Wednesday, September 17, 2008

Fed’s $85 Billion Loan Rescues Insurer


Vivek Prakash/Reuters

People lined up Tuesday outside an office of an American International Group subsidiary in Singapore’s main business district.

WASHINGTON — Fearing a financial crisis worldwide, the Federal Reserve reversed course on Tuesday and agreed to an $85 billion bailout that would give the government control of the troubled insurance giant American International Group.

The decision, only two weeks after the Treasury took over the federally chartered mortgage finance companies Fannie Mae and Freddie Mac, is the most radical intervention in private business in the central bank’s history.

With time running out after A.I.G. failed to get a bank loan to avoid bankruptcy, Treasury Secretary Henry M. Paulson Jr. and the Fed chairman, Ben S. Bernanke, convened a meeting with House and Senate leaders on Capitol Hill about 6:30 p.m. Tuesday to explain the rescue plan. They emerged just after 7:30 p.m. with Mr. Paulson and Mr. Bernanke looking grim, but with top lawmakers initially expressing support for the plan. But the bailout is likely to prove controversial, because it effectively puts taxpayer money at risk while protecting bad investments made by A.I.G. and other institutions it does business with.

What frightened Fed and Treasury officials was not simply the prospect of another giant corporate bankruptcy, but A.I.G.’s role as an enormous provider of esoteric financial insurance contracts to investors who bought complex debt securities. They effectively required A.I.G. to cover losses suffered by the buyers in the event the securities defaulted. It meant A.I.G. was potentially on the hook for billions of dollars’ worth of risky securities that were once considered safe.

If A.I.G. had collapsed — and been unable to pay all of its insurance claims — institutional investors around the world would have been instantly forced to reappraise the value of those securities, and that in turn would have reduced their own capital and the value of their own debt. Small investors, including anyone who owned money market funds with A.I.G. securities, could have been hurt, too. And some insurance policy holders were worried, even though they have some protections.

“It would have been a chain reaction,” said Uwe Reinhardt, a professor of economics at Princeton University. “The spillover effects could have been incredible.”

Financial markets, which on Monday had plunged over worries about A.I.G.’s possible collapse and the bankruptcy of Lehman Brothers, reacted with relief to the news of the bailout. In anticipation of a deal, stocks rose about 1 percent in the United States on Tuesday. Asian stock markets opened with strong gains on Wednesday morning, but the rally lost steam as worries returned about the extent of harm to the global financial system.

Still, the move will likely start an intense political debate during the presidential election campaign over who is to blame for the financial crisis that prompted the rescue.

Representative Barney Frank, Democrat of Massachusetts and chairman of the House Financial Services Committee, said Mr. Paulson and Mr. Bernanke had not requested any new legislative authority for the bailout at Tuesday night’s meeting. “The secretary and the chairman of the Fed, two Bush appointees, came down here and said, ‘We’re from the government, we’re here to help them,’ ” Mr. Frank said. “I mean this is one more affirmation that the lack of regulation has caused serious problems. That the private market screwed itself up and they need the government to come help them unscrew it.”

House Speaker Nancy Pelosi quickly criticized the rescue, calling the $85 billion a "staggering sum." Ms. Pelosi said the bailout was "just too enormous for the American people to guarantee." Her comments suggested that the Bush administration and the Fed would face sharp questioning in Congressional hearings. President Bush was briefed earlier in the afternoon.

A major concern is that the A.I.G. rescue won’t be the last. At Tuesday night’s meeting. lawmakers asked if there was any way of knowing if this would be the final major government intervention. Mr. Bernanke and Mr. Paulson said there was not. Indeed, the markets remain worried about the financial condition of major regional banks as well as that of Washington Mutual, the nation’s largest thrift.

The decision was a remarkable turnaround by the Bush administration and Mr. Paulson, who had flatly refused over the weekend to risk taxpayer money to prevent the collapse of Lehman Brothers or the distressed sale of Merrill Lynch to Bank of America. Earlier this year, the government bailed out another investment bank, Bear Stearns, by engineering a sale to JPMorgan Chase that left taxpayers on the hook for up to $29 billion of bad investments by Bear Stearns. The government hoped at the time that this unusual step would both calm markets and lead to a recovery by the financial system. But critics warned at the time that it would only encourage others to seek bailouts, and the eventual costs to the government would be staggering.

