New AIG Rescue Is Bank Blessing - WSJ

In Wednesday's The Wall Street Journal, there was an informative article regarding the revamping of the AIG loans by the federal government.

New AIG Rescue Is Bank Blessing
Buyers of Insurer's Default Swaps Would Recover Most of Their Money
By Serena Ng and Liam Pleven

Banks in the U.S. and abroad are among the biggest winners in the federal government's revamped $150 billion bailout of American International Group Inc.

Many banks that previously bought protection from the insurer on securities backed by now-troubled mortgage assets stand to recoup the bulk of their investments under a plan by AIG and the Federal Reserve Bank of New York to buy around $70 billion of those securities via a new company. These securities are collateralized debt obligations backed by subprime-mortgage bonds, commercial-mortgage loans and other assets.

Banks in the U.S., Europe and Canada bought credit-default swaps on these securities from AIG, which in turn promised to compensate them if the securities defaulted. Defaults haven't been a major problem, but the market values of these CDOs fell sharply over the past year or so.

That enabled the banks to pry roughly $35 billion in collateral from AIG as a result of those declines and downgrades in AIG's own credit ratings. The banks that have sought and received collateral from AIG include Goldman Sachs Group Inc., Merrill Lynch & Co., UBS AG, Deutsche Bank AG and others.

Throughout its AIG rescue efforts during the past two months, the government has had the banks in its sights; it made its initial bailout of AIG in part to avoid potential bank losses that might have threatened the broader financial system.

Under the plan announced Monday, the banks will get to keep the collateral they received from AIG, much of which came when the government made funds available to AIG in September. The banks also will sell the CDOs to the new facility at market prices averaging 50 cents on the dollar. The banks that participate will be compensated for the securities' full, or par, value in exchange for allowing AIG to unwind the credit-default swaps it wrote.

"It's like a home run for some of the banks," says Carlos Mendez, a senior managing director at ICP Capital, a fixed-income investment firm in New York. "They bought insurance from a company that ran into trouble and still managed to get all, or most, of their money back."

The contract cancellations will free the insurer from additional collateral calls on those swaps, which also have been responsible for billions of dollars in write-downs that AIG has logged in recent quarters. The plan is analogous to an insurer buying a house it provided fire insurance on, negating the need for an insurance policy on the home.

A person familiar with the government's rescue plan says it wasn't specifically designed to benefit individual banks at the expense of U.S. taxpayers and AIG, which will end up bearing the risk of the CDOs. However, officials wanted to give banks sufficient incentives to sell the securities so that AIG could cancel the swaps.

Officials also wanted to directly address the parts of AIG's business that were causing the most financial pain to the company. "The continuing deterioration in value of the CDOs ... meant that AIG had to post more and more collateral each day, which was a drain on their resources and potentially a threat to their solvency," says Leslie Rahl, president of Capital Market Risk Advisors, a risk consultancy in New York.

In an interview this week, AIG Chief Executive Edward Liddy said the revised rescue plan "ring-fenced" key problems, including the swaps. It also helps keep these problems from affecting AIG's other businesses, while giving the company more breathing room to sell assets to pay back a large loan from the Fed that is central to the bailout.

The New York Fed will provide as much as $30 billion to buy the multisector CDOs, and AIG will contribute $5 billion.

AIG also will bear the risk for the first $5 billion of losses among the securities purchased. If the assets increase in value or pay off over time, the Fed and AIG will share the benefits, with most of the upside going to taxpayers.

The Fed is leading the negotiations, and most of AIG's counterparties have been contacted. If some banks choose not to cancel the swap contracts, they would still bear the risk that AIG mightn't be able to meet its obligations down the road. But most of AIG's swap counterparties on the multisector CDOs are expected to sell their securities to the new facility and cancel the credit-default-swap contracts.

Even with this deal, AIG will still bear considerable risk under its CDS portfolio, because it continues to hold contracts that protect about $300 billion in securities backed by other types of assets, such as corporate loans. The swaps on the multisector CDOs, however, had been responsible for most of the $40 billion in collateral that AIG had posted on all its swaps through Nov. 5.

Source: The Wall Street Journal

Bank Stocks Soar; Markets Fall; Oil & Gasoline Drop

Bank stocks soared on Tuesday after the government set plans to inject $250 billion into the battered sector, where exposure to toxic mortgages and other debt has pummeled investor confidence and share prices.

Nine major lenders agreed to accept the preferred stock investments, which are limited to $25 billion per lender. The injections come as regulators worldwide scramble to unfreeze a financial system.

