Busch: Three Words for Today

Three Words For Today: Unusual, Exigent, and Catastrophic

Unusual: Yesterday, Reserve Primary Fund, a money-market mutual fund with $64.8 billion in assets as of Aug. 31, fell below $1 a share in net asset value because of losses on debt issued by Lehman Brothers Holdings Inc .

"Investor redemptions will be delayed as long as seven days," the fund's owner, Reserve Management Corp., said today in a statement.

The shock waves are already reverberating through the system as the scramble for US Treasuries and repos fall to almost 0.5 percent ... extremely expensive to get collateral. We may see the Tsy issue cash management bills to ease the crunch. It's an extreme situation and the witch hunt for money market funds that contain paper from Lehman and AIG continues...

Exigent: By now, everyone knows that the Federal Reserve has taken over AIG by issuing a two-year loan of $85 billion at libor plus 8.5 percentage points. The government gets warrants (equity participation) for an effective 79.9 percent equity stake in the insurer.

Under the "unusual and exigent" circumstances, the Federal Reserve has the legal authority granted to it to act. US Treasury Secretary was insistent that AIG's chief executive, Robert Willumstad, step down. I think the idea is to give the parent company time to unwind positions and generate capital to meet obligations that they can't do right now. Like Chrysler, some analysts are expecting the government to make a significant amount of money on the investment.

Catastrophic: So are the markets happy with the deal? I think in the short term, the markets are comforted by not having to go through two major bankruptcies simultaneously. Medium term, the government will most likely make a killing on the deal. Longer term, every company that gets large enough to cause ripples on the financial sector pond in a distressed environment should be extremely worried. What are the rules of engagement for the US Treasury and the Federal Reserve when it comes to intervening in the private sector? Unusual and Exigent? This is a dangerously broad and wide latitude for government intervention without any guidelines.

The fact that Treasury Secretary Hank Paulsonmet with Congressional leaders prior to doing the deal brings up a moral hazard question of a different color: who was lobbying for the bailout or who wanted it to go through?

While I have the utmost confidence in Hank Paulson, someone else at the helm might have a different agenda down the road. This takeover function needs to have oversight and rules or it has the potential to transform the US financial system into the Japanese financial system.

With the takeover of AIG, we may have already begun the process...



Andrew Busch

Andrew B. Busch here