Tuesday, September 16, 2008

US Economic Crisis Bulletin: Fed Holds Rates Amid Turmoil; Goldman Sachs Down; AIG Seeks Government Bailout

Fed holds rates amid market turmoil

By Michael Mackenzie in New York, Krishna Guha in Washington and Francesco Guerrera and Peter Thal Larsen in London
September 16 2008 21:15

The Federal Reserve kept interest rates unchanged at 2 per cent on Tuesday despite the turmoil convulsing global markets.

Its decision to hold firm came as turbulence caused by the failure of Lehman Brothers and fuelled by the crisis at AIG gripped the financial system for a second day, with brutal conditions in European money markets.

Morgan Stanley meanwhile announced profits of $1.43bn for the third quarter, moving its earnings announcement to late on Tuesday instead of Wednesday morning after the price of credit default swaps soared during the afternoon.

Equity markets rose on the news as investors saw the Fed’s rate decision as signalling that it was poised to announce a back-to-back loan to the embattled insurer AIG via a third party bank, such as JPMorgan Chase, as a partial substitute for a rate cut.

The S&P 500 was up 1 per cent in mid-afternoon trading having initally fallen on the news. In London, the FTSE 100 dropped 3.4 per cent to close at its lowest level since June 2005.

A Fed loan would calm market fears of sudden asset sales by the troubled insurance group. The Fed could also increase its swap lines with European central banks to satisfy the hunger for dollars outside the US.

In London the overnight dollar borrowing rate briefly hit 10 per cent amid a desperate scramble for liquidity.

Financial stocks came under severe strain early, with a slump in the shares of HBOS, the UK’s largest mortgage lender, and a damaging credit rating downgrade for Washington Mutual, the troubled US bank, though there were signs that investors were discriminating between financial stocks.

Central banks around the world fought surging demand for cash as banks hoarded reserves and refused to lend to each other, injecting about $230bn in overnight and two day liquidity.

The Vix volatility index – a gauge of fear on Wall Street – hit levels only exceeded on a single day during the March Bear Stearns crisis, while repo market liquidity dried up as institutions with Treasuries refused to lend them to other institutions for fear of counterparty risk.

“There is still a lot of fear and turmoil in the financial markets,” said David Viniar, chief financial officer of Goldman Sachs, after his firm reported the biggest drop in profits since its 1999 listing.

Shares in AIG fell more than 70 per cent before paring losses on hope of a government intervention.

Lehman Brothers, the investment bank that filed for bankruptcy at the weekend, reached an agreement in principle to sell most of its US broker-dealer operations to Barclays of the UK.

A global flight from risk led to enormous demand for safe government debt, while the cost of credit insurance for investment-grade companies soared to a record high in the US.

Emerging market bonds and equities slumped as investors pulled back from risky markets. Oil prices slumped more than $5 towards $90 a barrel as financial woes cast a pall over growth and AIG’s plight prompted investors to close positions on commodity contracts backed by the insurer.

In the European repo market, some banks were only accepting the highest quality collateral – German bunds – in exchange for cash. They were refusing to accept bonds of nations such as Italy and Greece, while some were said to be refusing to accept UK gilts.

In its statement accompanying the rates decision, the Fed said it viewed growth and inflation as “both of significant concern” and was monitoring financial developments “carefully” – a stance that keeps open the option of a rate cut in the coming weeks, but does not offer any predisposition to ease.

Copyright The Financial Times Limited 2008

AIG looks to US government for rescue

By Aline van Duyn in New York, Francesco Guerrera in London and Krishna Guha in Washington
September 16 2008 19:00

The survival of AIG, one of the world’s largest insurers, depended on the US government on Tuesday after hopes of private sector bail-out appeared to have faded.

Regulators and company executives held a fresh round of emergency meetings at the New York Federal Reserve amid fears that the collapse of the troubled insurer would further destabilise the global financial system.

The talks took on renewed urgency after a series of sharp credit rating cuts on Monday sent AIG’s shares into a further tailspin and its debt traded at highly distressed level. Amid increasingly desperate lobbying for government help, David Paterson, New York’s governor said the beleaguered had a “day” to solve problems.

Bankers said the company’s future depended on whether the government was prepared to provide a financial lifeline, at least on a temporary basis. The government has stressed its reluctance to provide any taxpayers money to prop up AIG. However, one possible option could be for a loan to be made via a third party, such as bank which can access funding from the Federal Reserve.

Estimates for the size of the funds needed to ensure liquidity for the insurer continues to grow. The latest estimates are that it would need some $70bn to shore up its balance sheet, up from the $40bn that was discussed over the weekend.

AIG is the biggest provider of commercial insurance in the US, one of the biggest writers of life assurance there, and the biggest provider of fixed annuities, a popular retirement savings product. It also has enormous global operations.

Once the biggest insurance company in the world, its market capitalisation has fallen to just over $7.5bn.

Bankers involved in discussions said that any plan to try and raise some $70bn in loans from investors had been scuppered by the credit downgrades and the sharp fall in AIG’s shares on Tuesday.

The company’s executives and its advisers were holed up in the offices of the New York Fed in an attempt to find a solution to at least give AIG more time to unwind its credit default swap positions, the source of many of its recent losses.