The 24-member KBW Bank Index rose as much as 13.6% and finished up 12.09%. Credit spreads on lenders' debt also tightened, suggesting that investors perceive less risk of default.

Bank of America, Citigroup, JPMorgan Chase, Wells Fargo, Goldman Sachs, Morgan Stanley, and Bank of New York Mellon are among the nine lenders to receive injections, people familiar with the plan said. Merrill Lynch & Co, which Bank of America is buying, and State Street Corp are also included, according to media reports.

"In recent weeks, the American people have felt the effects of a frozen financial system," U.S. Treasury Secretary Henry Paulson said at a news conference. "Today's actions are not what we ever wanted to do, but today's actions are what we must do to restore confidence to our financial system."

Funds will come from the $700 billion taxpayer-funded bailout package that President George W. Bush signed into law earlier this month.

Fueling the Financial System

"Hopefully, this strong approach is the dynamite needed to blast through the clogged-up financial system," said Sen. Chuck Schumer, a New York Democrat. New York is home to six of the nine initial recipients of the capital injections.

Separately, the Federal Reserve set plans to begin buying large amounts of short-term debt starting on October 27.

The Federal Deposit Insurance Corp (FDIC), meanwhile, said it will guarantee through June 30, 2012, new senior unsecured debt issued on or before June 30, 2009, and also back non-interest bearing deposit accounts that businesses typically use.

Regulators in Europe have pledged more than 1 trillion euros ($1.37 trillion) in direct capital injections for banks on that continent, and to help underwrite lending.

"We will be looking today to an absolute sea change in the global financial system in terms of liquidity," Stephen Schwarzman, chief executive of the private equity firm Blackstone Group, said at a Dubai investor conference.

Moody's Investors Service analysts Gregory Bauer and Robert Young said the $250 billion is equal to about one-fourth of all equity capital of the U.S. banking system. "This is a massive amount of fresh capital that now is reliably available to restore the health of the firms' balance sheets," they wrote.

Citigroup analysts, meanwhile, raised ratings for 14 U.S. banks to "buy" from either "hold" or "sell."

The capital injections do not free banks from problems tied to mortgages, consumer and business credit, and illiquid debt expected to persist well into 2009 or longer.

Analysts expect JPMorgan and Wells Fargo to report lower third-quarter results on Wednesday. Most major U.S. lenders are scheduled to report quarterly results by the end of next week.

Markets

A day after the Dow leaped 936.42 points in its biggest one-day point gain ever, investors looked past the U.S. pledge to pour $250 billion into major banks and instead focused on the outlook for earnings and the economy.

The Dow was down 76.62 points (0.82%). The S&P 500 Index was down 5.34 points (0.53%). The Nasdaq was down 65.24 points (3.54%).

Oil & Gasoline

Energy and materials companies fell as the price of oil slid on worries that a recession would curb the demand for oil and other commodities. U.S. crude oil futures fell $2.56 or 3.15%, to settle at $78.63 a barrel on the NYMEX. The average price for a gallon of gasoline is now $3.15.

Trading Volume

Trading was moderate on the NYSE, with about 1.88 billion shares changing hands, below last year's estimated daily average of roughly 1.90 billion, while on Nasdaq, about 2.89 billion shares traded, above last year's daily average of 2.17 billion.

Sources: Reuters, AP

Major Economic Plans From Europe, Middle East, and Australia Announced; Germany Has Its Own Rescue Package; It's Official - Wachovia to Wells Fargo

Nations from Europe to Australia rushed out plans on Sunday to shore up their banks, trying to halt a markets crash with pledges to back lending, buy stakes in financial institutions and take other emergency steps.

European leaders meeting in Paris said their line of attack would help halt the chaos that has frozen credit markets, the lifeblood of the financial system, and redrawn the world's financial industry.

"I believe that we will see over the coming few days worldwide action that will make people see that confidence in the banking system can be restored," British Prime Minister Gordon Brown told reporters.

In Washington, the United States worked on ways to buy stakes in struggling banks and other financial firms, something unthinkable until recently for the world's largest economy.

Markets gave an initial cheer to the moves to check the slump, with U.S. stock index futures rising more than 3% on Sunday evening, a sign the market could open up on Monday. New Zealand's dollar was stronger. German stocks rose 5% in off-exchange trading with big jumps in bank stocks.