The decision to rescue A.I.G. came on the same day that the Fed decided to leave its benchmark interest rate unchanged at 2 percent, turning aside hopes by many on Wall Street that the Fed would try to shore up confidence by cutting rates once again.

Fed and Treasury officials initially turned a cold shoulder to A.I.G. when company executives pleaded on Sunday night for the Fed to provide a $40 billion bridge loan to stave off a crippling downgrade of its credit ratings as a result of investment losses that totalled tens of billions of dollars.

But government officials reluctantly backed away from their tough-minded approach after a failed attempt to line up private financing with help from JPMorgan Chase and Goldman Sachs, which told federal officials they simply could not raise the money given both the general turmoil in credit markets and the specific fears of problems with A.I.G. The complexity of A.I.G.’s business, and the fact that it does business with thousands of companies around the globe, make its survival crucial at a time when there is stress throughout the financial system worldwide.

“It’s the interconnectedness and the fear of the unknown,” said Roger Altman, a former Treasury official under President Bill Clinton. “The prospect of the world’s largest insurer failing, together with the interconnectedness and the uncertainty about the collateral damage — that’s why it’s scaring people so much.”

Under the plan, the Fed will make a two-year loan to A.I.G. of up to $85 billion and, in return, will receive warrants that can be converted into common stock giving the government nearly 80 percent ownership of the insurer, if the existing shareholders approve. All of the company’s assets are being pledged to secure the loan. Existing stockholders have already seen the value of their stock drop more than 90 percent in the last year. Now they will suffer even more, although they will not be totally wiped out. The Fed was advised by Morgan Stanley, and A.I.G. by the Blackstone Group.

Fed staffers said that they expected A.I.G. would repay the loan before it comes due in two years, either through the sales of assets or through operations.

Asked why Lehman was allowed to fail, but A.I.G. was not, a Fed staffer said the markets were more prepared for the failure of an investment bank. Robert B. Willumstad, who became A.I.G.’s chief executive in June, will be succeeded by Edward M. Liddy, the former chairman of the Allstate Corporation. Under the terms of his employment contract with A.I.G., Mr. Willumstad could receive an exit package worth as much as $8.7 million if his removal is determined to be “without cause,” according to an analysis by James F. Reda and Associates.

A.I.G. is a sprawling empire built by Maurice R. Greenberg, who acquired hundreds of businesses all over the world until he was ousted amid an accounting scandal in 2005. Many of A.I.G.’s subsidiaries wrote insurance of various types. Others made home loans and leased aircraft. The diverse array of companies were more valuable under a single corporate parent like A.I.G., because their business cycles offset each other, giving A.I.G. a relatively smooth stream of revenue and income.

After Mr. Greenberg’s departure, A.I.G. restated its books over a five-year period and instituted conservative new accounting policies. But before the company could really rebuild itself, it became embroiled in the mortgage crisis. Some of its insurance companies ended up with mortgage-backed securities on their books, but the real trouble involved the insurance that its financial products unit offered investors for complex debt securities.

Its stock tumbled faster this year as first the debt securities lost value, and then the insurance contracts, called credit default swaps, came under a cloud.

The Fed’s extraordinary rescue of A.I.G. underscores how much fear remains about the destructive potential of the complex financial instruments, like credit default swaps, that brought A.I.G. to its knees. The market for such instruments has exploded in recent years, but it is almost entirely unregulated. When A.I.G. began to teeter in the last few days, it became clear that if it defaulted on its commitments under the swaps, it could set off a devastating chain reaction through the financial system.

“We are witnessing a rather unique event in the history of the United States,” said Suresh Sundaresan, the Chase Manhattan Bank professor of economics and finance at Columbia University. He thought the near brush with catastrophe would bring about an acceleration of efforts within the Treasury and the Fed to put safety controls on the use of credit default swaps.

“They’re going to tighten the screws and say, ‘We want some safeguards on this market,’ ” he said of the Fed and the Treasury.

The swaps are not securities and are not regulated by the Securities and Exchange Commission. And while they perform the same function as an insurance policy, they are not insurance in the conventional sense, so insurance regulators do not monitor them either.

That situation set the stage for deep losses for all the countless investors and other entities that had entered into A.I.G.’s swap contracts. Of the $441 billion in credit default swaps that A.I.G. listed at midyear, more than three-quarters were held by European banks.

