AIG - Aiaargh - tuneless music - miss-timing PR!

Economics and the markets are not unlike music, fingering the notes (yes, banknotes too) and knowing when to pluck, plonk, suck or blow (yes, the dealers' too and their coke habits). What we see are institutions that look like they have forgotten how to play, or are learning for the first time. Government responses have not yet played a tune. They are still getting the fingering positions right and learning to read Keynes notes. It is now time we heard some coherent tuneful music, but we may have to wait until April when the newly re-formed G20 orchestra gathers with all its instruments and sheet music in London. We hope they will agree to play the same classical pieces and agree on a new symphony.
Meanwhile, a good day is merely one without a Greek chorus of bad news like yesterday. Yesterday, world stock markets were expected to fall anyway, but had the added excuse of a flurry of badly-timed news, especially $30bn more government funding for AIG, the world's largest insurer, and an $18bn rights issue by one of the world's strongest banks, HSBC (see further discussion on this in my other blogs here).
Debate in the USA about all all this, AIG especially, is focusing on whether had more clarity been produced earlier, about firms' true balance sheets and about government response measures, then some major financial firms could have been allowed to 'fail' where failure means rescuing 'Main Street' but letting 'Wall Street' take the hits? AIG's 'Main Street' is over 70 million policy holders including 100,000 business entities employing 100 million Americans in domestic USA alone. Could they have been secured by AIG's insurance reserve funds and government support until all the accounts could be transferred and sold to other insurers? The idea is that if the main weight of government intervention had occurred say in the winter of 2007-08, then banks and others might have been better secured to support the economy in 2008 and 2009 to work with government positively and ant-cyclically. Now the burden is almost entirely on government and we have to wait for fiscal stimulus to trigger recovery before banks will return to their 2003 solvency level,and this reuires a 5% plus boost to the economy from Government. But, Government did not know until mid-2008 that it had the economy had been in recession already for 6 months! Once that was clear the stock market began steadily falling (short-sellers' heaven). In the UK, recession arrived six months later and was also only noticed when figures had been revised six months later. And the UK stocks fell steeply from mid-year. Various forward indicators now are looking more positive, and short-sellers are nervous. Certainly stock out on loan has fallen from 8-10% level in the S&P down to under 5%. But, the media response was in any case over-shocking; the media never balks at a 'good story' and good stories are not about what makes precise sense, not about talking up only talking down. The media is a short-seller of the news. Is that being irresponsible or just being news-professionals?
AIG had an $80bn infusion that included $60bn draw-down. The £30bn is half of that being drawn on (from Oval Office TARP) and remaining drawdown is $25bn after a $5bn loan. It would have been far better for the drawdown to have progressed gradually, not in one big hit notified to, and thereby spooking, the markets! One of the abiding lessons of this crisis is the damaging lack of a crisis-sensitivity in how press-releases are managed, and here I include Lloyds Bank interims and HSBC's rights issue along with many others where a pro-forma procedure is followed without context information to mitigate against panic-reactions!
AIG's $30bn is not a change in terms of the federal support as the markets assumed. The draw-downs are triggered by requirements that the “AAA” rating be maintained on AIG’s counterparty risk instruments. The policy behind federal support thus seems reducible to merely avoiding another Lehman-scale failure and wholesale-credit market meltdown. The devastation caused by Lehman’s failure was in wholesale funding (counterparty risk and liquidity risk). This is the complex market risk structure that is one of the main concerns of Basel II called double-default risk in which opposing parties of derivative instruments are dependent upon the credit worthiness of each other and where, for example, if the instrument requires a “AAA” credit rating, loss of the credit rating can become an element of default. The £30bn is therefore required as standby liquidity (like capital reserves) to further insure the assets so that at least the senior tranches retain AAA and contractual default-trigger thresholds are not crossed when investors can insist on liquidating the investments.
