Published September 16, 2008

Insurer AIG in the cross-hairs as Lehman bites the dust

Bank of America buys Merrill Lynch for US$50b in day that shakes US financial industry to the core

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(NEW YORK) Nervous investors waited for American International Group Inc (AIG) to announce a survival plan yesterday after two venerable Wall Street firms finally fell victim to a credit crisis that has plunged the financial system into turmoil.
Out of the picture: A Lehman employee making a call from his office yesterday

In the biggest financial shake-up since the Great Depression, frantic attempts to find a rescuer for investment bank Lehman Brothers failed over the weekend. And in an ominous move, AIG - the biggest US insurer by assets - had asked the Federal Reserve for an emergency loan, according to earlier news reports.

But yesterday, New York's governor David Paterson said that AIG has been given special permission to access US$20 billion of capital in its subsidiaries to free up liquidity. The move 'is not a government bailout', he said at a press conference. AIG is still a 'financially sound company', Mr Paterson added.

In one of the most turbulent days in Wall Street history, Lehman filed for bankruptcy protection from its creditors, rival Merrill Lynch agreed to be taken over, and the Fed threw a lifeline to the battered financial industry.

As a deepening crisis took new, bigger victims, the Fed said that for the first time it would accept stocks in exchange for cash loans, and 10 of the world's top banks agreed to establish a US$70 billion emergency fund, with any one of them able to tap up to a third of that.

There is also increasing speculation that the Fed will now consider lowering interest rates further to offset the impact of a tighter credit crunch on the faltering economy.The events are signalling a seismic shift in Wall Street's power structure, with big-name investment banks biting the dust and major banks like Bank of America (BOA) and JPMorgan Chase becoming the survivors.

'It's a return to pure capitalism, the survival of the fittest - the government can't and won't bail everybody out,' said Justin Urquhart Stewart, investment director at 7 Investment Management in London. 'Investors will now retreat to the trustworthy banks, though that's not a phrase that trips off the tongue easily nowadays.'

BOA agreed to buy Merrill in an all-stock deal worth US$50 billion when it was announced. BOA's shares fell 15 per cent in early trading yesterday, reducing the value of the transaction.

BOA was seeking a bargain, and the world's largest retail brokerage, known as The Thundering Herd, was seeking refuge from fears it could be the next victim.

'It's just shockingly fast how it happened,' a Merrill employee in Asia said. 'It's hard to believe there will be no more Merrill Lynch.'

Lehman said it filed for Chapter 11 bankruptcy protection and was attempting to sell assets, becoming Wall Street's highest-profile bankruptcy since junk bond specialist Drexel Burnham Lambert succumbed in 1990.

The fourth-largest US investment bank owes its 10 largest unsecured creditors more than US$157 billion, including debts to bondholders totalling US$155 billion and debts to at least seven Japanese bank lenders totalling US$1.62 billion.

Lehman's European arm appointed administrators, who said they would wind down the business in as orderly a manner as possible. Lehman's petition followed three days of talks between bank CEOs and regulators at the Fed's fortress- like Manhattan building.

'This shows the US government is saying 'enough' after saving other institutions and that they see Lehman as a private affair,' said Marie-Pierre Pillon, head of equity and credit research at Groupama Asset Management in Paris.

With Lehman and Merrill out of the picture, three of the top five US investment banks have effectively departed the scene inside six months. Bear Stearns was acquired in a fire sale by JPMorgan in March.

Britain's Barclays emerged as a front-runner to buy Lehman late on Sunday after BOA pulled back, but it was deterred by the US government's unwillingness to provide a financial backstop to potential losses. -- Reuters, Bloomberg, AP, AFP