“Suddenly banks would be holding a lot of bondlike instruments that were no longer insured,” Mr. Sundaresan said. “They would have to mark them down. And when they marked them down, they would require more capital. And then they would have to go out and raise capital in these markets, which is very difficult.”

Mr. Sundaresan said that for a new market arrangement to succeed, it would have to create a clearinghouse to track swaps trading, and daily requirements to post collateral, so that a huge counterparty would not suddenly find itself having to come up with billions of dollars overnight, the way A.I.G. did.

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Saudi Billionaire to Wall Street: See You Later

Saudi billionaire Prince Al-Walid bin Talal bin Abdulaziz al-Saud.
Saudi billionaire Prince Al-Walid bin Talal bin Abdulaziz al-Saud.

If Wall Street is hoping that Prince Alwaleed bin Talal will ride to the rescue of America's crumbling banks, here's the word from the Saudi billionaire: Thanks, but no thanks. Having bailed out Citicorp on a couple of occasions — most recently by helping in its recapitalization earlier this year — Al-Waleed says he's not in the market for any more U.S. financial sector assets.

I spoke with Alwaleed in Riyadh on Tuesday, as the world reeled from the shock of the Lehman Bros. bankruptcy. In his offices on the 66th floor of the iconic Kingdom Tower, the prince (a nephew of King Abdullah) seems a world away from the tumult in New York City. But a giant TV screen in his office was tuned to CNBC, and he conceded that his personal worth may have taken a hit with the stocks slide, though he stressed that he was doing well with investments closer to home.

Excerpts from the interview:

TIME: Did you see this coming?

Alwaleed: I'm not sure anyone at all saw the depth and magnitude of the problems faced by some financial companies in the U.S. I will quote [Alan] Greenspan in saying that this is a once-in-a-lifetime, or once-in-a-century event. It shows the gravity of the problem over there.

TIME: You were involved with Citi's recapitalization earlier this year. Considering everything that's happened since then, any regrets?

Alwaleed: No. You have to understand that our involvement in the recapitalization of Citi is a long-term thing. It's not a one-, two-, three-year plan. In January 1991, I was the only investor in Citigroup at that time, with around $600 million. The next year, things didn't go well, but over the next decade, things really boomed dramatically. You have to look at the investment in Citi as a long-term thing.

But clearly, the financial sector in the U.S. is facing a huge crisis. When you have two big companies like Bear Stearns and Lehman vanish, and Merrill Lynch being absorbed, that tells you a lot about the difficulties being faced by the financial sector in the U.S.

TIME: Is this the bottom?

Alwaleed: I'm not sure it's the bottom yet. We're trying to get to the bottom. But every time someone says we're at the bottom, things get a bit worse.

TIME: Would you buy now?

Alwaleed: No, I think we have enough involvement, with Citibank, in the financial services arena.

TIME: No more banks for you, then?

Alwaleed: No, I'm involved with Citibank. Legally I can't go beyond 5%. Right now, we're at 4.9%, and I think that's enough.

TIME: More recently your interest seems to have moved away from the U.S.

Alwaleed: We have a big exposure to the world economy in general — in banking, hotels, in real estate. But right now, there's a lot of emphasis on Saudi Arabia. Saudi Arabia is experiencing a big boom. There's a lot of emphasis on real estate, and on companies in Saudi Arabia.

TIME: What do you expect will be the knock-on effect on Saudi Arabia of the banking crisis and the overall economic downturn in the U.S.?

Alwaleed: The world's now a very connected place, so things like the cost of funds, the scarcity of debt — these will impact some of our projects in Saudi Arabia. There's nothing called immunity: you can't be immune to what's happening around the world. But I would say we're less impacted directly than countries in the vicinity of the U.S.

We have a lot of tail winds here, remember — the price of oil, and an economy that's on very solid ground. These can help to mitigate some of the issues that we may be having from the impact of the real-estate collapse in the U.S.

TIME: How has your personal net worth, your personal fortune been affected by the way the stock markets have performed in the past six months?

Alwaleed: No doubt, we were impacted like anybody else. Most of my wealth is in Kingdom Holding, but I have outside assets that are not being publicly traded. Like my regional [Arabic] media companies, Rotana and LBC. And I have a lot of personal real estate outside Kingdom Holding. All in all, we're withstanding it well.

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Ex-Best Buy Employee Regrets Selling Warranties Now That He's A Customer

We just got an email from reader Mike, who claims to be a former Best Buy employee who regrets selling all those extended warranties now that he's actually trying to use the one that he purchased.

