AIG's woes telegraphed to U.S. Treasury, Fed need for bailout/rescue plan

Posted Sep 27th 2008 5:40PM by Joseph Lazzaro
Filed under: Forecasts, Politics, Federal Reserve, Financial Crisis

Some investors/readers -- and certainly casual observers of the stock market in towns small and large -- have been perplexed by the turn of events that has led to the current state of affairs in these United States: namely how and why does the U.S. government need to pass a $700 billion bailout/intervention bill to end a financial crisis in the U.S., possibly globally?

While numerous economic, regulatory, and behavioral factors created the conditions that formed the basis for the crisis, economist Richard Felson told BloggingStocks that the imminent failure of insurance giant American International Group (NYSE: AIG), in his view, "was the flashpoint at which both [U.S. Treasury Secretary Henry] Paulson and [U.S. Federal Reserve Chairman Ben] Bernanke realized that a case-by-case, reactive policy would not be adequate to check the building financial storm."

No AIG, massive exposure

Felson pointed out that at least a portion of hedge fund trades -- and the trades of other financial institutions -- are predicated on the assumption that mortgage-backed securities are good/have value, or, if not, that the insurance behind these securities is in force as a result of policies written by AIG. When it became clear that AIG did not have the assets/resources to pay claims, it was necessary for the U.S. government to take over AIG via a $85 billion loan from the U.S. Federal Reserve for warrants for a 79.9% stake in the company.

Why was it necessary for the Fed to intervene? Because an AIG failure would have signaled to hedge funds, and other institutional investors, that not only was the insurance backing their mortgage-backed securities questionable, "the complex trades and counter-positions hedge funds had built around these stakes were now unhedged," Felson said.

In other words, absent AIG, "these institutions faced massive exposure, a risk level they didn't plan for or anticipate." And their first action to correct it, Felson said, would have been -- you guess it -- "massive selling to reduce exposure and risk." That would have meant "a very large plunge in the stock market," with accompanying stress on the bond and credit markets, he said. "Think Dow 7,000 or Dow 6,000, something along those lines," Felson said.

The Fed's intervention ensued, the credit markets remained stressed, but they stabilized. "But the data point was the last straw as far as Paulson and Bernanke were concerned. Reactive and piece-meal actions weren't going to be adequate. The problem is much bigger and requires active intervention to get the marked-down assets out of the system. They were like marine biologist Matt Hooper (Richard Dreyfuss) after conducting an autopsy on the first victim in the movie Jaws," Felson said. "Well this wasn't a boating accident and it wasn't caused by a fishing net. This was caused by a shark. And it's going to attack again and again until it's killed."

Economic Analysis: Paulson and congressional leaders are currently working on a $700 billion plan to go after that "shark." Here's hoping they get a plan in place, with U.S. congressional approval, very soon.

Tags: AIG, American International Group, bailout, bailout bill, Bernanke, bond market, credit default swaps, credit markets, featured, Fed, financial crisis, hedge funds, institutional investors, mortgage backed securities, Paulson, U.S. Congress, U.S. economy, U.S. Federal Reserve, U.S. Treasury

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Reader Comments (Page 1 of 1)

9-27-2008 @ 10:38PM

Debbie said...

They didn't worry about me when I was struggling- or anybody else , either. And now they wants me to cough up nearly $5000, assuming I make $360 a day!! I make $97 a day and THEY CAN'T HAVE IT!!!!!! i DON'T EVEN HAVE TO MONEY TO BURY MY LATEHUSBAND!! He's lying in a grave I haven't paid for yet! And I don't care if they have to bury all those blood suckers on Wall Street- you don't need my money- you need to take theirs away from them!! Economists my backside!! Spend-omists is what they are!

9-28-2008 @ 2:02AM

DaveF said...

Remember McCain wants to hand the same blithering incompetants who created this mess a 300 Billion dollar tax break. Reward the same thugs who will move their money and our jobs overseas at the first opportunity.

As for the reactive strategy Paulson was using it was merely to buy time so Bush could hand off this mess to the next administration, just like he is doing in Iraq.

9-28-2008 @ 12:16PM

w tim said...

I was for the bill, one event after another has come to play in our country. I now say forget the bill. With the banks going down the insure being help out and we are still moving along, not that I have anything fault with Wall Street because I have lost alot of money on Wall Street Stocks and I have to bill again in life and so will our country. So forget the bill and let start back better and smarter. God knows that's what I have to do.

9-28-2008 @ 12:39PM

w tim said...

Forget the bill with the the banks going down and the insure. The money investors have lost with these company going down I now say forget the bill who does it help us the investor or the Government. Who! Let credit freeze up that will teach everyone to use smarter choices next time around. I feel this as much as everyone else as an investor to the market, I have lost alot with these banks going down I was into them very big time and I lost with the takeover and bull**** that went on, on weekend not being able to get out. As a tax player who pays more tax trading in the Stock market. So let it be no bill and we all start over.