I would love to hear an answer from someone who knows more about this than me.

But this appears to fly in the face of everything I learned in US government 101.

Anyone who took the 201 course want to explain the legality of this?

went off during a Fox News interview tonight about the Fed's unilateral action.  He didn't say that he disagreed with it -- he did say that he was ticked off because Congress was left flying blind -- Bernanke never came to them to explain his reasoning.

As far as the legality goes, I guess the bridge loan to AIG could be construed under a really broad reading of the Fed Charter:

Section 2a. Monetary Policy Objectives
The Board of Governors of the Federal Reserve System and the Federal Open Market Committee shall maintain long run growth of the monetary and credit aggregates commensurate with the economy's long run potential to increase production, so as to promote effectively the goals of maximum employment, stable prices, and moderate long-term interest rates.

http://www.federalreserve.gov/...

If AIG went under yesterday morning, it probably would have sparked a global panic bringing EVERYONE down with it.  That still might happen, but I don't see that there was much choice with this one.  The Fed bought AIG a couple years to liquidate its assets.  AIG shareholders are essentially left holding worthless paper at this point -- they're the last people in line given that tax-payers are now AIG's main creditor.  Depending on how the sale goes, there's an outside chance that tax-payers could see a net profit on the sale of AIG subsidiaries -- many of which are still profitable.  It's a long shot, but given the options -- what choice was there?

This is capitalism's way of weeding out bad business practices.  If there is no risk in failing in the financial industry, people will take too much risk.  That is what occured here.

The industry (rightly) figured that even if they did behave wrecklessly the government would bail them out.  

Also, their CEOs have no incentive to not fail.  Even if they fail, they still get golden parachutes.

I say let them fall.  Will it hurt the markets short term?  Of course.  Our government can't be in the business of bailing out failed ones.

I've lost 25% of my 401k's value.  I demand a bailout also.  The government should make me whole again because their actions resulted in what we see today.  In that case bailout everyone.  But who is going to bailout our government?

I knew there was risk when I made my investments.  I can pull the plug today - and I could have pulled it last year.  The banks knew there was risk, and they could stop issuing risky loans at any time.  They didn't pull the plug until it was too late.  I am losing 25% of my savings because I didn't pull the plug.  The banks took the gamble and they LOST.  I took a gamble and I LOST.  The only difference is that the government won't be bailing me out.

And just another point.  WE are the government (of/for the people).  That means that WE - OUR MONEY - are bailing these corporations out.  It's not like YOU, JPTERP, aren't going to be paying for this anyways.  You, or perhaps your children, will ultimately pay.

And to the AIG shareholders: they had the option of voting in meetings and holding their CEOs accountable.  They had the option to restrict CEO excess and risky behavior.  They didn't.  They took the risk, and they lost.  They need to deal with it.  Nobody had a gun to their head and were forced to invest in AIG.  Personally I believe that shareholders need more rights and should exercise them.  But short of that we have an option: don't invest in stocks.  Nobody forces us to take the risk.

That's the problem with this system.  EVERYONE wants a safety net.  I believe we should have a safety net, but it should cushion the fall and help people get back up.  It shouldn't prevent the fall.  This applies to welfare, corporate welfare, government bailouts, etc.  The notion that our government will bail us out anyways, so don't worry about it, leads to poor decision making across our economy.

And no, I'm not a libertarian.  All one must do is look at our budget deficit and trade deficit, as well as how much money we are spending in entitlements and the military, to realize that something is going to give at some point.

We either will need to raise taxes or cut services.  We'll probably have to do both if we keep going like we are.

So we are spending 74% on either social security, the military, medicaid, or interest.  That leaves 18% for EVERYTHING else.  Instead of trim the military or cut costs in the entitlements, our government has chosen to simply GO INTO PERPETUAL DEBT.

This means that our national parks, our environmental initiatives, our highways, FEMA, FDA, and anything else outside of military and entitlements will be paid for through debt.

