Another Bailout, Why AIG and Not LEH?, Russian Market Crash, A Bull Market, and More!

by Addison Wiggin & Ian Mathias

  • ANOTHER guv’ment bailout… details on the U.S.’ steady march to socialism, and how much it’s costing you
  • So why AIG and not Lehman?
  • An options trader’s look into today’s market… and his catalyst for a market rebound
  • Housing starts plummet to 17-year low… so why are mortgage apps soaring?
  • Think the U.S. has it bad? Two other nations getting slammed by the global slowdown
  • The latest bull market emerges in London… floating dead animals

  So… now the world’s two biggest mortgage companies AND the world’s largest insurer are the property of the U.S. government?  

Velcom to Amerika.

  Here’s the quick and dirty of the Fed’s terms for the AIG bailout:

  • Fed will offer up to an $85 billion 2-year loan to AIG
  • In exchange, the Fed assumes 80% ownership of the firm
  • All money borrowed is to be repaid at 3-month Libor, plus 850 bps… about 11% interest rate
  • AIG will conduct an “orderly” sale of its assets until the loan is repaid.

Nice deal for the Fed, eh?

  “I just loaned $283 to AIG,” declares Eric Fry, “I and every other American. And the funny thing is no one asked our permission. The Federal Reserve simply took our money and handed it to a group of individuals who have demonstrated the ability to lose billions of dollars faster than almost anyone on the planet.

“I would rather have tossed the money in a wishing well…not only for the wishes, but also because the wishing well will repay the loan sooner. The Fed’s $85 billion ‘investment’ in AIG is just the latest chapter of the American financial tragedy — a sordid tale that begins with the extreme greed of a few and ends with the widespread suffering of the many.

“The Fed did what it had to do. It protected the millions of individuals and institutions who relied on the insurance policies of one of the world’s largest insurance companies. But let’s hope the tragedy does not end with an $85 billion bailout. Let’s hope our sordid story contains a few more tragic chapters, like ones that feature tales of AIG’s executive officers shedding tears of remorse on their prison dungarees.”

Heh, amen. For more from Eric, read your daily Rude Awakening.

  “Why save AIG and not Lehman?” Dan Denning asks from down under. “AIG was a major seller of credit default swaps (CDS). It was easy money for a while. You sell default insurance on mortgage-backed bonds. You collect the premium and never have to make good on the default… because… you know… what are the chances of that?

“These are unprecedented financial times. Lehman is also a major counterparty in the credit default swap market. Yet the Fed judged AIG’s role as a major seller of CDS more critical to the financial system. Why?

“One answer is that most of AIG’s customers are overseas. Not only would a bankruptcy trigger chaos is the CDS market, but many foreign customers insured by AIG would be in doubt about the value of their normal insurance policies. Just like with Fannie and Freddie, foreign creditors may have again forced the hand of the Treasury to use American taxpayer dollars to guarantee the value of their financial investments in the U.S.”

Dan forwarded us this picture of a line in front of an AIG subsidiary in Singapore this morning:

That’s a three-hour line queuing up in front of an AIG customer service center. Courtesy of The Straits Times.

An AIG bankruptcy would have cost the global financial industry at least $180 billion, chimed in RBC Capital Markets. AIG insured over $441 billion in fixed-income investments, many of which were held by the world’s biggest governments and organizations. Nearly $60 billion of those “investments” insured by AIG were subprime-related securities.

Until yesterday, AIG had $1.1 trillion in assets, 116,000 employees and 74 million clients in 130 nations. They insured people, property and businesses. They were in the consumer finance industry. Retirement management. Annuities. Money management. Risk management (ha!). Mutual funds. Private banking. They even leased airplanes.

  "I’m afraid we are not through it at all,” commented George Soros yesterday. “In some ways, we are still heading into the storm, rather than heading out of it. We are at a very precarious moment.”

Finance has “grown too big, it has taken up too big a share of the world’s resources. Now it is shaking, and I think when it becomes once again regulated, it will be less profitable.”

  “From an options trading perspective,” notes our options analyst Wayne Burritt, “the recent market-forced consolidation around Wall Street is a good thing: Weaker companies that make over-the-top bets are being weeded out and the risk they absorbed spread out. That provides buying companies with low-priced quality assets — such as asset management units — and should provide more systemic stability in the long run.

“That said, the fact is the subprime mess is going to weigh heavy on investors and markets until things get straightened out. And while no one has a crystal ball, my feeling is once the key real estate metrics begin to recover — including housing starts and existing home sales — we’ll begin to breathe a sigh of relief.”

Wayne was well insured for AIG’s blowout. His readers sold their S&P 500 SPDR Depository Receipts puts Tuesday for 150% gains… in just 14 days. Have Wayne help you survive this volatile market by trading options, here.

  Housing starts in the U.S. plummeted 6% in August, to a fresh 17-year low.

