The US Federal Reserve is taking the unprecedented step of offering an $US85 billion ($106 billion) rescue loan to save insurance giant American International Group from bankruptcy amid fears of a catastrophic effect on financial markets.
The rescue will cheer nervous investors who feared that AIG going into bankruptcy would add to recent market turmoil.
News of the portential bailout, coupled with the US Federal Reserve keeping interest rates steady, helped Wall St to rebound overnight. In turn, the Australian share market gained ground this morning on the back of the positive US lead.
Fed to the rescue
A central bank statement said the Federal Reserve Board made the decision "with the full support of the Treasury Department``.
"The secured loan has terms and conditions designed to protect the interests of the US government and taxpayers,`` the statement said.
All of AIG`s assets would be pledged to secure the loan while the Fed would retain a nearly 80 per cent stake in the company, the Fed announced.
The move came after federal officials reportedly tried but failed to persuade private firms over the weekend to put up funds to save AIG.
With the vast insurance firm facing bankruptcy, Treasury Secretary Henry Paulson, Fed Chairman Ben Bernanke and Fed President Timothy Geithner decided that a federal lifeline was needed to prevent a disastrous fall-out in the financial markets.
The final decision was made today (AEST) , as officials agreed it would be "catastrophic`` to allow the company to fail, the Wall Street Journal reported, quoting an unnamed source familiar with the deal.
David Kotok, chief investment officer at Cumberland Advisors, said earlier the US central bank had to act to avert a collapse at AIG that would be a calamity for markets -- which went into shock after the Lehman Brothers` bankruptcy Monday.
"This has the appearance of a cascade or a contagion. Failure of Lehman Brothers has created contagion because of counter-party risk that was not contained by the Fed,`` Mr Kotok added.
"Failure of AIG will make this much worse.``
Earlier this month the US government stepped in to save mortgage giants Freddie Mac and Fannie Mae – which were considered too big to be allowed to fail. The mortgage twins back about $US5 trillion in US home loans.
AIG shares have slumped by more than 80 per cent this year after it racked up big losses from the US mortgage crisis.
AIG’s woes come on the back of investment bank Lehman Brothers filing for bankruptcy and Merrill Lynch being swallowed by Bank of America.
AIG`s Australian impact
AIG has 74 million customers worldwide. More than two million Australian superannuation fund members rely on AIG Australia for income protection and death cover.
AIG also underwrites travel insurance for a string of corporate partners including ANZ, National Australia Bank, Jetstar and Diner`s Club. AIG Australia is also the underwriter for some of Australia’s biggest super funds, including Retail Employees Superannuation Trust, which boasts 1.7 million members, and Health Super.
Global share fears
If AIG had failed to raise the money necessary to fight off collapse, it would have sent Wall St into another tailspin.
Wall St managed to rally in a volatile session last night, after the US Federal Reserve kept interest rates steady – which was seen as a sign of confidence in the economy.
The Dow Jones Industrial Average shook off early losses and rallied 1.30 per cent, the Nasdaq rose 1.28 per cent and the Standard & Poor`s 500 index gained 1.75 per cent.
“The market couldn`t decide whether to buy low or keep panicking,`` said Elizabeth Harrow at Schaeffer`s Investment Research.
Other markets around the world were more in panic mode.
In London, the FTSE 100 index lost 3.43 per cent, in Paris the CAC 40 shed 1.96 per cent, Frankfurt’s DAX lost 1.63 per cent.
Asian markets all slumped yesterday, with Japanese shares down almost 5 per cent, Hong Kong down 5.4 percent, and South Korea losing 6.1 per cent.
Local moves
The ASX rallied today, after almost $16 billion was wiped off the value of the market yesterday.
By 12noon (AEST), the benchmark S&P/ASX200 was up 31.6 points, or 0.67 per cent to 4782.4, while the broader All Ordinaries was up 27.1 points, or 0.56 per cent, to 4826.9.
AMP Capital Investors chief economist Shane Oliver warned yesterday there was "no end of landmines in sight" making further stock market falls over the next month a strong possibility.
He forecasts the top 200 stock index could bottom out at about 4500 points next month before starting a slow and gradual recovery.
"Often financial calamities such as the collapse of Lehman Brothers mean we are getting close to the bottom," Dr Oliver said.
"Another 5 per cent fall over the next month is possible and that would make it the worst bear market since 1987. Ultimately, the central banks are pumping more money into the system and combined with the lower oil prices this should help the recovery."
Super woes
Since the market peaked at 6851 points in November last year, the ASX’s blue-chip index is down 31 per cent. This has put a major dent in Australians’ superannuation savings, with one expert saying people close to retirement may have to work for another couple of years to make up for the losses.
"Average annual returns over the past five years have been about 9 per cent, so if you`ve calculated your retirement based on getting similar returns during the past year, your sums will be way off," Jeff Bresnehan of Superratings said.
Interest rates outlook
The crisis in the US banking system and freezing of credit markets has, however, boosted the possibility the Reserve Bank of Australia will cut interest rates next month ahead of further cuts in 2009.
Some economists are forecasting rates could drop from 7 per cent to as low as 5.5 per cent by early 2010.
As an expat I can say without the bailout of AIG , Australia would be very hard hit. Most of the borrowing from Australian banks is via the US either directly or indirect. The US would of survived due to the large population but people in Australia would be paying more for their mortgages as banks offset their risk to AIG in most cases. Dont be too hasty to give crap to the USA , yes it has it faults but wether we all like it or not it drives the world financial economy
Posted by: LAX Boy of Los Angeles 3:14pm today
First there was bank socialism (all customers pay for the bank's stupid blunders at the same rate so the banks aren't impacted for being tiny collectives of idiots) now there is federal reserve socialism (all taxpayers have to pay for some overpaid morons in an investment bank who couldn't drive a simple shared note, let alone a complex derivative) which means double taxes for the next five decades because we all have to bail out some idiotic banks.
Posted by: David Ray 3:08pm today
Brett comment 105 - Hey, it's no secret that Democracy is hipocrisy (and what is the biggest democrate country in the world??)
Posted by: RD of Outback 3:05pm today
This has been brought on by banks lending money to people who had no chances of repaying it. Multiply that by a few million people, over several years and that equates to a financial institution collapse.Yes so the US government has bailed out Freddie Mac and Fannie May. All that means is that the US government owns a large percentage of homes!The ball has only just started to roll.We are witnessing the end of the western empire as we know it.Coming soon: the rising of the East.
Posted by: someone of somewhere 3:05pm today
No wonder the United States Current Account Deficit $12,250,000,000,000.00 that is $12.25 Trillion!
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