What frustrates me most about Democrats is that during the last two years spending rose by 8%.  It went up!  I'm voting for Obama - but I have every right to be upset at Democrats for not using their power to fix real problems.

Also, current military operations don't really show up on this graph - so in reality military is over 50%.  I voted for Democrats because I thought they would be responsible.  I consider increasing spending by 8% to be irresponsible.

Don't kid yourself - these bailouts are paid for by debt.  The more we go into debt, the lower the confidence in our currency.  If we aren't careful the USD won't be worth the paper its printed on.

your 401K is getting bailed out along with AIG.

If the Fed hadn't intervened in AIG's collapse there's a good chance that your 401K would have dropped to zero.  That's the Feds thinking in the intervention.

I'm not saying that any of this should make anyone feel good.  And I don't disagree with you about the big picture.  

If we make it clear that there will be no bailouts, that CEOs will get no golden parachutes, and that bad decisions will have consequences perhaps we wouldn't be here.

I don't agree that a total failure of AIG would collapse the entire market.  It would obviously be painful, but a company like AIG will eventually find a buyer.  Perhaps not at the price AIG or investors would like, but they will find a buyer.

Much of this is scare tactics.  "If you don't bail our company out, the entire economy will collapse".  It's as if every last financial firm is lining up right now to get bailed out.

As far as my 401k getting bailed out - it really wasn't.  I just incurred personal debt as a citizen of this country.  Would you ever take out a bank loan and invest that money in your 401k?  Well, our government just did that for you.  And the "bank" is foreign investors.  We are growing weaker, not stronger, with these moves.

Don't be fooled.  This didn't let air out of the balloon - it put even more air in.  Our balloon of debt is rising so rapidly that we could experience hyper-inflation - in short worthless money.  You will pay for these mistakes - if not now then later.

We are like drug addicts - and we just got our fix.  Unfortunately our addiction is getting out of control and it's only a matter of time until we OD.

But those are all actions that need to be taken BEFORE the sh-t hits the fan.  The regulatory system needs to be overhauled so that there are better firewalls in place.  

In reference to AIG, the bridge loan may back fire, and the company may still tank.  However, we're talking about a big player that underwrites a large chunk of securities including municipal bonds -- if they'd gone under they would have taken a lot more than just their shareholders.

If AIG goes under after the federal help, we tax-payers have just thrown away $85 billion.  If AIG is able to unload assets over the next two years, tax-payers are getting the loan repayed plus 11 percent interest.  Not ideal, but that's what we're looking at.

Consolidation of companies - where we have a few powerhouses at the top - creates a situation where if just one company fails it results in a meltdown of the markets.

That's how we know that companies are getting too big and that's when regulators should step in.  We shouldn't allow them to get so large that their failures cause great harm to our nation's economy.

Since we the tax payers now own these companies I think we should do to them what we did to ma bell - and split them into a dozen smaller companies.  It will be good for competition.  And I think the government should divest itself (ideally at a profit) ASAP.  

Also, it will create jobs since during the mergers people are always layed off.  By splitting the companies they must build their own back offices - they wouldn't have one large central one.

The magnitude of an AIG failure would have been huge.  Secretary Paulson tried to do exactly what you suggested.  He said in press conferences and to AIG, no way were they getting a helping hand they needed but to go to the market.  Paulson played a game of chicken with the market, and the market balked.  So, the Fed had to step in.  AIG insures not only just regular property & casualty stuff, they are all over the board.  And they backed up by insurance some of these mortgage derivatives.  So, if they disappeared then a lot of folks would have naked exposure to a pile of bad debt.  The credit market would have shut down because banks wouldn't lend to one another for fear that their counterparty was worthless.  

The markets operate on faith.  If no one trusts one another, then no one trades, assets then have no value, companies become insolvent, people are out of work because companies can't pay for operating expenses, and just a general spiral of bad things.  It's not like Enron or Aurthur Anderson going out of business.  They went out of business when the economy was in a relatively good place, and could absorb their overnight disappearance.  Times are tough, to add the vanishing of AIG would have been a nightmare.