While my story hasn't cost me thousands of dollars, it's brought me a lot of disappointment with the company I used to work for. For two years and three months, I was employee [redacted] at Store [redacted]. I sold computers, service plans, accessories, Geek Squad services and everything else they wanted me to like a good employee. I often defended the company online from people who had complaints and offered advice on what to do, based on my "inside" knowledge, to get these issues handled. So imagine my disappointment in the Geek Squad upon having to use a Performance Service Plan (PSP) on a Samsung monitor I had purchased.

On the morning of August 20th, I discovered my Samsung 204T was not responding to anything I was doing. After determining it was not the computer, based on a second monitor I have, I decided to make use of the PSP I had purchased for the monitor nearly three years prior when I was still working for Best Buy. I brought it to a different store than the one I worked at, and after having a small chat with the Geek Squad employee about it, he determined it would need to be shipped off to the repair facility. That's fine, I was expecting that. I asked him point blank "What are the turn around times like these days?"

"7-10 days" was the response. I commented "Oh, back when I used to work here it was closer to 2-3 weeks. Good to see it's gotten faster."

I figure that this is great, I'm going on vacation anyways and when I get back, the monitor should either be repaired or ready to be exchanged. Geek Squad even sends a tracking number to track the repair status of the monitor.

But nothing changes. Until August 29th, when it says it's arrived at the repair facility. Again, as a former employee I know that the service centers are USA based. Nine day shipping on the continental United States? What? I decide not to question it at the time. Status updates later in the day saying Parts Have Been Ordered. I'm a little disappointed that they're going to fix it instead of giving me a new one, but whatever. On September 4th, the status updates are saying that it's being repaired currently. No update until September 10th, at which point it is changed to "Exchange Assessment." "Product is in the process of approval or has been approved for an exchange. Please contact the Geek Squad Precinct within your Best Buy store for additional information." Great, I can get it exchanged finally!

So I head to the store with the paperwork from the Geek Squad page. Hey, it's the same guy that told me 7-10 days. But I let that slide at first when I show him the paperwork. He looks into the system and can't find any information on exchanging the monitor. He calls over a customer service representative, Rebecca, and the two of them look over the information on my repair. I hear some mumblings about the monitor being "junk out", and knowing what that is, I'm annoyed they're even looking at that since it has nothing to do with the exchange or repair. They also mention to each other about the parts for the monitor not even being available to order. Which makes me wonder where did 4 days of ordering parts and 6 days of repair go to when the parts didn't even exist? But I bite my tongue, hoping they'll just exchange it. At this point, they both inform me that the exchange has not been approved yet. I'm pissed now, and for the most part I keep my cool. The exchange I have with the Geek Squad employee goes like this.

Me: "When I first brought this in, you told me 7 to 10 days."
Him: "Business days"
Me: "That was like three weeks ago!"
Him: "Well there's nothing I can do about the service center being backed up."
Me: "You know, I used to work here. Why would you lie to me about the turn around time? That's bullshit."
Him: "All I can tell you is that this is the second to last step and the turn around for this should be pretty fast."
Me: "Whatever, I'll be back."

At that point, I leave. That was September 10th. At the time of this e-mail, it's September 15th and the system still has not updated.

I'm so disappointed in the service I've received on this monitor. It makes me feel bad that I sold these services for over two years, only to see this is how they were treating customers. One of the core things we were taught was to "Under promise, over deliver." Meaning that if a customer asks how long something is going to take, always go with the high end, and if takes less, great! Happy customer that we did something faster than we stated. If it takes the time we quoted, still happy that we did it on time. To see this core idea violated to this degree, it really cheapens what I did for them.

We recommend sending an EECB (Executive Email Carpet Bomb) to your former bosses. Just because you used to work there doesn't mean that you're not a customer, too. For more information about launching an EECB, click here. Maybe hearing from one of their own will be a wake-up call.

If not, if you used a credit card to pay for the monitor and warranty, you can always contact your credit card company and see if they'll help you get what you paid for.

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Rating agencies downgrade AIG, more cuts possible

HONG KONG, Sept 16 (Reuters) - The rating on embattled insurance giant American International Group Inc. (AIG.N: Quote, Profile, Research, Stock Buzz) was slashed by at least two notches by the three top global rating agencies, who also warned more downgrades could follow.

