Fed Injecting Money Into Financial Markets

The Federal Reserve said today it’s providing liquidity to financial markets to keep them running smoothly. Here’s a clip from a short statement on its web site:

The Federal Reserve will provide reserves as necessary through open market operations to promote trading in the federal funds market at rates close to the Federal Open Market Committee’s target rate of 5-1/4 percent. In current circumstances, depository institutions may experience unusual funding needs because of dislocations in money and credit markets.

The Fed and foreign central banks are responding to a drop in demand for securities backed by mortgages as well as losses by investment funds that hold the securities.

Early today, the Fed accepted a larger-than-expected $19 billion in three-day repurchase agreements, as a way to inject liquidity into the banking system, reports the Wall Street Journal. This comes on top of the Fed adding $24 billion yesterday.

Here’s a clip from the Journal’s web site:

The federal-funds rate – the rate at which banks make overnight loans to each other — had risen to 6% early Friday, sharply above the Fed’s 5.25% target rate, suggesting demand for reserves ahead of the weekend, according to John Silvia, chief economist at Wachovia Corp. After the $19 billion injection, the rate fell back toward the target.

Bloomberg reports that the $19 billion was provided by the Fed accepting mortgage-backed debt as collateral. (Hat tip to Calculated Risk blog.)

The European Central Bank on Thursday loaned an unprecedented 94.8 billion euros ($130.2 billion) in emergency funds to European banks.

And Asian central banks are adding cash to their banking systems, reports Reuters. Here’s more:

A Bank of Japan official said the bank injected funds at its regular money market operation on Friday due to a slight rise in the benchmark overnight call rate. The bank for the world’s second-largest economy offered to supply 1.0 trillion yen ($8.45 billion) in funds — at the higher end of market expectations.

The Reserve Bank of Australia pumped more than twice the usual amount of money into the banking system, injecting A$4.95 billion ($4.19 billion).

The banks acted to ensure there were enough funds for money markets to operate smoothly and to prevent short-term rates from spiking. The moves did not represent a substantive shift in monetary policy, analysts said.

By Mathew Padilla, Orange County Register

AIG Reassures Investors About Subprime

American International Group on Thursday told investors the housing market would have to spiral to Depression-era levels before the insurer would be harmed by its exposure to the residential mortgage market.

The world’s largest insurer has exposure to subprime loans — those made to people with tainted credit — as a lender, investor in mortgage-backed securities and supplier of mortgage insurance. But AIG characterized its exposure as minimal and said it would take declines of 30 percent to 40 percent in home values to dent the market for mortgages with stronger ratings, where most of its holdings lie.AIG said delinquencies on first-lien mortgages were on the rise at its mortgage insurance group. But the company also reassured investors that it has ample cash and “doesn’t need to liquidate any of its investment securities in a chaotic market.”

Cliff Gallant, equity analyst with Keefe, Bruyette & Woods Inc., estimates that of AIG’s $1.034 trillion in assets at June 30, it has some $3 billion to $5 billion that could go bad in subprime defaults — a thin slice of the overall pool.

It amounts to about $1 per share in exposure, “a reasonable worst-case scenario,” he said.

Analysts, on average, expect AIG to earn $6.53 per share this year.

As conditions in the credit market have tightened, investors have been sensitive to any sign of a ripple effect, in which the fallout from defaults on subprime loans would spread to other parts of the lending market. Any news of subprime mortgage or credit problems has sent stock prices reeling; on Thursday, the Dow Jones industrials were down by triple digits on concerns about liquidity in the credit markets.

“We believe that it would take declines in housing values to reach Depression proportions — along with default frequencies never experienced — before our AAA and AA investments would be impaired,” said Chief Risk Officer Bob Lewis, in a conference call with analysts on Thursday. “AAA”- and “AA”-rated investments are considered to be those of highest credit quality.

Home prices would have to slide by more than a third, and defaults among borrowers with strong credit would have to balloon above 45 percent, to begin to affect the AAA and AA bundles of securities, the company said.

As an investor, AIG has about $94.6 billion in residential mortgage market holdings, equal to about 11 percent of its total invested assets. Of that, the company has $28.7 billion, or 30 percent, in subprime residential mortgage-backed securities.

AIG has said repeatedly that it is “very comfortable with the size and quality of its investment portfolios.”

AIG’s American General Finance, which originates mortgages, has about $6 billion of its $19.2 billion real estate portfolio invested in the subprime space.

United Guaranty, AIG’s mortgage insurance arm, said first-lien mortgage delinquencies had risen to 3.98 percent in June from 3.71 percent in May.

President and Chief Executive Martin Sullivan told investors that the company remains “well-positioned, even in the event of further deterioration in this market.”

AIG shares fell about 3 percent Thursday amid the broader downturn in the market.

On Wednesday, after the market close, AIG reported a 34 percent jump in second-quarter profit on growth in its general and life insurance businesses. Its mortgage guaranty unit posted an operating loss, but the business accounts for a relatively small part of the company’s overall earnings.

By Lauren Villagran, AP