NYT: Fed to Give A.I.G. $85 bln Loan and Takeecon


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The Fed has a major strategic advantage over private sector buyers.

With the Fed making the loan, credit spreads in general should narrow.

This will add value to AIG’s short credit position which is where most of the mark to market losses are.

So the Fed’s actions to reduce systemic risk also increase the value of AIG once they take them over.

It’s good to be the Fed!

(not that it matters to the Fed itself financially one way or the other, but they probably don’t know that)

Fed Close to Deal to Give A.I.G. $85 Billion Loan


by Michael J. de la Merced and Eric Dash

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.

In return, the Fed will receive warrants, which give it an ownership stake. All of A.I.G.’s assets will be pledged to secure the loan, these people said.

The Fed’s action was disclosed after Treasury Secretary Henry M. Paulson and Ben S. Bernanke, president of the Federal Reserve, went to Capitol Hill on Tuesday evening 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 would not be able to complete the deal.

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.


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FOMC


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Wonder if Fisher cut a deal not to dissent for the hawkish inflation language?

Karim writes:

Decision (no cut) may be hawkish relative to expectations, but wording mostly dovish.

1st paragraph-all changes highlight downside risks to gwth; slowing export gwth a new wrinkle in addition to the usual financial market strains, labor market weakness and housing.

2nd paragraph-identical to prior except mention of inflation expectations has been dropped; so a downgrading of concern over inflation.

3rd paragraph-‘stand ready to act’ but no mention of ‘in a timely manner’.

Fisher dropped his dissent

NEW

Strains in financial markets have increased significantly and labor markets have weakened further. Economic growth appears to have slowed recently, partly reflecting a softening of household spending. Tight credit conditions, the ongoing housing contraction, and some slowing in export growth are likely to weigh on economic growth over the next few quarters. Over time, the substantial easing of monetary policy, combined with ongoing measures to foster market liquidity, should help to promote moderate economic growth.

Inflation has been high, spurred by the earlier increases in the prices of energy and some other commodities. The Committee expects inflation to moderate later this year and next year, but the inflation outlook remains highly uncertain.

The downside risks to growth and the upside risks to inflation are both of significant concern to the Committee. The Committee will monitor economic and financial developments carefully and will act as needed to promote sustainable economic growth and price stability.

OLD

Economic activity expanded in the second quarter, partly reflecting growth in consumer spending and exports. However, labor markets have softened further and financial markets remain under considerable stress. Tight credit conditions, the ongoing housing contraction, and elevated energy prices are likely to weigh on economic growth over the next few quarters. Over time, the substantial easing of monetary policy, combined with ongoing measures to foster market liquidity, should help to promote moderate economic growth.

Inflation has been high, spurred by the earlier increases in the prices of energy and some other commodities, and some indicators of inflation expectations have been elevated. The Committee expects inflation to moderate later this year and next year, but the inflation outlook remains highly uncertain.

Although downside risks to growth remain, the upside risks to inflation are also of significant concern to the Committee. The Committee will continue to monitor economic and financial developments and will act as needed to promote sustainable economic growth and price stability.


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Re: The Sunny Side


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(an email exchange)

>   
>   On Tue, Sep 16, 2008 at 10:24 AM, Tom wrote:
>   
>   Hi Coach,
>   
>   While financial markets are in a meltdown not unlike the post 9/11
>   experience,
>   

yes, major deleveraging going on

>   
>   the good news is that central banks around the world are providing
>   coordinated liquidity injections along with other positive actions that may
>   create a new basis for global financial rescues.
>   

yes, but all that does is set the fed funds rate and term fed funds rate. it’s about price, not quantity

>   
>   The creation of the League of Nations was an example of how the world
>   responded to WWI.
>   
>   Tom
>   
>   P.S. But it is still not time to buy stock.
>   

agreed!

watch for fiscal policy to do the heavy lifting to support GDP and employment.


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2008-09-16 JN Highlights


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Highlights:

Aug Consumer Sentiment Hits Record Low For 3rd Month
Govt Panel To Call For Cutting Corporate Tax To 30% By FY15
Ota Reelected As New Komeito Leader For Another 2 Years
Extra Budget To Total 1.81tn Yen, Govt Eyes 400bn Yen Bonds
Lehman Failure Not To Mar Japan Financial System: Ibuki
BOJ Injects Y1.5tln To Calm Markets
New-Condo Offerings Tumble 38% In Tokyo, Rise 7% In Osaka For Aug
Forex Focus: Yen To Benefit From Banking Woes
Stocks: Slide To 3-Year Low As Banks, Insurers Tumble
Bonds: Surge After Lehman Bankruptcy, Market Turmoil

 

Note Japan’s proposed fiscal responses: cutting corp tax and extra budget, while the proposed increased consumption tax has been delayed.

Same in most nations around the world.

Fiscal responses ‘work’ while interest rate cuts don’t.

The US tax rebates worked while there is no econometric evidence the rate cuts did anything, except maybe make things worse as they reduced personal income and contributed psychologically to a USD sell off and spike in import prices that probably hurt consumers at least as much as it helped exporters.

The Fed could to anything today from unchanged to a 50 cut.

