AIG, investment banks fall as Wall Street reels


The Dow Jones average as of Monday, September 15.

And then there were two.

Nervous investors awoke Monday to the shocking news that Lehman Brothers, the venerable 158-year-old investment bank, had filed for Chapter 11 bankruptcy protection. That same morning, Merrill Lynch was purchased by Bank of America as another storied investment bank fell victim to the deepening financial crisis. Their failures left only two independent investment banks on Wall Street: Goldman Sachs and Morgan Stanley, each of which is reportedly seeking to partner with a large bank.

The Dow tumbled more than 500 points on Monday, its worst single-day performance since a near 700-point decline on September 17, 2001, the first day U.S. markets reopened following the attacks of September 11, 2001. In a frenzied news conference on Monday afternoon, Secretary of the Treasury, Henry M. Paulson, Jr. stated, “We don’t take lightly ever putting the taxpayer on the line to support a financial institution. Moral hazard is something I don’t take lightly.” This statement came only six months after the Federal Government helped broker a deal in which JP Morgan agreed to buy Bear Stearns, provided that the Government assume the risk of $29 billion in bad debt carried by Bear.

Markets rallied Tuesday, on the back of a continued slide in crude oil prices and word that Barclay’s was in talks to purchase Lehman’s North American investment banking, fixed income and equities sales units, trading and research operations, as well as Lehman’s office building and two other facilities.

However, late Tuesday night, Wall Street was shaken once more by the previously unimaginable bailout of the world’s largest insurance company, the American International Group (AIG). Over the weekend, the Federal Reserve had rebuffed AIG’s plea for a $40 billion bridge loan to maintain liquidity. AIG was able to secure a $20 billion loan from the State of New York, but that was not nearly enough to save the company. After a joint effort by Goldman Sachs and J.P. Morgan to loan AIG $75 billion failed, the Government took the unprecedented move of offering up to $85 billion in cash under Section 13(3) of the Federal Reserve Act in return for a 79.9% equity stake in the company.

The Federal Reserve issued a statement late Tuesday night:

“The Board determined that, in current circumstances, a disorderly failure of AIG could add to already significant levels of financial market fragility and lead to substantially higher borrowing costs, reduced household wealth and materially weaker economic performance…The loan is collateralized by all the assets of AIG, and of its primary non-regulated subsidiaries.”

The arrangement transforms the U.S. Government from the insurer of last resort to the majority owner of the world’s largest insurance company. AIG began in 1919, when Cornelius Vander Starr became the first Westerner to sell insurance in Shanghai. Since that time, AIG has rapidly become the world’s largest insurance company, with revenues of $110 billion in 2007 and total assets of over $1 trillion as of June 2008.

Upon his death in 1968, Starr bequeathed a significant portion of his portion to the C.V. Starr Foundation, which immediately grew to become one of the largest private foundations in the United States. Harvard University has been a recipient of grants from the Starr Foundation for many years. The C.V. Starr Scholarship is awarded to one student at each of Harvard’s graduate and professional schools, including HLS, who is deemed to have financial need. Calls to the Starr Foundation for comment were not returned.

World markets initially cheered the news, with Asian markets opening higher by up to 2% on Wednesday orning. But by mid-afternoon, the financial clouds had thickened once again, the Dow Jones losing another 450 points to close at 10,609, more than 25% below its all-time closing high set less than a year ago.

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