Also to an earlier point, I think you overestimate the power of shareholders.  Most shareholders are large institutional investors.  You holding a stock in a brokerage account have no power to affect anything the corporation does.  Institutional investors rely on informational services to vote their shares.  But all shareholders are hindered by information asymmetry, management always has access to more information than the public (i.e. shareholders).  Equally shareholders do not manage the day to day operations of a corporation, nor do they make decisions regarding risk management or business activities undertaken.  That is what management does.  The information that shareholders get is primarily the financial statements and disclosures prepared by management of the company.  And I would challenge you to go through that public information and say that you as an investor could have discerned what they were doing was bad news.  Shareholders also don't have a lot of control over the slate of directors that are put forward for a vote at the annual shareholder meetings.  

With the genesis of Sarbanes-Oxley some of that has changed.  But I think in the aftermath of this crisis the shareholder rights movement will gain a whole lot more strength, enough to overcome Republican nay-sayers at the SEC.

like we can't let AIG fail because we need to keep the house of cards from toppling. Which, therefore, sounds to me like it's a solvency crisis and not a liquidity crisis.

I'm inclined to believe that almost all of these derivatives, especially CDS's, need to be heavily, heavily regulated, if not downright eliminated (commodities futures being the exception). As relawson stated above, no institution should ever again be allowed to grow so big that it becomes 'too big to fail'. We need strict regulations into the amount of leveraging these entities are allowed to engage in -- and there ought never again be leveraging on already leveraged assets, one degree of separation or none.

And again, the true picture of American political conservatism is coming through loud and clear -- socialize the risk, privatize the profit. But horrors if we spend one tenth of this amount of money insuring all the uninsured Americans for health care -- that's communism!

Definitively a liquidity issue.  If fundamentally nothing has changed about your business other than a specific set of assets has no price point anymore and you cannot mark it to market and suddenly you can't get access to even Commercial Paper to run your business, that's a liquidity crisis.  And it has affected not just AIG, but corporations across America.  You can see it by how many corporations are drawing on their bank lines of credit instead of issuing commercial paper.  You don't usually hit the revolvers unless you are in deep trouble.  And that is a lot of firms.

Did you see that Constellation is now the subject of a buy out?  And why is that?  Lack of liquidity for their trading operations.  And some of that can be hung on allowing Lehman to fail in that Lehman was one of their funders.  Constellation owns BG&E and what will that mean for their employees?

As to regulating specific financial instruments, innovation in financial markets has sped past regulation.  And it will no doubt do it again.  Rules based regulation in the SEC style has not stopped business failures or massive frauds.  Rules based regulation like the IRS just creates a ton of people who craft tax shelters designed to work within those rules.  I am 100% behind Paulson on this (well maybe 80%).  We need to overhaul our financial market regulation and move to a principles based approach along the lines of what CFTC does, along the lines of International Financial Reporting Standards (IFRS).  You can have CFTC regulate these products, but the products are still going to get traded.  You will still have folks like LTCM and Ameranth and so on.  The design of regulation, in this space, has to be to manage systemic risk which is what has happened here and not the risk of individual instruments within the market.  

And last derivatives are not bad!  They allow us to spread risk and manage risk.  Say I'm worried about rising interest rates and I have floating rate debt.  Well, I can issue an interest rate swap and bam! free of that risk.  Someone else who wants that risk gets it.  Or even better you distribute it among many people and it is like insurance contracts.  I'm afraid that my huge position in Microsoft stock is going to tank; I can take out put option and I am free of that worry.  Credit Default Swaps works exactly the same way.  I don't want to worry about that risk and someone else is willing to take that chance at a price, we make a deal and viola!  It is a financial market innovation that has allowed many a company to free themselves of managing some risks so that they can focus on other value-added activities at their company.  The bad players weren't the derivatives.  The bad players were the folks who were originating these bad loans.  They were the Credit Rating Agencies that failed to do any due diligence, and will Moody's and S&P get punished by this?  Nope.