US federal policy is driven by the need to avoid another “Lehman” as we can see in support for AIG and Citigroup, while trying to stop short of the 80% stock ownership by government at which point the balance sheets of these come on-budget, onto the federal budget, adding to its deficit and debt. The international standards practice is for current debts to be added to national debt but not offset by current assets, hence the fear of a misinterpreted cost to taxpayers. This is the circle of the argument, how much do taxpayers stand to lose one way or the other, and this looms far larger than the offsetting question of how much do taxpayers stand to gain one way or the other? This is of course a biased argument driven forward politically by net taxpayers and not by net recipients of government transfers, and hence the divide here also appears in party politics. The Democrats accuse the Republicans of risking economic disaster by holding on to monetarist thinking and caring less about the systemic roundabouts. The Republicans accuse the democrats of bankrupting the country, by which they mean government finances at an enormous cost to future taxpayers. Ditto, between Labour and Conservatives in the UK and between centre-left and centre-right in all OECD countries.
We will spend years examining the many decisions, about Bear Stearns or Fannie Mae, lehman, other banks, fiscal or monetary responses, shareholder value protection or not, off-market, on-market, off-budget, on-budget, and many other such questions as exercises that will occupy students, economists, historians, and other analysts and academics for decades. But are those the relevant questions for banks, governments and other portfolio managers today? Decisions made today and tomorrow come down to (1) will government intervention via equity ownership, and or (2) huge expansion and fiscal stance on central banks and governments balance sheets, and or (3) trillions of contingent guarantees combine prevent prolonged depression and hasten recovery?
Economic history says the answer is yes. There are no limits to government credit that can be extended in support of this, whatever it takes, in whatever amounts necessary and with whatever tools needed. And this is especially, some say uniquely, true of the USA, which is the major counterparty via the US$ to the whole of the rest of the world. If you believe as I do, that the OECD economies will find some bottoming in 2009 or early 2010, then all the model and accounting calculations will find a new level for clearing between creditors and debtors that is economically affordable whereby taxpayer risks are much reduced and in prospect of earning profits.
Some would add that inflation will help and deflation massively hinder recovery. Whichever is more true, governments believe the former view and this too is what bailouts like AIG or RBS and many others are also all about. G20 in April should, for the first time, and on an international or global scale, issue clarifying plans that should take much of the anxiety that feeds off uncertainty out of the markets. This must especially include far less uncertainty with Western Europe’s approach including the deteriorating situation in Eastern Europe that is raising the bar with major questions for the whole EU and whether it can deliver a financial aid plan for the region. If not, then the EU project is seriously discredited and will take a long time to recover.
The Euro is just shy of its lowest level vs the $ since November, one reason for the low £ oil price. Global bond markets are the main beneficiary of the equity weakness today but these cannot recoup the credit weakness in all other credit sources.
In the US and other OECD countries consumers are shifting focus to saving from spending. Private saving will soar as Governments flood in with bond issues. How this translates in higher transmission mechanism flow-through to the economy is what is exercising government political-economists. For example, in the USA, the President's economic teams will be extrapolating from the following recent data:
In the US, January Income unexpectedly rose 0.4% vs expectations of a decline of 0.2%. Income was boosted by “special factors” such as COLA increases and more pay to goverment workers and military personnel. Excluding these and other special factors, Income rose 0.2%, still better than estimates. Spending rose 0.6%, 0.2% more than forecast and with a 0.2% gain in the PCE, REAL spending rose 0.4%. As a result of the income rise, savings rate rose to 5% from 3.9%, and is now at the highest since April ‘95 and would still be in the 4%+ range even after taking out the one time adjustment boosts to income. The savings rate is likely headed towards the 8-10% range and roughly speaking, for every 1% pt increase, there is about $100b less consumption spending. This will be a painful process of zig-zag adjustments on the path of the economy's credit and economic cycle.
FOR THE FULLEST ACCOUNT OF AIG's PROBLEMS AND CREDIT DEFAULT SWAPS AND HOW THEY SELL-SHORT THE MARKETS SEE: CRUNCH IMAGES BLOG VIA CLICK ON 'VIEW PROFILE'