Will Wall Street Devour AIG?

Just the largest US insurance company, and not a bank. Ben will not feel compelled to save them unless they represent significant counterparty risk to banks.

In a discussion today on Bloomberg, Fed head Jeff Lacker of Richmond indicated that while the common equity holders of Fannie and Freddie may take a hit, the preferred shares are another matter since "they are heavily owned by the banks, and we cannot have the banks being hurt by taking losses."

If that happens, if the banks are bailed out as a part of the nationalization of Fannie and Freddie, then free markets and risk-based capitalism are a thing of the past. The Fed and Wall Street will attempt to do whatever it takes short of burning down the rest of the country to save the few big banks.

AIG Falls as Goldman Says a Capital Raise Is `Likely'
By Hugh Son

Aug. 19 (Bloomberg) -- American International Group Inc., the biggest U.S. insurer by assets, led the decliners in the Dow Jones Industrial Average after Goldman Sachs Group Inc. said it's ``increasingly likely'' the firm will have to raise more capital.

AIG may have to pay $20 billion on credit-default swaps that the company sold to protect fixed-income investors against losses, resulting in rating-firm downgrades and a ``large scale'' capital raise, analyst Thomas Cholnoky said in a note today. The company dropped $1.67, or 7.7 percent, to $19.93 at 12:06 p.m. in New York Stock Exchange composite trading.

Chief Executive Officer Robert Willumstad, 62, hasn't ruled out raising more capital after three straight quarterly losses driven by about $25 billion in writedowns tied to valuation declines on the swaps. AIG may eventually have to pay as much as $8.5 billion on the contracts, three times more than the firm previously estimated, the New York-based insurer said Aug. 7.

``Investor confidence in AIG is damaged,'' Cholnoky wrote. ``The stock may continue to drift downward as investors remain wary of the possibility of a dilutive capital raise.'' Cholnoky cut his 12-month price target to $23 from $30.

AIG has declined 66 percent this year in New York Stock Exchange composite trading, the worst performance in the Dow Jones Industrial Average. The company raised $20.3 billion in May by selling debt and equity.

The insurer hadn't made any payments on the swaps as of Aug. 7 and posted $16.5 billion of collateral through July 31 demanded by investors who purchased protection through the contracts. The swaps guaranteed $441 billion of assets at the end of June, including $57.8 billion in securities tied to subprime mortgages.

`Troubling' Risks

AIG's losses put the company at risk of losing employees and may convince potential customers to take their business elsewhere, said Cholnoky, who rates AIG ``neutral.'' Investors who believe AIG's writedowns will eventually reverse, must consider ``the important and troubling near-term risks,'' he said.

Cholnoky correctly predicted that AIG would post a loss in the fourth quarter of 2007, while the average estimate of 18 analysts surveyed by Bloomberg was for profit of 73 cents a share.

The insurer may raise $20 billion in a worst-case scenario to cushion writedowns, Sanford Bernstein analyst Todd Bault said Aug. 13 in a note. The capital would be required if Willumstad decided to stem future losses tied to the housing market by selling subprime-related holdings at a loss and buying the securities tied to credit-default swaps, Bault said.

Rating Downgrade

Willumstad, also chairman of AIG, was named CEO in June. He has promised to complete a review of AIG by Sept. 25 to help return the insurer to profitability.

Nine analysts recommend investors accumulate AIG shares, 9 say to ``hold'' and one says ``sell,'' according to Bloomberg data.

Standard & Poor's cut AIG's credit rating by one level to AA-, the fourth-highest investment grade, in May after the company posted a record $7.81 billion first-quarter loss.

Another downgrade is likely ``if earnings do not stabilize by the third quarter,'' S&P said Aug. 7.

Investors may demand $13.3 billion more in collateral if the insurer's credit rating is downgraded again, AIG said Aug. 6 in a regulatory filing. Ratings reductions ``could have a material adverse effect on AIG's liquidity,'' the insurer said.

The Spiral - Downfall of an Investment Bank

Thanks to Going Private for producing this satire

The Spiral - Part I - Those Vultures

The Spiral - Part II - Managing Directors Everywhere

The Spiral - Part III - On Stage

The Spiral - Part IV - Liquidation

The Worst Is Yet To Come in the US Financial Crisis

Large U.S. Banks May Fail Amid Recession, Rogoff Says
By Shamim Adam

Aug. 19 (Bloomberg) -- Credit market turmoil has driven the U.S. into a recession and may topple some of the nation's biggest banks, said Kenneth Rogoff, former chief economist at the International Monetary Fund.

``The worst is yet to come in the U.S.,'' Rogoff said in an interview in Singapore today. ``The financial sector needs to shrink; I don't think simply having a couple of medium-sized banks and a couple of small banks going under is going to do the job.''

The U.S. housing slump has triggered more than $500 billion of credit market losses for banks globally and led to the collapse and sale of Bear Stearns Cos., the fifth-largest U.S. securities firm. Rogoff said the government should nationalize Fannie Mae and Freddie Mac, the nation's biggest mortgage-finance companies, which have lost more than 80 percent of market value this year.

Freddie Mac and Fannie Mae ``should have been closed down 10 years ago,'' he said. ``They need to be nationalized, the equity holders should lose all their money. Probably we need to guarantee the bonds, simply because the U.S. has led everyone into believing they would guarantee the bonds.''

...``The only way to put discipline into the system is to allow some companies to go bust,'' Rogoff said. ``You can't just have an industry where they make giant profits or they get bailed out.''

The world's largest economy is already in a recession, and the housing market will continue to deteriorate, Rogoff said. The U.S. slowdown will last into the second half of next year, he said, predicting a faster recovery in Europe and Asia.

The Federal Reserve, which has left its key interest rate at 2 percent after the most aggressive series of rate reductions in two decades, risks raising inflationary pressures, he said.

``Rates are too low,'' Rogoff said. ``They must realize we're going to get inflation if things stay where they are. They need to raise rates but I don't think they are going to because they're way too nervous.''

To contact the reporter on this story: Shamim Adam in Singapore at sadam2@bloomberg.net.

Bravo Roubini!

Nouriel Roubini is an original thinker, a forward thinking economist, and importantly is not swayed by a policy bias or political loyalies as so many other popular economists seem to be. Roubini pursues the outcome of his data, which is broadly based and insightfully examined.

The scandal is that so many other economists seemingly missed such an obvious set of conclusions by such a huge margin. Sometimes market action and peer pressure can be overwhelming.

Anyone can be mistaken. But we saw too many instances of 'financial leaders' who were willfully wrong, dismissive, censorious, and driven by things other than a stewardship of knowledge it appears.

Bravo Roubini! Ringraziamo il Dottore per il coraggio del suo lavoro.


Nouriel Roubini Gets a Medal
Brad Setser
Sunday, August 17th, 2008

A well-deserved one too. Nouriel stuck to his core views — housing was massively over-valued, the financial system was heavily exposed to a fall in home prices and the fall out from a fall in US home prices wouldn’t be contained either nationally or globally – when those views were decidedly unpopular.

Back in early 2007, there was a great deal of complacency among America’s financial leadership. Many thought macroeconomic volatility had been vanquished, and as a result financial volatility was justly low. High levels of leverage consequently made sense — and a range of asset market prices reflected this. In the language of the time: credit markets weren’t over-valued, equity markets were under-valued. Recessions - or at least severe recessions and financial crises – were things that happened to other countries, not the US. The US had survived the .com bubble with only a shallow downturn. The 2003-2006 rise oil prices hadn’t put a big dent in the US economy. The large US current account deficit reflected high savings abroad and the attractiveness of the US financial assets; the US, after all, had a comparative advantage in financial-engineering. The IMF wrote that “innovative US fixed income markets [provided] many assets which simply aren’t available elsewhere” (see p. 12). There wasn’t much too worry about.

Read Michael Lewis’ argument that Davos man spent too much time worrying. He wrote in 2007:

Oil prices double, the U.S. housing market tanks — no matter what happens, financial markets adjust quickly and without hysteria. There are obviously a few things to worry about just now in the world, but the inability of traders to find a sensible price for the spread between European junk and European Treasuries isn’t one of them. So why do these people waste so much of their breath and, presumably, thought, with their elaborate expressions of concern?

Even the IMF – which is paid to worry – was tired of worrying. In late January of 2007, Chris Giles of the FT ran an article, based on an interview with the IMF’s Deputy Managing Director, that was titled “Big risks to global economy receding.” I thought that captured the mood of those times well.

Nouriel didn’t waver then. Others (myself included) did. Standing apart from the herd can be hard.

Over time, the focus of Nouriel’s concerns has shifted over time from the United States’ external deficit to the housing market and the financial system. But there has been a core consistency to his views: he never thought that it was healthy for the US to borrow heavily from the rest of the world to finance large fiscal deficits, high levels of consumption and lots of investment in suburban housing. And he thought this borrowing binge would end badly. Very badly.

...Yale’s Shiller notes that Nouriel’s greatest strength his capacity to synthesize an enormous amount of information: “Nouriel has a different way of seeing things than most economists: he gets into everything.” I wrote Bailouts and Bail-ins with Nouriel and I then worked for Nouriel at RGEMonitor – and I fully agree. The breadth of Nouriel’s interests — and his ability to synthesize information from multiple sources — is extraordinary.

I wouldn’t mind if Dr. Roubini was proved to be a bit too pessimistic, and not all the near-term risks he sees come to pass. But I also think it would be a mistake to base policy on the assumption that the worst of the credit crisis is over.