At the current rate, “only” 895,000 homes will be built in the U.S. this year. Housing starts haven’t been that slow since 1991… when there were nearly 50 million fewer Americans

  Yet mortgage applications skyrocketed last week. The Mortgage Bankers Association’s index of purchase or refinance applications shot up 33% last week, to the highest level since May.

Refis alone jumped 88%, the biggest gain since 2001. Again, you can thank Uncle Sam for that one. The average 30-year fixed loan fell from 6% to a five-month low of 5.8% after Fannie and Freddie were nationalized.

  In the stock market, “investors” were somehow emboldened yesterday by the Fed’s decision to do nothing to lending rates. Immediately after the FOMC’s decision, markets surged into the black… the Dow and Nasdaq finished up 1.3%, and the S&P 500 shot up 1.7%.

Heh. You can’t beat the logic. Last year, lowering rates created a buying opportunity because they "showed that the Fed was worried about the market." Today, holding rates steady is a buying opportunity, because it "shows that the Fed isn’t worried about the market."


  The dollar continues to defy logic itself. Despite all the shenanigans by the Fed and AIG and Merrill and Goldman and the Treasury… the dollar index remains stalwart, at just under 79.

  Gold, on the other hand, is finally coming to its senses. Right as we were about to publish, the spot price shot up $50 an ounce, to over $830. There’s word of the U.S. Treasury issuing notes to expand the Fed’s balance sheet, and the American market is still in the dumps… rest assured we’ll have much more to say on this matter tomorrow.

  The Russian stock market crashed yesterday. The ruble-denominated Micex index, one of Russia’s major indexes, plunged 17% — its biggest one-day drop since the 1998 banking crisis. The dollar-denominated RTS fell 11%.

As we cautioned last week, Russian traders are stuck between tumbling energy prices (the meat of the Russian stock market) and a liquidity crisis even worse than here in I.O.U.S.A. The blinding sell-off became so severe that regulators halted trading yesterday.

Traders were back at it this morning, as the RTS and Micex fell another 5% today. We’ll be picking this market over soon, in search of buying opportunities. Stay tuned…

The English are wrangling a crisis of their own as well. HBOS, the U.K.’s biggest mortgage lender, has seen its shares kicked to the dirt over the last two days. They’re down 40%.

Rumors abound… either Lloyd’s, HSBC or the U.K. government is circling for a bailout. Regardless, HBOS is giving English regulators quite a rash this morning. The company controls 20% of the already ailing U.K. mortgage market and employs 72,000.

  Perhaps they ought to hit up Brit garbage “artist” Damien Hirst for a loan. Hirst broke the record for money earned in a single-artist auction yesterday. He netted over $200 million by selling pieces like this:

Just think how awesome that would look in your living room

“The Golden Calf” went for $18 million. Other works included a collage of dead butterflies, an artful arrangement of cigarette butts, some skulls and a big tank with a dead shark. 

The $200 million auction smashed the previous record holder: 88 works of Pablo Picasso.

  "Finally someone (yesterday’s 5 ) mentioned the decline in oil without a corresponding drop in gasoline, Ike notwithstanding," writes a reader. "I estimate oil has come down about 35%-plus, while gasoline, at least in my neighborhood, still costs the same. 

“I am definitely not a fan of a windfall profit tax on the oil companies, and I understand the need to plow those profits back in new equipment and searching for new drilling sites. However, if the oil companies do not at least pretend they are not completely profit driven and provide some relief for the consumer, some clown in Congress or the Senate or wherever looking to make a name for himself/herself will force through some legislation that will drastically hamstring the oil companies from doing what they do best, and ultimately affect all our standard of living."

  "I am in local government in the Houston area," writes a reader, "and was in line at Luby’s Cafeteria today. I saw a couple of refinery workers and took the opportunity to ask what they were hearing about the great shape our petrochemical and refining capacity was in, according to the TV talking heads.
"They said while their two refineries were reported as unscathed, in fact, one was limping by with a compromised computer system, and the other said a cooling tower was out and was uncertain when production would return to normal.

“I asked them if they considered their plants to be functional, and both said not in any normal sense.
"I wonder if all the great news about how lucky we were with Gulf Coast drilling and refining has had a touch of spin judiciously applied for public consumption?"

The 5: Are you suggesting someone in the media is less than straight with the facts? Who would ever dream of such a thing?


Addison Wiggin
The 5 Min. Forecast

P.S. Samples of the I.O.U.S.A. the companion book arrived in our office this morning. They look spiffy.

P.S.S. Also on the movie front, the deal for the U.K. theatrical distribution rights was concluded yesterday. The film will be in Leicester Square before you know it. Heh.

If you’re in the Washington, D.C./Baltimore area and you’d like to see the film this weekend, you’ll have two opportunities. I.O.U.S.A. is screening at the Chesapeake Film Festival, in Easton, Md. The first screening will be at 10 a.m. on Saturday. The second will be at 1 p.m. on Sunday. David Walker, Patrick Creadon, yours truly and the Maryland comptroller general will be on hand for the question-and-answer sessions following the screenings.

C’mon by… support the film! Details here.   


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