Fed Backtracked

Well, what can you say.... I thought the money could be forthcoming from big foreign banks, obviously the sum came short and the Fed decided that the financial guys called its bluff and decided to fold instead. Many will question why Bear Stearns, and the Fannie & Freddie... but not Lehman Brothers?? For AIG, they stepped in again.

I thought they had drawn a line in the sand saying no more bailouts by leaving Lehman to go to bankruptcy. Obviously Merrill had the same ultimatum from the Fed and Treasury as well, before deciding to fold as well and be bought by Bank of America. John Thain must be thinking, umf'ers blind sided me... and bluffed me to lose my firm.

To be fair to the Fed, they are treading uncharted waters literally. They had to step in when the proverbial stuff hit the fan for LTCM. The trouble is the Fed and Treasury do not know what will be the implosion effects if AIG is left to fail, its really big. The biggest bankruptcy in US history prior to Lehman was Worldcom with US$103bn, next came Enron with US$63bn, and then Conseco with US$61bn - all in 2001-2002. Even Refco which failed in 2005 was only a US$33bn thing.

Hence to allow Lehman to fail was already taking the Fed and Treasury to uncharted waters, Lehman was a US$639bn more than 5x the Worldcom bustup. They saw the markets being able to absorb the failure of Lehman with relative little harm. But they don't know about AIG's impact. Plus, could the markets digest and take in two consequent huge failures?

They are not just staking their reputation here, but the well being of not just the US economy but global repercussions. Obviously the feedback from other central banks (esp Japan) was that many Japanese banks have huge exposure to AIG, and would have communicated that to the two bigwigs. Lehman's failure also affected Lehman Japan which had US$37.5bn in liabilities, or 3.9 trillion yen. Looking at Japan's financial history, that was the second biggest failure after Kyoei Life which went bust in 2000 with liabilities of 4.5 trillion yen.

Hence Japan really could not really stomach another AIG related failure which may well result in a newcomer topping the list of failures in Japan. At the end of the day, the Fed and Treasury could not open their cards when the lenders did not come through.

End result more toxic assets onto the Fed's balance sheet. I had written a scathing article questioning USD's strength over the last few weeks for this Saturday's paper. These events have basically reinforced and brought forward the demise of USD going forward.

For equity markets, the Fed's move would be greeted with a smile. Free markets people will frown. Life goes on.

p/s photos: Sandra Dewi