On Tuesday the Fed’s took what some called a “tough love” stance and chose to hold the Fed Funds Rate at 2 percent for the third straight meeting. This move leaves the prime lending rate at 5 percent. The prime rate is attached to credit cards, equity lines, student and car loans. The Fed did acknowledge the issues in the financial markets and hinted that they would stand ready to do what is necessary.
When the Fed said they would make a move if needed, most equated that to an interest rate cut in the near future, which is still possible, but perhaps they were also hinting at what they would do to step in and help AIG. When you woke up this morning if you turned on the television you should have been bombarded with the Fed’s decision to step in and rescue AIG.
This is not a surprising move, but for some people disheartening. The AIG Bailout by the Fed is an $85 billion 2 year loan, with an almost 11.5% interest rate. The interest rate is based off of Libor plus 8.5% so can move up or down with the Libor index. AIG will need to sell assets to pay back this loan and their losses from this bailout is projected at about $30 billion. So who will pay for this loan? Well on top of that exorborant interest rate and the 79.9% stake the Feds have taken in the company, the Feds will also sell short-term cash bills.
So yeas the tax payers are still on the hook for this loan and the risk is significant, but the Feds look to be trying to cover themselves in this deal. The panic over this move, as evidenced today in the stock market, is substantial. However what always surprises me is that we do not see that fear makes situations that much worse. The stock market being down over 350 points on the Dow Jones Industrial Average and stockholders dropping stocks in AIG as well as the other financial institutions will only cause more devastation.
There are two left standing at this point and the fear factor may take them down, Goldman Sachs is down 21% and Morgan Stanley is down 36%. If one or both of these companies announces in the near future that they are in trouble, the general consensus will be it was because of the mortgage meltdown, but in all actuality it will be because of PANIC. No one is parting with their money and the lenders need it badly. Money makes the world go round. It is a self fulfilling prophecy at this point, nothing more. If you pull your money out these companies will not survive, it is that simple.
What does all of this means to the average person?
First, if AIG is your home, auto, or life insurer you do not need to worry that they will not fulfill claims. AIG’s subsidiaries sell insurance, handle retirement accounts through annuities. Its financial markets subsidiary serves investment banks, pension funds, governments and other institutional investors, and AIG manages portfolios of stocks, bonds and real estate. AIG has $1 trillion in assets and it is not their insurance subsidiaries that are struggling, their insurance division is actually still profitable.
Those that will be most heavily affected by this are the individuals that have invested in this sector through stocks, bonds, 401K’s, etc., and those that are employed in or have a business that is tied to, the financial industry.
Will we make it out of this Financial Tsunami?
Well let us not forget that the SNL explosion in the 1980’s cost this country half a trillion dollars, we made it out of that mess we will make out of this one. The economy not only rebounded after the SNL crisis and the Dot Com bust, it has flourished at points in the last two decades. So stay tuff and don’t get caught up in the inflammatory titles, there will be something new to worry about next week.
Some great resources for more information: