Tuesday, September 16, 2008

AIG Bailout: The Financial System Hangs in the Balance

Good Afternoon Everyone!

Its been quite a day in the markets. All eyes are now focused on AIG. It looks like the Fed might blink and bailout AIG:

"Sept. 16 (Bloomberg) -- The Federal Reserve is considering extending a ``loan package'' to American International Group Inc., the insurer facing a cash shortage, according to a person familiar with the negotiations.

The stance by federal regulators is a reversal from a position they held as late as last night, and people with knowledge of the talks are ``cautiously optimistic,'' said the person, who declined to be identified because negotiations are confidential.

The person gave no timetable for reaching an agreement or estimate on how much money New York-based AIG would need. New York Fed spokesman Andrew Williams declined to comment."

My Take:

This is the ultimate game of chicken between the Fed and the private banks. The banks are holding out on offering a loan to AIG to see how the Fed reacts. Now that the Fed has blinked, the banks have come out with a more hawkish tone in terms of lending money to AIG.

When its all said and done, I expect the Fed to give in and extend some type of hand to AIG. I think the Fed is afraid too see what the ramifications of an AIG failure would be given the lack of confidence that now grips the markets.. Lets see how this all plays out. If AIG fails, all hell is going to break loose in the financial markets.

Fed: No rate cut!

Kudos to the Fed. Maybe they are finally starting to get it. Here is the news on the Fed holding Rates:

"Sept. 16 (Bloomberg) -- The Federal Reserve left its main interest rate at 2 percent, rebuffing calls by some investors for a cut after Lehman Brothers Holdings Inc.'s bankruptcy shook markets worldwide.

``Downside risks to growth and the upside risk to inflation are both of significant concern,'' the Federal Open Market Committee said in a statement in Washington. ``The committee will monitor economic and financial developments carefully and will act as needed to promote sustainable economic growth and price stability.''

Chairman Ben S. Bernanke and his colleagues signaled they will continue to address market turmoil with emergency lending and aim monetary policy at a longer-term economic forecast that may still show the economy skirting a recession. Stocks fell after the decision, while the dollar gained and Treasuries remained higher."

My Take:

I think the Fed decided they needed to save some bullets for the next blowup. The obsession on AIG gave them the opportunity to take a breather without taking too much heat. This was the right call and it was a unanimous decision.

This deleveraging is going to destroy many financial firms. The Fed knows there are many more battles down the road. I think they also are sending the message to Wall St. that there is a line of moral hazard that they refuse to cross.

Here is another reason why the Fed may have decided to hold rates at 2%. Well take a look at the TIC report(Treasury International Capitol) for July:

"Treasury International Capital (TIC) data for July 2008 are released today and posted on the U.S. Treasury website (www.treas.gov/tic). The next release, which will report on data for August, is scheduled for October 16, 2008.

Net foreign purchases of long-term securities were $6.1 billion.

Net foreign purchases of long-term U.S. securities were negative $25.6 billion. Of this, net purchases by private foreign investors were negative $20.7 billion, and net purchases by foreign official institutions were negative $4.9 billion.

U.S. residents sold a net $31.7 billion of long-term foreign securities.

Net foreign acquisition of long-term securities, taking into account adjustments, is estimated to have been negative $8.2 billion.

Foreign holdings of dollar-denominated short-term U.S. securities, including Treasury bills, and other custody liabilities decreased $8.4 billion. Foreign holdings of Treasury bills decreased $4.4 billion.

Banks’ own net dollar-denominated liabilities to foreign residents declined $58.1 billion.
Monthly net TIC flows were negative $74.8 billion. Of this, net foreign private flows were negative $92.9 billion, and net foreign official flows were $18.2 billion."

Final Take:

The Boys on Wall St. all want a cut because it helps bailout the financials. What the Fed is focusing on is the larger picture IMO. This data had to scare the hell out of the Fed.

WE CANNOT afford to lose our foreign buyers of treasuries. Foreigners are getting increasingly tired of all of the lies, fraud, and manipulation on Wall St. As you can see by this Fed report, they are starting to walk away! The game is over if this continues folks.

Bottom Line:

The fact the DOW is up today is ridiculous. Stocks are soaring based on a potential AIG bailout. The huge bounce in the last few minutes leads me to believe that the deal is probably already done.

If Wall St. had a brain, they would get away from there minute by minute trading and start focusing on the fact that foreigners are starting backing away from our debt. The TIC report blew me away folks. This is a frightening development.

The "bubble boys" just want to cheer on the bailout. This is just more simpleton thinking by a bunch of pump monkeys. Party on boys because you have very few days left.

This "black hole" of debt that's about to suck away our economy will soon turn those cheers into jeers. I will be back on with any AIG news.


Jeff said...

Be careful Out there guys and gals. Money markets are NOT safe or insured by the FDIC. If you are in a money market fund, check out where their assets are.

If they are into subprime, pull your money and get it into treasuries or a CD under 100k.

There was a $64 billion major money market fund that blewup tonight. Redemptions have been halted:

Check out your holdings and make adjustments to your portfolio. Its getting rough out there folks:

"Sept. 16 (Bloomberg) -- Reserve Primary Fund, a money- market mutual fund with $64.8 billion in assets as of Aug. 31, fell below $1 a share in net asset value because of losses on debt issued by Lehman Brothers Holdings Inc.

Investor redemptions will be delayed as long as seven days, the fund's owner, Reserve Management Corp., said today in a statement. Withdrawals requested before 3 p.m. New York time today will be paid at $1 a share.

Bruce Bent, chairman of New York-based Reserve Management, opened the first money-market mutual fund in 1970. The only other money-market fund to inflict losses on investors was the Community Bankers Mutual Fund in Denver, which liquidated in 1994 because of losses on interest-rate derivatives.

