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The Fed, AIG and Lehman, or who is too big to fail?

Written by A Forex View From Afar on Wednesday, September 17, 2008

In the last trading session, equities rose despite the Fed holding interest rates at the current 2.00% level, even though the markets’ view was that the central bank would cut 25 basis points to help the financial system.

At the same time, the Fed published a statement that closely followed the interest rate meeting, saying the conditions in the financial markets had deteriorated even further, while the credit crisis’ effects over the real economy will span for the coming quarters. The hold decision together with the statement should have made equities take (another) deep plunge, however the market rose and closed the session in positive territory. What helped the market ignore the FOMC, although a rarity was the rumor that the Fed and the Treasury will step in and bail out AIG.

Those rumors were confirmed later in the day. The Fed will provide an $85 billion loan to the insurer, and taking as collateral 79.9% of the company’s stock shares. According to RBC Capital Markets, losses from an AIG bankruptcy would have topped $180 billion, since the company provides insurance for $441 billion of fixed-income investments, from which $57.8 billion are securities tied to sub-prime mortgages.

Some voices have been raised saying the Fed should have taken the same measure in Lehman’s case. The Fed is walking a fine line between who is “to big to fail” and who is not. Nonetheless, Barclays, the company which abandoned talks for a takeover a few days ago, announced it will buy the Lehman’s U.S. unit, and announced they are looking for more of Lehman’s businesses. A Barclay’s official called it a “once in a lifetime opportunity”

In the meantime, there is more evidence that the inter-banking tensions is mounting. The dollar LIBOR, the rate at which banks access dollar funds, rose yesterday by 3.33%, the biggest gain ever recorded in history. In normal market conditions, the LIBOR trades somewhere slightly above the Fed funds rate.

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Fundies and Trading
There is a constant question from some traders as to why anybody would ever need to consider the ‘F’ word when trading. Fundamentals: what is so damaging at looking at both Technical charts and having a Fundamental filter to gauge how many Lots to put on? Why is it that accepting that Technicals give us price points to trade, but Fundamentals determine the direction that we travel is so difficult for some traders to accept? Without a Fundamental Filter very few pure Technical traders would have seen this Dollar move coming today.

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