In less than 24 hrs Paulson made two completely different statements. What could have changed his mind? “Sept. 15 (Bloomberg) – U.S. Treasury Secretary Henry Paulson said he never considered bailing out Lehman Brothers Holdings Inc. and that a government loan to American International Group Inc. isn’t currently an option.” ``I support the steps taken by the Federal Reserve tonight to assist AIG in continuing to meet its obligations, mitigate broader disruptions and at the same time protect the taxpayers,’’ Paulson said in an e-mailed statement released in Washington.
well you could differentiate between the fed and the treasury, although one could certainly disagree with that differentiation.
Probably a change in their economic models reflecting a high probability of deep prolonged financial distress. The failure of AIG would have been catastrophic. AIG insures many financial instruments and contracts on the balances sheets of financial institutions. The insurance by AIG allows the institution to hold the security with less capital requirements, ie risk based capital. If IAG were to go away, first their securities would be classified as higher risk, and the banks would be forced to raise capital. Second, the value of the securities in the open market falls, as they lose AA credit enhancement. Guess what! Mark to market! More asset losses, more capital raising. In addition, AIG has a significant amount of assets that would need to be sold on the open market. While there would be a market for some of the assets (private equity, hedge funds etc) many are distressed, illiquid securities valued using L3 valuations. Their open market sales would establish prices for banks to revalue similar positions…more capital raising. Also, AIG has significant positions in money market funds. Their bankrupcy causes MMF values to fall below $1 NAV. Investors panic, lose trust in money funds and cause a run on funds. Market for commercial paper dries up. Companies can’t fund their operations. Also, the CDS market being instantly unwound creates valuation problems for investors. Models get thrown out of wack, the securities market comes to a crash as investors that held riskless positions suddenly have exposure. Corporate bond selloff is instantaneous, pushing credit spreads to record levels. Borrowing becomes impossible. Credit freezes. Thats probably about why they did this. All of this still needs to happen, but they want it to occur more slowly. This buys everyone time to: 1.- Allow CDS investors to revalue their hedged positions, assess risk. Some contracts have time to expire, others have time to purchase additional hedges or unwind positions 2.- Allow MMFS to mature their exposure to AIG (max maturity 13 months in current holdings) 3- Allow transfer of risk to speculative investors. 4- Allow institutions time to assess exposure and plan course of action 5- Give banks opportunity adjust capital positions without duress 6- Avoid forced liquidation and allow asset sales at arms length prices