People close to the discussions said government help was needed to give AIG time to separate AIG’s insurance operation from its troubled portfolios of assess credit default swaps and investments.

Goldman Sachs has been hired by AIG to assess the potential losses on its bad assets. JPMorgan Chase and Blackstone are advising the company, while Morgan Stanley is helping the Fed consider its options.

New York insurance regulators on Monday said AIG could access up to $20bn of capital held by life insurance subsidiaries. However, access to such capital was dependent on the insurer securing a longer-term financing plan according to people involved in the plan.

Copyright The Financial Times Limited 2008

Goldman Sachs earnings slide

By Greg Farrell in New York
September 16 2008 13:54

Goldman Sachs, the US investment bank, reported profits of $845m for the third quarter on revenues of $6.04bn. Earnings per share were $1.81, slightly below consensus estimates but above the most dire predictions of $1.60 per share.

The results were significantly below last year’s third quarter but compare favourably with results posted by Goldman’s competitors, which have been awash in red ink in 2008.

Investment banking revenues were $1.29bn, down 40 per cent from the same period last year, while financial advisory revenues, at $619m, fell 56 per cent.

In trading and principal investments, revenues were $2.7bn, down 67 per cent from the same period in 2007. The company’s fixed income business took in $1.6bn, also off 67 per cent lower than last year.

Net revenues in equities were $1.56bn, 50 per cent lower than the previous year, while principal investments showed a net loss of $453m.

Copyright The Financial Times Limited 2008

WaMu faces price to keep deposits

By Saskia Scholtes in New York
September 16 2008 21:27

Washington Mutual may face increased costs to keep the confidence of depositors, say analysts, after the largest US savings and loan institution was downgraded to junk by both Standard & Poor’s and Moody’s.

“This week and next will be the moment of truth for WaMu,” said Fred Cannon, an analyst at Keefe Bruyette & Woods. “Their primary sources of liquidity are retail deposits and advances from the Federal Home Loan Banks [FHLB] but, now they are junk-rated, WaMu may have to pay more to encourage depositors.”

Paying higher rates to sustain the bank’s $143bn (€101bn, £80bn) deposit base will impede WaMu’s ability to make profits over the long term. Until this week, the bank offered 5 per cent on one-year certificates of deposit – the highest in the market. Deposit campaigns of this kind can attract new customers, said Mr Cannon, but they do not make money for the bank when its own cost of funds for one year is also about 5 per cent.

WaMu said last week customer deposits had fallen $5bn from the end of the second quarter. However, it said “reliable sources of liquidity” were up $10bn to $50bn and the bank had not seen any “dramatic” moves in deposit flows “for some time”. If WaMu can see off the risk of a run on customer deposits, the rating downgrades from S&P and Moody’s will have no near-term liquidity impact.

WaMu is the fourth largest commercial bank in the US, with $310bn in deposits. None of WaMu’s unsecured debt is subject to rating-based triggers that would require the bank to repay early and WaMu does not expect the ratings to have a material effect on its borrowing, collateral or margin requirements, the bank said.

S&P acknowledged that WaMu’s deposit base appears to be stable and the company has enough liquidity to meet all fixed obligations throughout 2010. “The bank is operating with adequate capital positions from a regulatory perspective and has demonstrated funding resilience as the deposit franchise has remained stable,” the rating agency said.

However, the downgrades do reflect concerns around WaMu’s ability to weather further losses on its portfolio of mortgage and home equity loans and its reduced financial flexibility to raise capital. WaMu warned investors this year that the bank might have to write down as much as $19bn in bad debt.

In April, WaMu raised $7bn in new capital from outside investors led by TPG, the private equity group. The bank’s stock has since fallen by about 80 per cent and the cost of protecting its debt against default in the derivative markets has soared to distressed levels. Analysts at CreditSights estimated that WaMu might need between $2bn and $10bn to remain above a 7.5 per cent Tier 1 capital ratio.

“The company’s limited financial flexibility makes it more difficult for it to replenish capital and preserve diversified and stable funding sources. Both issues are critical to restoring the strength of the institution,” said Craig Emrick, a Moody’s analyst.

The rating agency said WaMu has limited exposure to short-term wholesale funding and the FHLB have been a stable source of funding. However, WaMu’s liquidity resources have become concentrated in the FHLB because of lack of confidence in the debt markets.

WaMu said it believed Moody’s downgrade was “inconsistent with the company’s current financial condition” and appeared “to reflect the current uncertainty in the markets, rather than a thorough evaluation of Washington Mutual’s business”.

Much will depend on Alan Fishman, the bank’s new chief executive, who replaced the long-serving Kerry Killinger last week. Mr Fishman has not yet convinced investors that he can turn the bank round or execute a sale at more than fire-sale prices.

Mr Cannon at Keefe, Bruyette & Woods said WaMu might struggle to find a buyer because of an accounting rule that would force a purchaser to write down the bank’s assets to market prices, requiring them to raise costly capital. JPMorgan floated the idea of a takeover in the spring but it was rejected in favour of the TPG investment.

JPMorgan remains interested, depending on price.

Mr Fishman said last week it was “way early” to comment on potential options for the company.

Copyright The Financial Times Limited 2008

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