Investors run for the exits as they try to make sense of the Fed's massive bailout
by BusinessWeek staff, Associated Press, and other sources
American International Group (AIG), one of the world's largest insurers, has been saved with a staggering $85 billion injection of taxpayer money, joining Fannie Mae (FNM) and Freddie Mac (FRE) under the government's control. Investors' reaction: Not good.
Under the deal announced late on Sept. 16, the Federal Reserve will provide a two-year, $85 billion emergency loan to AIG, which teetered on the edge of failure because of stresses caused by the collapse of the subprime mortgage market and the credit crunch that ensued. In return, the government will get a 79.9% stake in AIG and the right to remove senior management. AIG Chief Executive Robert Willumstad is expected to be replaced by Edward Liddy, the former head of insurer Allstate (ALL), according to The Wall Street Journal, citing a person it did not name. Willumstad had been at the helm of AIG since June.
The emergency loan from the Fed is the first step in a process by which AIG will restructure itself, selling off some of its businesses. The loan will be repaid by the proceeds of those sales. With the loan, the company can do that in a more orderly fashion, and perhaps at higher prices. In a statement, AIG's directors said they expect the sales to "enable AIG's businesses to continue as substantial participants in their respective markets."
On the Block
Obvious candidates for the auction block include the aircraft leasing business and the consumer finance arm. Neither is likely to gain top dollar in a sale under current market conditions, but with recent downgrades of AIG debt, they are no longer benefiting much from the parent company's ability to borrow at low rates, and may do well enough on their own. Insurance divisions are also expected to be sold.
Former AIG CEO Hank Greenberg, who was unceremoniously ousted from the AIG corner office in 2005 and has since been embroiled in lawsuits over the propriety of his actions as CEO, could be among the bidders. In a Securities & Exxchange Commission filing posted only hours before the bailout came, Greenberg, who is still AIG's largest individual shareholder, and a group of other investors notified the company they had retained investment bank Perella Weinberg Partners as financial adviser. Actions being analyzed include possible acquisition of assets from AIG, seeking a seat on the board, and taking the company private, among others.
The Fed said it determined that a disorderly failure of AIG could hurt the already delicate financial markets and the economy. It also could "lead to substantially higher borrowing costs, reduced household wealth, and materially weaker economic performance," the Fed said in a statement.
The decision to help AIG marked a reversal for the government from the weekend, when it refused to use taxpayer money to bail out Lehman Brothers Holdings (LEH). Lehman, which filed for bankruptcy protection on Sept. 15, collapsed under the weight of mounting losses related to its real estate holdings.
The move was similar to the government's seizure on Sept. 7 of mortgage giants Fannie Mae and Freddie Mac, in which the Treasury Dept. said it was prepared to put up as much as $100 billion over time in each of the companies, if needed, to keep them from going broke.
Investors, already weary after the 504-point drop in the Dow Jones industrial average on Sept. 15 after Lehman declared bankruptcy, voted again with their feet as they tried to make sense of it all. Around 1:35 p.m. EDT on Sept. 17, the Dow average tumbled 357.11 points (3.23%) and the broader S&P 500-stock index lost 46.27 points (3.81%). Bonds rallied, and gold prices shot up about 10%, as investors sought some kind of safety.
AIG shares skidded 40%, to 2.28, in afternoon trading, down from a high of 70.13 in the past year. And investment bank stocks continued to get hammered, with Morgan Stanley (MS) falling nearly 31% and Goldman Sachs (GS) down 15% on Sept. 17.
The AIG plan creates a lot of confusion and unanswered questions, says Nouriel Roubini, an economics professor at New York University. He believes it would have been better to push AIG into Chapter 11 or Chapter 7 bankruptcy proceedings and then provide the government financial support in the form of traditional debtor-in-possession (DIP) financing. The plan now opens the gates for other private companies to ask for bailout money, he says.
Collaring the Shorts
After reading the Fed's statement, Paul Kedrosky at Infectious Greed wrote : "There is lots to be worried about here, including what 'collateralized' really means in such a fluid context, and why the U.S. has not been joined by the central banks of any other countries."
In the wake of criticism that short-sellers have been causing the severe declines in financial stocks, the government announced new measures early on Sept. 17 to protect stock investors against naked short-selling. The SEC's new rules will apply to all public companies starting on Sept. 18, requiring traders who short a stock to deliver securities at the settlement date, with penalties for failure to do so within three days. Such penalties will include banning further short sales in the same security or a declaration of fraud if shorts deceive the broker-dealers about their intentions, according to economic research firm Action Economics.
Meanwhile, economists and pundits have been offering an array of reasons for how Wall Street got into the current mess, ranging from short-sellers and Alan Greenspan's loose monetary policy in the early 1990s to lack of regulation and oversight in mortgage lending, along with widespread investment in risky securities such as credit default swaps. Author Michael Lewis, in a Bloomberg News column, names two culprits. His first is SEC Chairman Christopher Cox. "He went as far out of his way as he could to enable the brokerage firms by harassing the small group of informed financial people who have been trying to tell the truth to the markets: the short-sellers," Lewis wrote. "But in this case, they are the closest thing we have to heroes."
The second culprit, according to Lewis' line of reasoning, is Wall Street CEOs, particularly Stan O'Neal, the former chief of Merrill Lynch (MER). Wrote Lewis: "Of the lot, O'Neal deserves perhaps the greatest scorn as he took a business that wasn't well designed to take huge trading risks and wagered it all on a single bet."