They seemed to have decided to use interest rates for ‘monetary policy’ and other tools for ‘market functioning’.

So for market functioning they just expanded the scope of the TAF and the Treasury lending facility, and may do more of that type of thing at today’s meeting, including adjusting the terms of the discount rate.

The question is whether falling commodities and the stronger USD will lead to a further rate cut.

What the Fed knows and has recognized since the Bear Stearns episode is that markets are going to open every day and do their thing, as the last week’s activity has demonstrated.

The Fed’s perceived risk of markets simply not opening and not trading has subsided.

Also, with the Treasury take over of the agencies mtg rates have dropped over 50 bp and availability of mortgage funding has been sustained.

The Fed considers this an ‘easing of financial conditions’ and is the move they’ve wanted to see to support housing, which has shown signs of stabilizing.

And the Treasury has shown it’s there to ‘write the check’ as it sees the need to prevent systemic risk.

So from that point of view there has already been a substantial ease in ‘financial conditions’, and the Fed may not see a need for further immediate ease.

Their forecasts will continue to show ‘moderating inflation and continued downside risks to growth’.

It all depends on their fear factor. They could leave fed funds unchanged or cut up to 50, depending on their concern regarding systemic risk.


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2008-09-16 USER


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ICSC-UBS Store Sales WoW (Sep 16)

Survey n/a
Actual -1.6
Prior -0.1
Revised n/a

 
Not a good sign, but partially seasonal (see year over year below). Shoppers getting scared by the financial sector again?

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ICSC-UBS Store Sales YoY (Sep 16)

Survey n/a
Actual 1.30
Prior 1.90
Revised n/a

 
Down a bit, but still positive.

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Redbook MoM (Sep 16)

Survey n/a
Actual -1.10
Prior -0.8
Revised n/a

 
Same, down some but somewhat seasonal (see year over year).

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Redbook Weekly YoY (Sep 16)

Survey n/a
Actual 1.40
Prior 1.80
Revised n/a

 
Down some but still positive and off the bottom.

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ICSC-Redbook Comparison TABLE (Sep 16)

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Consumer Price Index MoM (Aug)

Survey -0.1%
Actual -0.1%
Prior 0.8%
Revised n/a

 
Down only a tenth even with the big drop in commodities.

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CPI Ex Food and Energy MoM (Aug)

Survey 0.2%
Actual 0.2%
Prior 0.3%
Revised n/a

 
No let up here but this lags headline.

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Consumer Price Index YoY (Aug)

Survey 5.5%
Actual 5.4%
Prior 5.6%
Revised n/a

 
Not much of a drop here as crude fell last august as well.

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CPI Ex Food and Energy YoY (Aug)

Survey 2.6%
Actual 2.5%
Prior 2.5%
Revised n/a

 
Way above the Fed’s target and comfort zone

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CPI Core Index SA (Aug)

Survey n/a
Actual 216.650
Prior 216.230
Revised n/a

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Consumer Price Index NSA (Aug)

Survey 219.300
Actual 219.086
Prior 219.964
Revised n/a

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Consumer Price Index ALLX 1 (Aug)

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Consumer Price Index ALLX 2 (Aug)

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Consumer Price Index TABLE (Aug)

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Consumer Price Index TABLE 2 (Aug)

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Consumer Price Index TABLE 3 (Aug)

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NAHB Housing Market Index (Sep )

Survey 17
Actual 18
Prior 16
Revised n/a

 
A touch better than expected, perking up a bit, but still very low historically and could spring back quickly with the agencies back in action.

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NAHB Housing Market Index TABLE (Sep)

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NAHB Housing Market Index TABLE 2 (Sep)

 
Future sales looking pretty good.

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FOMC Rate Decision (Sep 16)

Survey 2.00%
Actual 2.00%
Prior 2.00%
Revised n/a

 
Wonder if Fisher cut a deal not to dissent for the Hawkish inflation language

Karim writes:

Headline CPI -0.137% m/m and core CPI up .194% m/m

  • Trending items stayed on trend (OER +0.1% and medical +0.2%)

  • Volatile items a bit of a wash

  • Recreation (+0.5) and apparel (+1.0%) higher than normal

  • Lodging away from home (-1%) lower than normal

Fed view likely reinforced that decline in commodity prices plus growing economic slack, especially in labor market, will dampen inflation into 2009.

  • Decision (no cut) may be hawkish relative to expectations, but wording mostly dovish.

  • 1st paragraph- All changes highlight downside risks to growth; slowing export growth a new wrinkle in addition to the usual financial market strains, labor market weakness and housing.

  • 2nd paragraph-Identical to prior except mention of inflation expectations has been dropped; so a downgrading of concern over inflation.

  • 3rd paragraph-‘Stand ready to act’ but no mention of ‘in a timely manner’.

  • Fisher dropped his dissent.


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2008-09-15 Weekly Credit Graph Packet


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Blip up due to the current turmoil.

