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US government digs deep to avert financial crisis

23 September 2008 Gareth Stokes

Where would we be if it wasn’t for the US government? We’re not talking about their continued meddling in international politics; but rather their ability to provide much needed capital to prop up that country’s ailing financial services sector. Since Bear Stearne became the first victim of the so-called sub-prime contagion the US Federal Reserve has had to repeatedly reach into its pockets to help. And we’re not talking petty cash!

On 7 September 2008 the government announced the biggest private sector intervention in history. The US Treasury agreed to extend a lifeline of $100bn to each of the country’s mortgage lending giants, Freddie Mac and Fannie Mae. In doing so they effectively co-signed on liabilities of $5.4trn (the total value of mortgages backed by the two companies). Analysts are divided as to whether this was the right move; though most agree that backing the companies responsible for 70% of all US mortgages would restore confidence in global mortgage-backed securities. The bad news for the Fed is that each successive bailout flushes more struggling financial companies out of the woodwork.

AIG – a massive global insurer

The latest is American International Group (AIG), a world leader in insurance and financial services with operations in more than 130 countries. The company, which boasts that it is the world’s leading international insurance organisation, has run head-on into a weak US housing market, disruption to credit markets and global equity market volatility. Part of the problem is that AIG insures approximately $88bn of assets worldwide – including mortgages and commercial loans. It reported a net loss of $13.16bn for the first six months of 2008 against a net income of $8.41bn for the previous comparable period. What a hammer!

As the company teetered on the brink of collapse the US Federal Reserve decided to offer a lifeline in the form of a two-year emergency loan of up to $85bn. According to White House spokesperson, Tony Fratto, “these steps were taken in the interest of promoting stability in financial markets and limiting damage to the broader economy.” But the rescue package comes at a massive cost. Government will end up with a 79.9% stake in AIG and will be able to make critical decisions with regards senior management placements.

Some you win, and some you lose

Other financial institutions weren’t as lucky. The Fed refused to intervene when US investment bank Lehman Brothers filed for bankruptcy earlier this week after suffering a $3.8bn third quarter loss, largely on the back of its real estate holdings. Many analysts nervously observe that the 158-year old company survived the Great Depression; but couldn’t muster enough fight for the current credit crisis.

What many investors don’t realise is the extent of the fallout following the collapse of one or more US financial institutions. When AIG Insurance falters – or when Lehman Brothers goes under – other global operators inevitably have some exposure. Zurich based re-insurer Swiss Re is a case in point. Shortly after the Lehman Brothers and AIG announcements the company issued a press release in which it revealed it had exposure to both companies. “Swiss Re estimates its overall net exposure to Lehman Brothers at approximately CHF 50m and to AIG at approximately CHF 200m (excluding re-insurance transactions),” said the group. It doesn’t sound like much for a global company with CHF 42.874bn in 2007 turnover; but it converts to around R1.767bn at today’s exchange rate.

Editor’s thoughts:
When Lehman Brothers collapsed we heard rumours that RMB had some exposure to the group. This was quickly denied by FirstRand chief executive Paul Harris who told SAPA: “We don’t own any Lehman paper and we owe them more than they owe us.” Another possible victim is Redefine Property Fund which was co-funding a mixed development project in Cape Town with Lehman. Do you think local financial services companies have seen the last of the US credit crisis? Add your comments below, or send them to gareth@fanews.co.za

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