Tuesday, September 16, 2008

Fed loans $85 billion to AIG for 80 percent stake

Oh My God! This is just--wow! Wow! Wow! From the New York Times:

In an extraordinary turn, the Federal Reserve was close to a deal Tuesday night to take a nearly 80 percent stake in the troubled giant insurance company, the American International Group, in exchange for an $85 billion loan, according to people briefed on the negotiations.

All of A.I.G.’s assets would be pledged to secure the loan, these people said, and in return, the Fed would receive warrants that could be exchanged for an ownership stake. Stock of existing shareholders would be diluted, but not wiped out.

A person briefed on the matter said the agreement does not require shareholder approval.

If the Fed takes a controlling stake, it is likely that it would want to replace A.I.G.’s board as well as its chief executive and chairman, Robert B. Willumstad.

The Fed’s action came after Treasury Secretary Henry M. Paulson and Ben S. Bernanke, president of the Federal Reserve, went to Capitol Hill on Tuesday night to meet with House and Senate leaders. Mr. Paulson called the Senate majority leader, Harry Reid, Democrat of Nevada, about 5 p.m. and asked for a meeting in the Senate leader’s office, which began about 6:30 p.m.

The Federal Reserve and Goldman Sachs and JPMorgan Chase had been trying to arrange a $75 billion loan for A.I.G. to stave off the financial crisis caused by complex debt securities and credit default swaps. The Federal Reserve stepped in after it became clear Tuesday afternoon that the banking consortium could not complete the deal in time.

Without the help, A.I.G. was expected to be forced to file for bankruptcy protection.

The need for the loans became necessary after the major credit ratings agencies downgraded A.I.G. late Monday, a move that likely to have forced the company to turn over billions of dollars in collateral to its derivatives trading partners worsening its financial health.

Until this week, it would have been unthinkable for the Federal Reserve to bail out an insurance company, and A.I.G.’s request for help from the Fed of just a few days ago was rebuffed.

But with the prospect of a giant bankruptcy looming — one with unpredictable consequences for the world financial system — the Fed abandoned precedent and agreed to let the money flow.

Attending the meeting on the Capitol Hill were Democratic Senate leaders that included Charles E. Schumer of New York, Richard J. Durbin of Illinois, Christopher J. Dodd of Connecticut and Kent Conrad of North Dakota A contingent of Republicans was led by Mitch McConnell of Kentucky, the minority leader, and included Richard C. Shelby of Alabama, Jon Kyl of Arizona and Judd Gregg of New Hampshire. House leaders included John Boehner of Ohio, the Republican leader; Spencer Bachus, Republican of Alabama; and Barney Frank, Democrat of Massachusetts. Members of the leaders’ staffs were asked to leave the meeting shortly after it began.

I don't know where to begin--this is so unprecedented. The U.S. government has taken control of a major Wall Street insurance and investment corporation. The first quick comment I can see is that if the Fed takes control of AIG, then you can bet that the board and AIG's CEO, Robert B. Willumstad, will be fired. I'd say fire the board and Willumstad now, and don't allow Willumstad to walk away with his golden parachute.

The second comment I have is who will be next? By taking control of AIG, the Fed is now telling Wall Street that if you go bankrupt due to the subprime mortgage mess, we will bail you out and take control of your investment firm. So who will be the next company in the Fed's new investment portfolio? Will Washington Mutual become the next casualty to be taken over by the Fed? Will Citigroup become the next casualty?

I found this U.S. News and World Report story, showing the top ten biggest U.S. banks that have gone into failure:

1. Continental Illinois National Bank and Trust, Chicago (1984)
Total assets: $40.0 billion

2. First Republic Bank, Dallas (1988)
Total assets: $32.5 billion

3. American S&LA, Stockton, Calif. (1988)
Total assets: $30.2 billion

4. Bank of New England, Boston (1991)
Total assets: $21.7 billion

5. MCorp, Dallas (1989)
Total assets: $18.5 billion

6. Gibraltar Savings, Simi Valley, Calif. (1989)
Total assets: $15.1 billion

7. First City Bancorporation, Houston (1988)
Total assets: $13.0 billion

8. Homefed Bank, San Diego (1992)
Total assets: $12.2 billion

9. Southeast Bank, Miami (1991)
Total assets: $11.0 billion

10. Goldome, Buffalo (1991)
Total assets: $9.9 billion

Continental Illinois National Bank and Trust was seized by the Fed in 1984 with total assets of $40 billion. American Income Group has total assets of over $1 trillion dollars. This is huge. And we're not even through with the financials reporting write-downs and losses due to the subprime mortgage collapse.

How many more banks are going to fail? How many more banks will the Fed take control of?

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