The plan backed by prime ministers and presidents from the 15 countries that share the euro currency included state guarantees for new medium-term bank debt and state injections of capital into banks, adding to help from the ECB to unfreeze commercial paper markets, which would provide companies with vital access to funding and help stave off an economic slump.

"The steps taken in Europe are very positive. European governments in the last 72 hours got religion and realized they have a serious problem to address," billionaire investor George Soros told reporters.

Details of how governments would buy stakes in banks are due to emerge during the week, starting with France, Germany and Italy on Monday.

"This is not a gift to banks but to help them function," French President Nicolas Sarkozy said.

Portugal said it will offer a financing line worth 20 billion euros ($27.45 billion) to guarantee the liquidity of its banks. The Norwegian government announced a plan to provide $57 billion in liquidity for commercial banks.

Australia and New Zealand said they were working together to offer blanket bank deposit guarantees.

Gulf Arab states also took steps to boost confidence in the financial system, including a cut by Saudi Arabia of its benchmark repo rate and a vow by the United Arab Emirates to protect national banks and guarantee deposits.

The Paris meeting was hastily arranged by Sarkozy on the heels of a meeting in Washington of finance officials from the G7 rich nations that offered no concrete, collective action but promised to do whatever was needed to unfreeze credit markets.

Britain's Brown -- whose country does not use the euro -- was invited to Paris because the euro zone wanted to replicate something like the rescue plan announced in London last week. Britain's plan makes available 50 billion pounds ($86 billion) of taxpayers' money for injection into Britain's banks and, crucially, calls for underwriting interbank lending.

There was no explicit reference to state guarantees for bank-to-bank lending in Sunday's euro zone leaders statement, but Marco Annunziata, an economist with Italian bank Unicredit, said plans for bank funding and recapitalization addressed fears of counterparty risk that has shriveled the bank-to-bank lending vital for markets.

Britain could announce early on Monday it will pump over 40 billion pounds ($69 billion) into major banks and take big stakes in them, people familiar with the matter said Sunday.

Germany Has Its Own Rescue Package

A German rescue package for its banks will be worth around 400 billion euros ($549 billion) and be restricted until the end of 2009, a senior official in Chancellor Angela Merkel's conservatives said on Sunday.

"This whole law we have planned will expire again on Dec. 31, 2009," Volker Kauder, parliamentary floor leader of Merkel's Christian Democrats (CDU), told state broadcaster ARD.

Kauder said the overall package would be worth "in the region of" 400 billion euros, confirming earlier reports. Part of the plan is set to include interbank guarantees, which Kauder said would likely be worth between 200-250 billion euros.

After meeting in Paris, leaders from the euro zone economies and Britain pledged on Sunday to pump public money into banks battered by the credit crisis. German coalition sources said Berlin plans to provide equity capital worth up to 100 billion euros to help its banks cope with the fallout from the crisis.

"Banks which take advantage of this state help will have to reckon with massive changes though," Kauder added. One such example of this would be restrictions imposed on executive pay, Kauder said.

German media said the cabinet planned to make a decision about the British-style package on Monday, and aimed to enact the measures as soon as possible via a fast-tracked law. "The aim is for an orderly but quick legislative process aimed at averting risks for our economy," Finance Ministry spokesman Torsten Albig said on Sunday.

Following a meeting with French President Nicolas Sarkozy on Saturday, Merkel said Germany might inject capital into its banks but was not planning to take permanent stakes in them.

According to a document circulated at the Paris summit, two key things agreed by European leaders were the commitments to provide capital and insure or directly buy into new debt issues.

Wachovia and Wells Fargo Get Rare Sunday Approval

The Federal Reserve said on Sunday it approved the takeover of Wachovia and its banking subsidiaries by Wells Fargo.

The Fed's decision formally made Wells Fargo the victor in a battle between it and Citigroup. The fight between Wells Fargo and Citigroup was acrimonious right up to the point when Citigroup finally backed out last Thursday.

It had drawn particular attention because it took place amid the frantic scramble by the U.S. government and regulators to devise ways for shoring up hard-pressed financial institutions, including through possible direct injections of capital into banks.

The Fed cited the "unusual and exigent circumstances affecting the financial markets, the weakened financial condition of Wachovia and all other facts" in its decision, saying it had shortened the usual notice period it generally gives regulators about such takeovers.

The deal could be completed in five days, the Fed said.

After Citigroup dropped out last Thursday, the Fed said it would immediately begin considering Wells Fargo's bid for Wachovia and Sunday's approval came as little surprise.

Sources: Reuters, AP