Wednesday, September 17, 2008

Federal Reserve offers $85 billion to AIG

Reversed stated policy from just days ago:

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 S. 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.
“It would have been a chain reaction,” said Uwe Reinhardt, a professor of economics at
Princeton University. “The spillover effects could have been incredible.”
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.
On Wednesday, European stocks were slightly stronger in mixed afternoon trading, but an early rally in Asia lost steam on concerns about the American financial system and China’s economy. And shares were down sharply on Wall Street.
Still, the rescue 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.
Barney Frank, Democrat of Massachusetts and chairman of the House Financial Services Committee, said Mr. Paulson and Mr. Bernanke had not requested any new legislative authority for the bailout at Tuesday night’s meeting. “The secretary and the chairman of the Fed, two Bush appointees, came down here and said, ‘We’re from the government, we’re here to help them,’ ” Mr. Frank said. “I mean this is one more affirmation that the lack of regulation has caused serious problems. That the private market screwed itself up and they need the government to come help them unscrew it.”
House Speaker
Nancy Pelosi quickly criticized the rescue, calling the $85 billion a "staggering sum." Ms. Pelosi said the bailout was "just too enormous for the American people to guarantee." Her comments suggested that the Bush administration and the Fed would face sharp questioning in Congressional hearings. President Bush was briefed earlier in the afternoon.
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.

I agree with the policy in this emergency situation. Hopefully Democrats win this November election, enact better regulations, and then let the Free Market reign.

Craig Farmer
making the word "liberal" safe again!

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