ANALYSIS: AIG loan signals new US era of regulation, intervention

By Chris Cermak Sep 18, 2008, 1:37 GMT

Washington - In a country that prides itself on free-market principles, US taxpayer dollars are are already on the hook for more than 300 billion dollars in financial industry bailouts, and, by some accounts, the government is just getting started.

The Federal Reserve's unprecedented, 85-billion-dollar loan and effective takeover of the largest US insurer, American International Group Inc, was only the latest in a string of emergency interventions this year on Wall Street.

With investors fearing more failures on the horizon by banks exposed to the credit crisis that started in the subprime mortgage market, Treasury Secretary Henry Paulson has not ruled out further action.

The Federal Reserve, the US central bank, has already opened up new short-term lending to shore up the balance sheets of struggling brokerages, adding an ocean of liquidity to the banking system - 200 billion dollars just this week - and taking on the devalued, mortgage-related assets in return.

Just two weeks ago, the Fed took control of government-chartered mortgage giants Fannie Mae and Freddie Mac and pledged 200 billion dollars to keep them afloat. Earlier this year, the Federal Reserve bankrolled JP Morgan Chase's 29-billion-dollar purchase of troubled investment banking firm Bear Stearns.

The turmoil began with a housing downturn that fuelled a record rate of home foreclosures, which in turn have decimated Wall Street's market for mortgage-backed securities. More than 500 billion dollars in asset writedowns have been posted so far.

The practices that brought the US financial sector to the brink - bundling questionable mortgages into enticing, high-return but deceptively risky investments - have left politicians blaming Wall Street for a culture of 'greed' that forced the government's hand.

Legislators from both ends of the political spectrum grudgingly accepted the bailouts as a necessary evil to stave off wider economic fallout from the credit crisis. Lending between banks has seized up, while opportunities for consumers to acquire new mortgages are fast dwindling.

More government measures could be in the works. Talk in the last few days has been of creating a separate government agency that could take on the bad mortgage debt at the heart of the current financial turmoil.

The idea mirrors a 1989 trust set up to absorb the losses from a crisis in the savings and loan industry. The Resolution Trust Corp took on and liquidated nearly 400 billion dollars in assets.

White House spokeswoman Dana Perino said the Bush administration was keeping an 'open mind.' Christopher Dodd, chairman of the Senate Banking Committee, told reporters that the Fed already had the authority to do the job.

With the current crisis still smouldering, all sides have vowed to prevent the government from having to intervene in the future. There appears to be a consensus that more stringent oversight of Wall Street is the only way forward.

Both presidential candidates have promised a new wave of regulation of the financial sector. Already in March, Paulson unveiled plans for a major overhaul of regulatory authorities that he argued have not been properly updated since the Great Depression.

Republican presidential nominee John McCain, who had opposed a bailout of AIG, on Wednesday said that the Fed was 'forced' to come to the rescue and promised further action if elected on November 4.

'We should never again allow the United States to be in this position,' McCain said. 'We need strong and effective regulation, a return to job-creating growth and a restoration of ethics and the social contract between businesses and America.'

Such noises mark a sharp turn from the last two decades, when Wall Street investment firms prided themselves on market innovations that received little government oversight.

'The watchword was deregulation,' Robert Reich, labour secretary under former president Bill Clinton, told US broadcaster CNN. Reich characterized some of the current solutions as 'socialized capitalism.'