credit crunch

“An old fashioned run on the Bank”

Washington Mutual Bank was seized by government regulators and it’s branches sold to J.P. Morgan Chase & Co in the biggest bank failure in U.S. history. According to the Office of Thrift Supervision, bank customers withdrew $16.7 billion dollars causing it to become “unsound”.

Calls for Excessive CEO Compensation for Failed Companies are falling on deaf ears.

As shocking as it is to see the largest bank failure in American history, is even worse to hear about the compensation going to the CEO that has been in charge for only three weeks. It is being reported that Washington Mutual CEO, Alan Fishman, who took over as CEO on September 8th, 2008, will receive a total of 20 million in compensation. This is truly outrageous that the Board of Directors would award this package; and also that Fishman would actually accept it. With Congress still deadlocked on the 700 billion dollar bailout package, one of the main talking points of the proposal has been not to reward CEOs that presided over the bank failures and the companies that need to be bailed out. This truly shows how out of touch some of corporate America really is. No wonder Main Street does not want to bail out Wall Street. This is a prime example why there is so much outrage by American Taxpayers.  With all due respect to Mr. Fishman, what did he possibly accomplish to earn even a fraction of this windfall in three weeks time ?

What should be done?

Hopefully, clearer heads will prevail with the Board of Directors and Mr. Fishman with regard to his compensation. Mr. Fishman should do the right thing as a sign of good faith for the betterment of the shareholders and employees of Washington Mutual and either refuse to receive, or return the majority of the outlandish compensation . CEOs deserve to be paid handsomely when they perform and create shareholder value; however, they should NOT be paid 20 million dollars for becoming the captain of a ship whose mast was already in the water and then, watch it sink to the bottom in less than three weeks.

As we wrote yesterday, AIG was indeed bailed out by the Federal Reserve. Despite putting out the word on the street that they were not going to use taxpayer dollars for a bailout, the Fed went ahead and did it anyway. They probably looked at AIG’s books really closely and calculated the kind of global tsunami that would ensue and how many other companies that would fall like dominoes in the carnage.

This is the statement from the Federal Reserve’s website: ”

The Federal Reserve Board on Tuesday, with the full support of the Treasury Department, authorized the Federal Reserve Bank of New York to lend up to $85 billion to the American International Group (AIG) under section 13(3) of the Federal Reserve Act. The secured loan has terms and conditions designed to protect the interests of the U.S. government and taxpayers.

The Board determined that, in current circumstances, a disorderly failure of AIG could add to already significant levels of financial market fragility and lead to substantially higher borrowing costs, reduced household wealth, and materially weaker economic performance.

The purpose of this liquidity facility is to assist AIG in meeting its obligations as they come due. This loan will facilitate a process under which AIG will sell certain of its businesses in an orderly manner, with the least possible disruption to the overall economy.

The AIG facility has a 24-month term. Interest will accrue on the outstanding balance at a rate of three-month Libor plus 850 basis points. AIG will be permitted to draw up to $85 billion under the facility.

The interests of taxpayers are protected by key terms of the loan. The loan is collateralized by all the assets of AIG, and of its primary non-regulated subsidiaries.  These assets include the stock of substantially all of the regulated subsidiaries.  The loan is expected to be repaid from the proceeds of the sale of the firm’s assets. The U.S. government will receive a 79.9 percent equity interest in AIG and has the right to veto the payment of dividends to common and preferred shareholders.”

The language of the terms of the loan, as it is written clearly states that the assets of AIG will be liquidated to repay the principal and interest. It  is called a loan and clearly has a stated interest rate and term; however, it is a loan that could never be paid back in full with interest by the sale of AIG’s assets.  The reality of the situation is that the Fed paid 85 billion dollars for a 79.9% equity interest in AIG to bring order to the chaos that may have cratered the financial system worldwide. They will own and control the company. Now what happens with AIG as a going concern?  Is Chairman Bernanke going to take out an insurance debit book and start collecting insurance payments from AIG policyholders? He clearly is not; but the Fed is now one of the largest insurers in the world.

How many bailouts are left in the Fed’s bag of tricks? What is the smell test now for a bailout? Has the Lehman bankruptcy become the over/under for a bailout? A company that has liabilities equivalent to  Lehman’s size or below is allowed to fail, and a company with bigger problems than Lehman gets bailed out? These are clearly both crazy and scary economic times we are living in today. There is no telling how far-reaching this credit crunch is going to go; when it is going to end. These questions that have been put forth are just a tip of the iceberg. Stay tuned, it should be interesting.

The credit crunch has reared its ugly head again. Lehman Brothers, the venerable 158 year old Wall Street firm, was allowed to fail when there would be no guarantees from the Federal Reserve for Lehman’s toxic paper for a potential white knight  Ala the J.P. Morgan/ Bear Stearns deal. All the potential suitors packed up and went home when they couldn’t get a sweetheart deal from the Fed like J.P. Morgan got for Bear Stearns. Why was Lehman not bailed out like Bear Stearns, Fannie Mae and Freddie Mac?

With political pressure from Congress and in the media, it certainly does appear that Lehman Brothers was a sacrificial lamb. Despite denials from the company, the financial problems that they might have been facing have been well documented in the media the last few months; and did not have a warp speed cash crisis that developed with  Bear Stearns. Why was there no action taken to thwart a Lehman bankruptcy and the repercussions, Vis-a-vis  the counter-party risk fallout? Was Lehman allowed to fail because of all the negative sentiment in the media of our nation becoming a Socialist power since the Fannie Mae/Freddie Mac bailout and the taxpayer’s outrage that ensued?

By all accounts, AIG is in the midst of a crisis that places them to be next in line for failure. They have asked for a 40 billion dollar lifeline from the Fed to avoid a credit ratings downgrade which may be their death knell. According to  Credit Suisse analyst Thomas Gallagher, who  wrote in a research note”Liquidity is clearly under pressure now with over $13 billion of additional collateral posting required for (the company) in the event of a ratings downgrade,”. NY State announced today that AIG will be allowed to borrow 20 billion from AIG subsidiaries. Where is the other 20 billion dollars going to come from? If Warren Buffet does not come to the rescue, my guess is that the money comes from the Federal Reserve and the United States Treasury.

There is certainly a lot of blame to go around for Lehman’s failure starting with senior management as to why their balance sheet had so much leverage and bad bets. There was also ample time to come up with a rescue/restructuring plan to possible avoid bankruptcy. With the Federal Reserve having to deal with the  AIG crisis at the same time, and possibly many other problem companies right around the corner, may have allowed Lehman Brothers to become a political sacrificial lamb.

What do you think? Your feedback is welcome.