I don't know nearly as much about this stuff as you probably do -- finance is probably one of my least knowledgable areas. Still, I consider myself a reasonably intelligent guy, and this stuff just doesn't pass the bullshit smell test to me.

I mean, at some point doesn't a liquidity problem turn into a solvency problem? If you're leveraged 100 times against your actual liquid assets, well, in my mind that's insolvent if there's a run of withdrawals -- no matter how much gimickry you have that says that you have the x billion dollars, if you can't get that money, is it really there?

Too much smoke and mirrors.

You're a bright guy, and I'm generally with you on your energy analysis stuff ... and I have come to trust your intelligence and knowledge based on your track record. Still, the systemic risk seems inherent in this kind of system to me ... the entire problem seems to be that the risks are higher than what the calculations would say. I don't see how you can hedge against all risks ... which means the risk of catastrophe must be higher than the models say. So we get today's situation.

I'll even stipulate that I might just be very ignorant of probabilities and the underlying fact situations. But I've studied quantum mechanics, and organic chemistry, and process control, and molecular biotechnology, and the theory of relativity ... big math and complicated theories don't scare me. But I can't get my ahead around this stuff, which makes me think that it's lunacy.  

Liquidity is ultimately the issue, solvency is the effect.  The issue of certain assets no longer having a price point has led lenders to fear that a business as a whole is untrustworthy.  And fears of these nature tend to become self-fulfilling prophecies as was the issue with Bear Sterns.  

All businesses and even individuals require credit in order to operate.  Some fortunate business (like Exxon Mobil and Microsoft, for example) site on such a huge pile of cash, they don't need credit like others do.  But that is really the exception.  Think of it like this, imagine your house has suddenly cannot be sold.  You find yourself in a liquidity crisis (i.e., asset has no value).  But let's say you still are making money and maybe you have a ton of other investments.  Then say your creditors suddenly lost all faith in you and called your lines of credit (credit card debt, personal lines of credit, mortgages, etc...), you wouldn't be able to pay all of that at once.  And suddenly, you would be insolvent.  You still have a good job and still make money.  But creditors lose faith in the value of the collateral you possess.  So a liquidity issue can become an insolvency issue.  

So, yes, liquidity can and does at times becomes an insolvency issue.  But it didn't have to be.  Everyone just took this one thing to its logical conclusion and overreacted.  That being if credit rating agencies said one batch of MBS's was investment grade and it turned out to be not, then what else were they wrong on?  And if one group of assets turns out to be worthless, then what other things on the balance sheet turn out to be worthless?  And how much exposure does this company have to these bad assets?  I don't know because that is not disclosed to the public, so I go crazy and pull out all my money, make margin calls, call my debt, etc...  And then self-fulfilling prophecy, the business is unable to handle that all at once and collapses.  

As far as leverage goes, that's a firm's decision.  Like you as an individual.  Leverage can help you reap extraordinary profits.  For example, you borrow $1000 and invest $100 of your own money in a security.  The security is then sold for $2000.  You make $900 and your return on investment is 900%.  Leverage is wonderful like that.  It bares risk though.  To the extent it multiplies your upside, it multiplies the downside too.  The result of this situation is that we may end up turning all financial institutions into regulated banks where they have to maintain a certain amount of capital on hand to mitigate liquidity risk.

And last on risk, of course, you never get rid of risk.  Derivatives don't get rid of risk, they just spread it.  Just like your auto insurance.  The risk of you having a high speed collision does not go away with auto insurance.  All you have done is put the cost of that risk against an insurance company.  Same thing with any derivative.  

