AIG News: Blindfolded and Ready

By The Greek:

The Federal Reserve meets today for its regularly scheduled monetary policy meeting. It was expected to be a relatively uneventful meeting previously, but it now looks well-placed to address the most recent financial market turmoil and even offer more direct aid to the AIG (NYSE: AIG) emergency.

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The Federal Open Market Committee meets today and will announce monetary policy at 2:15 PM ET. Treasuries now indicate a strong majority expectation for a 25 basis point cut this afternoon. In months past, any emergency would have had the Fed on a conference call last night and announcing a move this morning. The market had given the Fed a pass in recent weeks, feeling its concern for inflation was well-founded and that rates were accommodating enough for economic expansion and financial market liquidity. However, with commodities crashing, the market is reevaluating prior thinking.

Meanwhile, the Fed did act this morning, flooding another $50 billion of liquidity into the system to encourage banks to lend among one another. Imagine, banks do not want to be entangled with the obligations of their peers because each fears the risk of the other. The interbank rate had expanded to 3.75% overnight, from 2.0%, and it returned to 2.0% after the Fed added liquidity.

"However, we're not so sure a rate cut is necessary now. In fact, it may be destructive."

However, we're not so sure a rate cut is necessary now. In fact, it may be destructive. Mortgage rates, which are key to market and economic recovery, have been giving ground since the Fannie (NYSE: FNM) Freddie (NYSE: FRE) intervention. Why risk inciting rates higher by giving the market reason to fear inflation again. The market believes the Fed will act out of concern that, if it does not act, the financial markets might collapse. In the past, this Fed has unfailingly obliged the market.

However, just this week, for the first time, the federal government said, "enough is enough." When Secretary Paulson denied rescue to Lehman Brothers (NYSE: LEH), he drew the line. Now, AIG (NYSE: AIG) is at risk thanks to rating agency downgrades that have raised its capital requirements. The rating agencies (NYSE: MCO, NYSE: MHP) would argue that AIG's increased risk caused the problem and raised its own capital requirements, and that they are acting in the interests of the market and investors. With the stock market dropping sharply since rating agency actions, what do you think about this viewpoint? Are they helping us? Comment below...

Thus far, the feds have refrained from action, and the State of New York had to defend its interests as a result, allowing AIG to temporarily lend to itself. In the meantime, New York is reportedly asking the government to provide AIG with a bridge loan to help it with its short-term capital requirements. Meanwhile, the New York Fed is reportedly meeting with JP Morgan (NYSE: JPM) and Morgan Stanley (NYSE: MS) to extend capital to AIG; AIG would then reportedly sells assets to recover to required capital levels. Clearly, the terms for the saviors would be extremely favorable, considering the risk born. In other words, JPM stands to make out like a bandit again! Within this whole mess, JP Morgan shareholders have clearly made the right choice among industry investment opportunities. The Goldman Sachs (NYSE: GS) crew is not far behind, but their stock has given back approximately 33% of value over the past few days. GS reported earnings 10 cents short of consensus today, marking the first quarter doing so, after 13 strong reports in a row.

Back to Focus, AIG

It appears something will be arranged, but it's unclear how AIG shareholders will make out, and they can look toward the graveyard where their brethren from Bear Stearns and others lie silenced. In our view, AIG shareholders should be angry at one of two groups. First of all, the move by the credit agencies has led the company into this crisis, and if AIG was not given fair warning that it was possible and/or coming, then they would have reason to be incensed. It seems that this is why the agencies use "credit watch" warnings... to avoid such predicaments.

Secondly, AIG investors should be angry at their own management team, because they are currently begging for time to set up financing. If they were properly forewarned that downgrade was possible, then they had adequate time already to act to insure capital would be in place, and failed. They would argue that this would limit return on capital, but better to limit return on capital than to complete kill it... If they tried, and couldn't find funding, then they are unlikely to find it now, especially not on better terms.

In any event, we think a direct action for AIG is more likely than a Fed Funds Rate cut is today, but the Fed has proven pawn of market will in the past, and so you might get your 25 Bps cut as well.

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