IG On-the-Run Spreads (Sep 15)

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IG6 Spreads (Sep 15)

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IG7 Spreads (Sep 15)

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IG8 Spreads (Sep 15)

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IG9 Spreads (Sep 15)


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2008-09-15 USER


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Empire State Manufacturing Survey (Sep)

Survey 1.0
Actual -7.4
Prior 2.8
Revised n/a

 
Down and worse than expected but still off the lows.

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Empire State Manufacturing Survey ALLX 1 (Sep)

 
Employees and new orders up, while prices paid and received numbers moderated.

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Empire State Manufacturing Survey ALLX 2 (Sep)

 
Capex and Tech spending up.

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Industrial Production MoM (Aug)

Survey -0.3%
Actual -1.1%
Prior 0.2%
Revised 0.1%

 
A lot worse than expected and prior month revised down.

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Industrial Production YoY (Aug)

Survey n/a
Actual -1.5%
Prior -0.4%
Revised n/a

 
Not looking good. Ex autos still down .6 month over month.


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AS: Fed moves


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I’ve been recommending the following for the Fed for quite a while (see Proposals for the Fed):

  1. Lower the discount rate the Fed Funds rate and:
    1. Accept a pledge of any bank legal collateral from any member bank.
    2. Impose no restriction on quantity borrowed.
    3. Impose no restriction on the duration of any member bank borrowing.
  1. Likewise, remove collateral restrictions on the TAF operations.
    1. Set the maturity and interest rate for each TAF operation.
    2. Leave demand open-ended, rather than the current policy of limiting quantity.

Failure to implement the above shows a failure to understand fundamental monetary operations.

These policy changes would alleviate critical liquidity issues, and not, per se, alter net bank reserve demand (not that the size of the bank reserve ‘matters’).

Part of the current crisis is due to the failure to implement the above changes that would have:

  1. Normalized bank liquidity.
  2. Prevented the forced sales of investment grade, unimpaired, bank legal assets.
  3. Allowed banks to finance bank legal assets for third parties.
  4. Allowed markets to function to deleverage impaired assets.

The Fed is slowly moving in that direction, but, unfortunately, not proactively to ‘fix’ a flawed institutional structure, but reactively as things fall apart in no small part due to lack of action:

Federal Reserve lowers standards for collateral from primary dealers

The collateral eligible to be pledged at the Primary Dealer Credit Facility (PDCF) has been broadened to closely match the types of collateral that can be pledged in the tri-party repo systems of the two major clearing banks. Previously, PDCF collateral had been limited to investment-grade debt securities.

The collateral for the Term Securities Lending Facility (TSLF) also has been expanded; eligible collateral for Schedule 2 auctions will now include all investment-grade debt securities. Previously, only Treasury securities, agency securities, and AAA-rated mortgage-backed and asset-backed securities could be pledged.

These changes represent a significant broadening in the collateral accepted under both programs and should enhance the effectiveness of these facilities in supporting the liquidity of primary dealers and financial markets more generally.

Also, Schedule 2 TSLF auctions will be conducted each week; previously, Schedule 2 auctions had been conducted every two weeks. In addition, the amounts offered under Schedule 2 auctions will be increased to a total of $150 billion, from a total of $125 billion. Amounts offered in Schedule 1 auctions will remain at a total of $50 billion. Thus, the total amount offered in the TSLF program will rise to $200 billion from $175 billion.

The Board also adopted an interim final rule that provides a temporary exception to the limitations in section 23A of the Federal Reserve Act. It allows all insured depository institutions to provide liquidity to their affiliates for assets typically funded in the tri-party repo market. This exception expires on January 30, 2009, unless extended by the Board, and is subject to various conditions to promote safety and soundness.


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Racing to the bottom


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Here’s how I see the problem:

  1. The Fed and Treasury have set precedents of, for all practical purposes, wiping out shareholders when providing what they consider ‘taxpayer money at risk’.
  1. With FNMA, the Treasury provided funding on their own initiative without consent of management.

 
 
Therefore, while justified or not, this means the government can, on its own, decide to provide ‘taxpayer money’ AND eliminate all shareholder value.

This creates a serious risk for any shareholder for ANY business.

For an extreme example, the Treasury could decide unilaterally, that ANY corporation (including, for the strongest example, GE) needs a Treasury guarantee to be sure it can fund itself and won’t fail.

And any such action could carry with it eliminating any/all shareholder value.

This is the risk to Lehman shareholders.

Lehman may be perfectly able to function at some level without the need of new capital to survive.

But markets must now discount that possibility that the Treasury or Fed could decide Lehman’s counterparty risk poses sufficient systemic risk to justify intervention with ‘taxpayer money’ at risk, which would carry with it the elimination of all shareholder value.

The means the risk to shareholders from government intervention is much higher than the risk of bankruptcy or any other form of liquidation.

There was no economic reason for the Treasury to take 79.9% of the housing agencies capital. ‘Tax payer money’ was already as senior as the Treasury wanted it, and any funds added by Treasury also carried any type of interest and various other payments the Treasury desired.

All that wiping out most of the residual value for shareholders did was add a new element of catastrophic risk for all shareholders.

So when a stock like Lehman goes down, which increases the perception of risk of government intervention, the risk of shareholder value going to zero due to government intervention increases as well.

Not my first choice of institutional structure.


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