Tuesday, September 16, 2008

The Fed Owns AIG...What???

Top Line: The only issue tonight is the Fed's intervention in the AIG saga. By now you've all heard about it but we were stunned by this move.

Looking back to the Bear Stearns' buyout by JP Morgan with a little $29 Billion help from the Fed, we think the move seems calm in comparison to the events of the past two week(end)s. In a highly criticized Fed intervention in that case, JPM took a "bold" step on short notice to save the world from financial collapse.

Ten days ago, in what we consider a widely anticipated move, the US Treasury took over the GSE's Fannie Mae and Freddie Mac in order to save the world from financial collapse. We wondered at the time what alternate universe we were in that would have the government take over the GSE's. Now, we are equally bewildered.

Over the past few days, we thought maybe the powers that be had sent a strong message that they were not going to be getting involved with the little messes that financial companies found themselves in. The first time was when Paulson said a big "NO WAY" to a Treasury involvement in the Lehman troubles. The second was this afternoon when the Fed said "NO WAY" to a modest rate cut even though the market wanted one.

Oh, but tonight's news that the Fed was in the business of loaning money to AIG trumps both of those denials. The Fed used some emergency powers this evening to bring yet another lending facility to the situation. Going back to Bear Stearns, the Fed was in the process of setting up a lending facility that would allow them to loan money to financial companies like Bear Stearns but the setup date was two weeks out, way too long for Bear Stearns to make it. That meant that the Fed's hands were tied so that's why they twisted JPM's arm and loaned them $29 Billion in order to do the Bear Stearns' deal.

Since AIG is an insurance company, they aren't afforded the same privileges from the Fed as a normal financial company. This time the Fed just said, we can do this using "emergency" powers. This time the Fed just decided there were no lenders for AIG that could put up the necessary $75 billion so they decided to put up $85 billion of their own??? Not only is the number unfathomable, the loan is for 24 months. This deal seems to provide the Fed with "options" or "warrants" that give the Fed the possibility of 80% ownership of the company and some control over decisions that are made.

We know that we are not giving you anything new to chew on but this is one of the biggest financial news items of a generation in the US. It will get some recognition in the media on Wednesday but it will not live in the spotlight it deserves. We think it is a large step in the Wrong direction. AIG dwarfs LEH in terms of the magnitude of the impact its failure would have on the financial world but that doesn't make it the right thing to do.

We have been telling you for a long, long time that the Fed will be powerless to prevent the oncoming train wreck but they are doing whatever they can to slow it down. We do not believe that the problems are over with this move. We think they have tried to be on the front end of the problems to prevent "bad" things from happening...but since their huge drops in interest rates (3.25%) over the course of the last year were not enough, the Fed seems to have spent a lot of their funds to keep the economy going.

It was February of 2007 when the subprime mortgage "issue" surfaced. Back then, the news was that it was a small problem and it would easily be contained. Right...

Today's market action took out another one of our positions, the TLT's traded above 100 so we are out of them for now. The run was pretty good with about a ten percent move in three months plus dividends of about one percent over the period.

As for the short positions we are in, SDS and QID, we were thinking about selling them this morning at the same time as the TLT's but decided that the lows are still in the future so kept them. That decision was punished as the day wore on but, if we have to, we will re-evaluate the situation over the next week or two. Our expectation is that the market will hold up for another few days since this is options expiration week and the market put in a strong low this morning and rallied out of it with the "positive" AIG news.

GDX 30.55
BGEIX 14.90
HUI: 281.36

FSI: 74.02

VXO: 33.03 (high of 37.69, getting closer, and heading up, to 50)

SDS: 71.57 -2.44 (it's too bad)
QID: 49.22 -0.89 (and more after hours)

Dow Industrials: 11,059.02 +141.51

But, why you are really here is for Jackson pic's :-)

Just playing at Grampa's house...

Every once in a while a guy just needs to clean up...

1 comment:

Anonymous said...

First--Bear market surprises are always to the down side. Today is the first day that seems like recognition is taking hold on Wall Street...More tonight.

We received an email from a reader asking several questions:

Okay, I need your input on this "Federal Reserve Loan". Are we still basically filing bankruptcy, but in a more controlled state? What does this do to AIG stock and it's future? Is there a future of AIG stock or will it just go away once we all are sold off?

I know AGF will be sold, but didn't know if AIG in some sort of shell will be still a company.

Here is our answer, for now. As the situation develops further we will comment further:

To me, this is a technical bankruptcy except that the Fed is going to provide funds for AIG's cash needs. In a bankruptcy, there are different ways to handle the debts that companies owe, some are just not paid and the bond holders just walk away empty handed. In other cases, they might sell off the assets backing up the company and give the proceeds back to the bond holders in the priority that has been or is agreed. In this case, the Fed seems to want to orchestrate an orderly selloff of assets, such as AGF, so they are not done at fire sale prices. They can do this because they can put it off as long as the $85 billion is available. The Fed does Not want to lose money on this, or any, deal; however, they are getting deeper and deeper into risky investments especially this year, not just with AIG. Their normal operation is in Treasury securities, not this type of thing.

Whatever value is left over after paying off the Fed and other bond holders would accrue to the stock holders...but, in this and most cases, the bond holders are not made whole so the stock owners are basically out. Still, the stock is trading in the low $2 range so there are some out there who believe that there may still be some value. To me, there are much better places to Gamble than with AIG stock. And, even if the Shell were to remain intact, it will ultimately be a much different company, especially with the current management wanting to dismantle it.

Some of these things are yet to be determined which is what is causing the scare on Wall Street today, not just in AIG stock.