AIG rescue hopes, Morgan Stanley earnings, ease markets

NEW YORK/LONDON Tue Sep 16, 2008 7:55pm EDT

1 of 17. A Wall St. sign is seen in New York's financial district September 16, 2008.

Credit: Reuters/Lucas Jackson

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NEW YORK/LONDON (Reuters) - Growing expectations of a U.S. government-financed rescue of insurer AIG and the sale of Lehman Brothers' investment banking unit provided hope on Tuesday that worldwide financial tremors may be near an end.

The developments helped ease disappointment over a U.S. Federal Reserve decision to keep interest rates unchanged as well as weaker-than-expected revenues at Goldman Sachs Group Inc, the larger of the two surviving major U.S. investment banks.

But investors was reassured by Morgan Stanley's earnings report, which came a day early and handily beat expectations. Its shares jumped 8 percent in after-hours trading.

Both companies reaffirmed their faith in the independent broker-dealer business model despite the recent bankruptcy of Lehman, which came months after Bear Stearns virtually collapsed and was taken over.

"Between Goldman Sachs and Morgan Stanley, we are getting some modest positive news in what has been an otherwise dark five-day period," said Keith Wirtz, president and chief investment officer of Fifth Third Asset Management.

U.S. stocks overall surged at the end of a volatile session, with the Dow Jones industrial average gaining 142 points and beaten-down thrift Washington Mutual Inc (WaMu) up 18 percent.

AIG shares fell 48 percent in late electronic trading. Bloomberg reported that the U.S. government is considering conservatorship as an option for the insurer. Bloomberg cited two people briefed on AIG talks.

A federal government source told Reuters no federal agency has legal authority to put AIG into a conservatorship.

And Britain's Daily Mail newspaper, without citing its sources, reported that JPMorgan Chase & Co was expected to make a bid for Washington Mutual. But two people familiar with the matter told Reuters that JPMorgan was not in active talks at the moment to buy the largest U.S. savings and loan institution.

'CATASTROPHIC PROBLEM'

In a sign of how much U.S. authorities have been trying to prop up the markets, the Federal Reserve Bank of New York took the unusual step of providing some $87 billion in financing to Lehman units to prevent disruption in trading markets as customers flee.

Hours before Lehman's creditors were set to have their first formal meeting post-bankruptcy, there was a glimmer of hope for some of its roughly 26,000 employees.

Britain's Barclays Plc has agreed to pay $2 billion to buy Lehman's core U.S. broker-dealer business, including equity, fixed income, M&A advisory and other parts, a person familiar with the matter said.

A potential bankruptcy by American International Group Inc could have a market impact of $180 billion, or 50 percent of total capital raised by financial institutions worldwide since the beginning of the credit crunch, according to one estimate.

In a sign that worries about the solidity of AIG, until recently the top U.S. insurer by market capitalization, were spreading to other asset classes, some firms ceased making markets in commodity securities backed by matching contracts from AIG on Monday afternoon, ETF Securities said. The affected securities are known as exchange-traded commodities (ETCs).

Bloomberg News, citing a person familiar with the negotiations, reported that the Fed was considering extending a "loan package" to AIG.

AIG stock sank 48 percent after hours, but still trimmed earlier declines of up to 74 percent. For the year, it has plummeted 94 percent.

Earlier, New York Gov. David Paterson told CNBC that the insurer has "a day" to solve its problems. A failure would result in a "catastrophic problem" for the market, said Paterson, whose administration oversees regulation of AIG.

In a sign of continuing turbulence, banks' cost of overnight borrowing surged above 10 percent, signaling extreme distrust among the institutions. That's about five times the typical level, given that the Federal Reserve's target for short-term rates now stands at 2 percent.

The two rates typically track each other. Overnight dollar deposit rates eased later in the day, but were still at high levels.

AIG CONTRACTS AT STAKE

Both Moody's and Fitch Ratings cut AIG's rating by two notches on Monday, while Standard & Poor's Rating Services lowered its rating by three pegs.

The downgrades meant that AIG's trading partners can require the insurer to post an additional $14.5 billion in collateral, according to an August 6 regulatory filing. They could also result in the early termination of some contracts, requiring an additional $5.4 billion in payments, the filing showed.

"You don't just have a potential impact on the reinsurer side, you have it on the institutions that might be holding AIG paper," said Lorraine Tan, director of research for Asia at Standard and Poor's in Singapore.

"This would have a much bigger impact than a bank going down like Lehman or Bear (Stearns), or even a Wachovia (Corp) or WaMu in the U.S. AIG has a much bigger presence globally. Their reach to a global customer base is quite sizable," she said.

AIG ended 2007 with 116,000 employees, more than four times as many as Lehman.

Top U.S. savings and loan WaMu saw its rating cut to "junk" status by Standard & Poor's on Monday amid concerns about mortgage losses. But WaMu shares rose 18 percent on continued speculation about a possible takeover by JPMorgan Chase.

"The second leg of the subprime crisis has begun," Jun Kwang-woo, head of South Korea's Financial Services Commission, told reporters. "It could be painful, but a recovery, once in place, may be rapid."

(Editing by Jeffrey Benkoe)

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