The triple strike jolted the insurer even as it is struggling to find funding sources at a time of global financial tumult which has brought two of the biggest Wall Street investment banks to their knees. [ID:nN13574113]

Moody's Investors Service cut AIG's rating to A2 from Aa3, a two-notch downgrade. Standard & Poor's Ratings Services lowered the rating to A-minus from AA-minus, a three-peg reduction and Fitch Ratings reduced its standing to A from AA-minus, a two notch cut.

AIG's ratings are still investment grade, although all three agencies said more downgrades could follow.

The announcements were made during Asia time on Tuesday, hours after New York state officials pieced together a $20 billion lifeline which would give the company temporary respite. [ID:nN15279674]

AIG's troubles, much like those of some of its Wall Street peers, stem from guarantees it wrote on mortgage-linked derivatives that have left it with a total of $18 billion in losses over the past three quarters.

In recent days, AIG has explored a wide range of options to shore up capital and avoid rating cuts.

JPMorgan (JPM.N: Quote, Profile, Research, Stock Buzz) and Goldman Sachs (GS.N: Quote, Profile, Research, Stock Buzz) are exploring putting together a syndicated $70 billion to $75 billion credit facility for AIG, among other options.

This additional funding is critical for the insurer's survival in the longer term.

Ahead of the downgrades, shares of AIG, once the world's largest insurer ranked by market value, plummeted 61 percent to $4.76 on one of Wall Street's most tumultuous days, with Lehman Brothers Holdings Inc (LEH.N: Quote, Profile, Research, Stock Buzz) on the verge of collapse and Bank of America (BAC.N: Quote, Profile, Research, Stock Buzz) moving to take over Merrill Lynch & Co (MER.N: Quote, Profile, Research, Stock Buzz). (Reporting by Umesh Desai; Editing by Anshuman Daga)

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Japan's Landfills Abound with Gold, Silver and Platinum

Written by Peg Fong

In Japan's landfills, there is enough gold, silver and platinum to propel the country into the top tier of resource-producing countries - along with Australia, Brazil and Canada.

The millions of electronics that are discarded each year, including televisions, mobile phones, MP3 players and computers, have created so-called “urban mines.”

These mines, according to a new survey by the National Institute for Materials Science in Tsukuba, have untapped resources that no one has figured out how to extract yet. With all the materials found in the discarded electronics, Japan now has three times as much gold, silver and indium, a thin coating used for LCDs, as the world needs each year. The amount of platinum hidden in them thar landfills is six times as much as global consumption.

The high concentration of precious metals is an indication of two things: consumers in Japan replace their electronic items very quickly and only 13 per cent, or about 550 tonnes a year, are recycled.

For each phone (and about 20 million mobile phones are replaced by the Japanese annually) the remnants of copper, gold, lead, palladium, tin, titanium and zinc could be removed. The Japanese government is now looking at ways to encourage consumers to gather their discarded cell phones, computers and other electronics and recycle them while looking at how to excavate the landfills to mine these metals.

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Fight Over Natural Gas Has Bolivia on Brink of Collapse

The Banking Collapse Will Propel Obama to Victory

If he wants it to, that is. In the only statement that has broken through, Obama actually said “I certainly don't fault Sen. McCain for these problems, but I do fault the economic philosophy he subscribes to.” Fault him for God’s sake. Stop being so nuanced! The Obama campaign should immediately release an ad that asks why McCain has been wasting his time talking about nonsense when we have real problems in our lives. Obama can list all of the specious, identity-based arguments (celebrity, lipstick on a pig, cosmopolitan, etc.) and ask why McCain is so obsessed with him when the country is falling apart.

But the Obama Campaign has to be quick to seize the high ground on the current economic crisis. If they do, they can successfully reframe the debate on the issues. There is not doubt in my mind that Obama will win if voters make their decision based on issues, not identity. If the campaign hesitates at all though, McCain will claim the “Wall St. Reformer” mantle for himself though, the truth be damned.

This is the best chance the Dems have to really raise Palin’s negatives. When this much is going wrong in our economy, who wants the female incarnation of Dan Quayle to be a 72 year-old’s heartbeat away from the Presidency?

JWilkes had a great article on the substance of the Lehman failure and the Bush / McCain response to it. Complex as the subject is, the politics are simple. Hit McCain, and hit him hard. He’ll either have to defend the last eight years and alienate independents, or disown them and alienate the 30% of people who still think that Bush is a great president.

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