The AIG Crisis

9/17/08
These are momentous times. Current events in the fixed income area may paralyze the world’s economy and push it eventually into a deep recession. This is not a forecast but rather one of several potential scenarios.
I could elaborate in person on current events. Fortunately, because of the centrality of fixed income securities in the current crisis, better persons than me comment on the situation and it is my pleasure to refer you to several excellent sources:
1. In today’s New York Time read “Fed Agrees to Lend A.I.G. $85 Billion to Head Off Crisis” In particular, examine the Multimedia chart in this article titled “AIG Troubles and Why They matter”. You should review the concept of Credit-Default Swaps that I discussed in an earlier posting.
2. The front page from today’s WSJ (print!). The article titled “U.S. to Take Over AIG in $85 Billion Bailout; Central Banks Inject Cash as Credit Dries Up” mentions the fact that even money market funds are no longer safe. This means that for the first time in two decades, investors who park their cash in a MM funds can actually collect less than 100% of what they deposited. In short: their buck may break.
3. You should also listen to an excellent interview conducted today with Professor Michael Greenberg, (a U. of Maryland law professor) on Fresh Air – an NPR podcast. It takes 38 minutes to listen but it’s worth it.

To me the most worrisome development is that banks stopped lending to each other. This may have happened either because banks don’t have excess reserves or because they don’t trust each other.

Last: it is easy to forget but the FNMA-Freddie Mac dominated the news only a week ago. Are you sure you can describe the nature of the business conducted by those two institutions?