial system. If there's No Deal, there could be far worse consequences than a 500 point Dow loss.

The real problem is that there are dozens of companies that could be the systemic risk that blows a hole in the entire global financial system. If AIG does survive, there will be another company that's in trouble...and another...and another.

There will eventually be a No Deal large enough to take out the system sooner or later. Either the Fed will draw a line, or they won't have the money to save them. That possibility is looking to be sooner...MUCH sooner.

Even if it's not AIG, there will be more contestants on Deal or No Deal, Wall Street Edition. Many, many more.

Which one will break the global derivative market and with it plunge America and the world into a financial nightmare?

Be prepared.

Cross-posted at the Frog Pond.


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