``This is uncharted territory,'' said Peter Crane, president of Crane Data LLC in Westborough, Massachusetts, which tracks money-market funds. ``That's certainly a stunner.''

The fund held $785 million in Lehman Brothers commercial paper and medium-term notes. The fund's board revalued the Lehman holdings at $0 effective 4:00 p.m. Lehman filed for bankruptcy protection yesterday.

Bent often said the best money-market funds should be ``boring.'' He derided other funds that invested in securities linked to subprime mortgages and other risky debt.

Jeff said...

Link to above story:


Jeff said...

CNBC reporting that the Fed is close to a deal with AIG. They will give AIG a bridge loan of around $90 billion. Government will get warrents on AIG's equity.

It appears that the equity holders will be wiped out.

Another sticksave looks to be certian. It also appears the government will be running the company.

We are in uncharted territiory folks. I wouldn't be surprised if we see a bounce tomorrow on the news.

When is this socialism going to end? Futures are up. Capitalism is dead!

ZMonet said...

Jeff, I'd love to get your take on what we should be doing with our 401K, stocks, etc. given the current environment. I realize it is a little late in the game (maybe), but should they be moved to securities?

Is your take that rising interest rates will further negatively impact housing? I would assume so. My stance has been that I will continue to rent until housing is more in line with fundamentals even if rates rise. I figure you can always refinance. Is this faulty logic. I guess what I'm asking is there a good chance that any money saved in housing being driven down in price will be lost in increased interest payments?

I just stumbled in here from the Baltimore Housing blog, but I must say that I really enjoy/appreciate your insight.

Jeff said...

Hey Zemonet

I am glad you are enjoying the site.

You ask some great questions. I am glad you are renting. I am as well!

The answer to your question is easy. Keep renting!

Cash will be king when the housing market bottoms. Housing prices will drop as interest rates rise. Rates shouldn't be the reason to buy or not buy in this toxic environment.

If you have a lot of cash you are in a great position because your down payment will be a bigger % of what you owe to the bank.

Who knows, if you have a nice down payment and rates go through the roof, you may be able to pay mostly cash for your house!

Regarding your 401k, just stay diversified. My advice is to keep your whatever age is in fixed income. This means be in bonds, CD's, and most importantly treasuries.

Diversify the rest of your holdings however you see fit.

I personally am in 80% fixed income, but I am coservative in nature when things are bad.

Having some short positions as a hedge is great protection if stocks continue to plunge.

There are a variety of ways to do this. Give me a shout if you have questions.

Good luck!

Avl Guy said...

AIG is a done deal.
We taxpayers are now the proud owners of a bouncing Over-Leveraged Insolvant Insurance Company.

Jeff said...


Its crazy isn't it? Whats next? The taxpayer is going to get screwed in the long run...

We will pay for this! Lets see what happens in the markets tomorrow.

ZMonet said...

Thanks Jeff. In terms of beginning my research on short funds to balance out my long side portfolio, can you suggest some funds to look at? Also, my little knowledge on shorting stocks, even through a fund, is that you have to micromanage a bit more than going long a fund. Is this true, or are there certain short funds that are so diverse that this isn't as much in play? Obviously it is all an educated bet no matter which way you go. Finally, out of curiosity, if you are renting when do you plan on buying (as of right now, I realize that is largely based on how much housing falls) and approx. what percentage of your assets are liquid (cash, CDs, etc.)?


Jeff said...


I think the inverse ETF's are the safest and most conservative way to short stocks.

You can buy these funds to short individual areas in the market. I personally have bought a basket of them. I personally own (TWM), (QID), (SDS), (SRS), (SKF).

I have more money in SDS(S&P 500) because I think we have a ways to go on the downside. (SKF) shorts financials and I am thinking about closing that position soon as we near a bottom.

Check each fund out on your own. The other funds short the russell(TWM), tech(QID), and commercial real estate(SRS).

Keep in mind this is a small part of my portfolio, and I also have long postions in various stocks and funds. However, the funds above are a nice hedge if the crap hits the fan.

Regarding buying real estate, I don't know when I will jump in. I think we have a ways to go on the downside here as well.

Each real estate market is different so its hard to give advice here. For example, I think some areas like the inland empire of Cali and parts of Florida are near the bottom.

Rates will be going higher and prices will be dropping so I am in no rush up here in MD. I think we have a ways to go on the downside in Baltimore. My timeline to buy is probably 2 years down the road.

The nice thing about housing cycles is they tend to skid along the bottom for years unlike stocks. You can be late to the bottom and still get a good deal.

ZMonet said...

Thanks Jeff. I'm in full agreement on real estate and will continue to sit on the sidelines until I just can't stand to rent any longer or the housing market is more fundamentally sound in terms of affordability (price to income, etc.). If you don't mind my asking, what percentage of your overall investments do you put into a short play? I'm about 50% in cash; 15% in government securities (just changed over from a 2030 mutual fund); 20% mutual funds and 15% long stocks (only 15% now because they've taken a beating). These assets are probably just 2x gross yearly income so my job is still my greatest asset. I still have a 30 year retirement time horizon. FYI -- the 50% cash @ around 3.5% is because I'm not entirely sure when I will buy a house. Any thoughts?

Jeff said...


Sounds like a nice portfolio to ride out the storm. I am about 10-15% short.

Just make sure your cash is in CD's and treasuries. Stay away from money market funds

In terms of buying a house. Stay on sidelines.

Buying a house depends on where you live and what price range you are looking at. Your cash position in terms of what you have to put down also falls into this equation.

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