Need more money? Just ask…
Today's Financial News - Posted November 10, 2008
Washington is putting more and more taxpayer money on the line. Are we merely feeding a dangerous addiction or will this be the solution we need to avoid a long-term recession? A look at AIG (NYSE:AIG) will give us some answers.
By Andrew Snyder, TodaysFinancialNews.com
Baltimore – (TFN): What if I were to ask you for a billion-dollar loan? If you are smart, you would ask for some sort of collateral, right? A billion dollars is a lot of money. You want to make sure you get every penny of it back.
So what if I tell you I will give you whatever is inside a big manila envelope for collateral? There could be billions of dollars worth of securities in the envelope, or it could be my grandpa’s old recipe for snake oil. Unfortunately, you will have no idea what I am offering until I default on my loan and you try to exchange it for cash.
If you are a smart businessman, or even a financially inclined third grader trading baseball cards at recess, you would not loan me a penny until you knew what was in that envelope.
Unfortunately, the nation’s banking industry was not so smart. It offered trillions of dollars in loans without knowing anything about the collateral offered in return.
Everybody is doing it
For a perfect example, all we have to do is look at American International Group (NYSE:AIG). The federal government is working overtime with this one.
If you recall, Washington handed the nearly dead insurance company an $85 billion lifeline in September when AIG was on the brink of extinction and about to hand pink slips to more than 100,000 global employees. It made investors believe there was hope.
In late October, the government realized $85 billion was not quite enough, so it shelled out another $37.8 billion. The cash bought the company another few weeks of operating time.
Now, it looks as though the original plans were faulty. Instead of buying AIG’s distressed assets (those mortgages, default swaps, and all the other junk in that manila folder I mentioned), the Federal Reserve and the Treasury Department are re-thinking their plans.
They have pulled their original deal off the table and replaced it with even more taxpayer money. This time the deal calls for $150 billion, nearly twice the original amount.
This latest lifeline is a much smarter move, however. Instead of purchasing the infamous manila folder, the government is directly taking a stake in AIG. It is using funds from the TARP initiative to purchase $40 billion worth of preferred stock. It will combine that stake with a $60 billion loan to AIG. And the remaining $50 million will be used to purchase selected distressed assets, a much smaller chunk of the mystery folder.
This setup has a handful of benefits that the original plan did not. First, it gives Washington a stake in AIG. Yes, it is a victory for the world’s socialists, but it also puts much more pressure on AIG executives to make smart financial decisions.
It also eliminates the government’s risk to those pesky distressed assets. With absolutely no way of knowing their value until they are unpackaged, dismantled, and sold, the Fed would run into the same problems AIG had. By keeping the portfolio with AIG and simply loaning it enough money to maintain cash flow while it deals with its debt, risk is lowered across the board.
But the big question, and it is a very big question, remains. Will $150 billion be enough? And if not, how far should the government go before it throws in the towel?
Can I have some more, please?
It is beginning to look like Washington is doing nothing more than feeding a dangerous, expensive heroin addiction.
AIG, or any other major company for that matter, says, “Just one more hit and I will quit tomorrow.”
And Washington says, “Well, okay, if you say so.”
All we can do now is hope the fallout from the financial sector is contained. So far, the news is not great. Circuit City (NYSE:CC) cannot find the credit to buy its holiday inventory and has filed for bankruptcy proection.
And after two years of huge losses in the United States, DHL is firing nearly 10,000 workers while it closes most of its American delivery operations.
And finally, Citigroup (NYSE:C) is rumored to be close to announcing the acquisition of a regional retail bank. After the Wachovia (NYSE:WB) deal blew up in the bank’s face, a successful acquisition is just what Citigroup needs to get heading in the right direction once again.
The nation’s financial meltdown is far from complete, but the government and the free markets are working overtime to get the situation fixed as soon as possible.
Pay attention, do your homework and invest wisely and you could make some serious money as hundreds of billions of dollars exchange hands over the next few weeks.
Next Article: Guns better than gold?
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