And finally, if I haven't made this point through my other ones, it is all faith.  If you and I believe something has value, then it does.  Then the money is there as you pointed out.  If we don't, then it doesn't.  Collectively our faith has amazing power in this regard.  Look at the stupid popularity and pricing of Apple products.  Steve Jobs throws out some smoke and mirrors, and people think his products are manna from heaven.  Or even better DeBeers and diamonds, diamonds are not as rare as other precious stones.  But people buy into the notion that they need to have brilliant cut diamond engagement and wedding rings.  If suddenly people lost that faith, Apple and DeBeers would be in deep trouble.

You are obviously very knowledgable about this subject- much more than I am.  You analysis is quite in depth.

But to Ron1's point, there is a smell here.  To the average (educated) person these steps don't appear like steps that will stop the problem.  It may buy people time, but will it loosen the credit markets?  Will my business have easier access to money?  I don't think it will.  And we are no longer talking about a $70B bailout of AIG.  Now we are talking about a $700B bailout of anyone the fed believes needs to be bailed out.  

I think American businesses will not have more confidence as a result of this.  Short sighted people who think a few weeks is a lifetime (traders) may like it, but long term I find this debt to be very concerning.

And to be sure - we will be losing money.  We aren't buying good debt, we are buying BAD debt.  Many of the debtors won't be paying their loans.  We need to make sure that our government is selling these newly acquired homes for fair market values, and not dump them so that scavengers can pick them up for pennies on the dollar.

There is a smell here, and I don't like it.  The tax payers will revolt if we wind up paying for this.

See my above post, but the gist is that the government needs to restore trust and faith in the markets.  It's like FDR's fire side chats.  These things will most likely help a whole lot.  And they will prevent the credit market from shrinking to nothing, which your business and you personally would feel immensely.

Is a quasi-governmental entity.  The Reserve Board is the government piece, the reserve banks are the private piece.  The $85 billion is from the Federal Reserve Bank of New York.  The board of governors authorized that under their very broad powers to regulate money supply, the banking sector, the financial system of American in general.  If you go to their site and read the release, they quote the Act under which they have this authority.

In this case they didn't just regulate the supply of money though.  They acquired ownership of the companies.  This wasn't limited to increasing the supply of money - it was a bonified bailout of a corporation.

If they interpret the act to give them that much authority, then the act needs to be amended.  I haven't read it, but I can't imagine our government giving the fed that much power.

They did not acquire the company.  They lent them money an $85 billion credit facility that AIG can draw on at LIBOR plus 850 basis points, which would be around 12% depending on which LIBOR rate it is (which let me add is a super high rate).  The collateral on the loan is all of AIG's assets.  AIG issued warrants to the government as a part of the credit facility.  The warrants allow the government to purchase up to 79% of the company's stock at an immaterial cost.  They also give the government the right to veto dividend payments to preferred and common shareholders.  

Warrants are regular derivatives that companies give out to sweeten debt offerings.  To the extent that these were terms of the credit facility, the Federal Reserve Bank of New York (again private, not the government) with approval by the Board of Governors can write any loan terms it wants to adequately secure the loan.

The power is broad, I am copying the text of the section here so you can see:

In unusual and exigent circumstances, the Board of Governors of the Federal Reserve System, by the affirmative vote of not less than five members, may authorize any Federal reserve bank, during such periods as the said board may determine, at rates established in accordance with the provisions of section 14, subdivision (d), of this Act, to discount for any individual, partnership, or corporation, notes, drafts, and bills of exchange when such notes, drafts, and bills of exchange are indorsed or otherwise secured to the satisfaction of the Federal Reserve bank: Provided, That before discounting any such note, draft, or bill of exchange for an individual, partnership, or corporation the Federal reserve bank shall obtain evidence that such individual, partnership, or corporation is unable to secure adequate credit accommodations from other banking institutions. All such discounts for individuals, partnerships, or corporations shall be subject to such limitations, restrictions, and regulations as the Board of Governors of the Federal Reserve System may prescribe.