'AIG could be a much bigger problem than Lehman Brothers'

Posted Sep 15th 2008 10:10AM by Joseph Lazzaro
Filed under: International Markets, Forecasts, Other Issues, Merrill Lynch (MER), Lehman Br Holdings (LEH), Federal Reserve

The dollar Monday recovered from lows registered earlier in the session, but traders said uncertainty permeated the currency market, given the unprecedented developments in the global financial system.

"We're in unchartered waters, and no one is certain about the impact on the dollar or the financial system," currency trader Andrew Resnick told BloggingStocks earlier Monday. "The logical, rational view is that the dollar will fall based on the expectation of increased government spending and borrowing to deal with the widening financial crisis. But a major dollar fall may not occur if the markets judge the worst is over. That's why a lot of traders are flat now." Resnick added that he was flat, or had no open currency trading positions.

The dollar initially fell early Monday morning about 1.5-2% against the euro, British pound, yen and Swiss franc, but recovered somewhat after the European Central Bank and the Bank of England joined the U.S. Federal Reserve in taking action to calm the financial markets jolted by Lehman Brothers (NYSE: LEH) bankruptcy filing, Bloomberg News reported Monday.

ECB, BOE, Fed all add liquidity to system

The ECB awarded banks a one-day, money market auction of $30 billion that was three times oversubscribed, while the BOE loaned banks $9 billion for three days. Earlier, the Fed expanded the collateral it will accept for loans to securities firms.

As of 8:45 a.m. EDT, the dollar traded at $1.4150 versus the euro, $1.7847 versus the British pound, 105.49 yen versus Japan's yen, and $1.1234 versus the Swiss franc.

Resnick said the currency market remains concerned about the fate of American International Group (NYSE: AIG), the largest U.S. insurer of assets.

"AIG could be a much bigger problem than Lehman Brothers," Resnick said. "If AIG cannot sell assets, a ratings downgraded would trigger a collateral call from debt investors who bought credit default swaps. If institutions like hedge and pension funds are uncertain that the hedges they established with AIG are in force, that could lead them to seek hedges elsewhere and/or sell assets to raise capital or reduce their market risk. It will not be a pleasant scenario."

Resnick said the Fed may have to intervene "to stabilize AIG, if it is convinced that a run on AIG or an AIG failure, would destabilize the financial markets." He added that he's confident that AIG will survive in some form, although they may have to sell some assets or restructure their operations.

Dollar / Economic Analysis: The watch words for Monday: AIG and liquidity. The major central banks will remain at the ready to provide liquidity to intervene in those institutions that are either 'too big to fail or too interconnected to fail.' Further, U.S. officials will be monitoring AIG, given the large role it plays in credit default swaps: the goal most likely will be to stabilize AIG to prevent cds-related panic selling. Stay tuned.

Tags: 091508, AIG, American International Group, Bank of England, BOE, bond market, British pound, credit default swaps, credit markets, dollar, ECB, euro, European Central Bank, Fed, financial crisis, interest rates, inthenews, monetary policy, Swiss franc, U.S. Federal Reserve