Cash is King!

The recent problems with Lehman Brothers and A.I.G. insurance is a liquidity problems and not a solvency problem. It is estimated that A.I.G. has a trillion dollars in assets and needs 75 billion in cash to weather this financial storm. To put this in perspective, if you have a house worth $100,000 dollars and you would need $7,500 to keep it. This is confusing isn’t it? The reason they can’t get a loan is the same as Lehman Brothers and that is sub prime loans.

Sub prime loans are loans to less qualified individuals and companies, but let’s go back and look at the industry of mortgages.

In the 1980’s a security was developed that was backed by mortgages through Fannie Mae and Freddie Mac corporations. Until recently the U.S. Gov. had said it would back these securities and that was enough.

In the last few years a larger percent of mortgages created were sub prime and also adjustable mortgages. This allowed people to get into homes for no money down and a low interest rate. These rates went up within a few years to a point were these marginal customers couldn’t cover the loan and default. It is estimated that 13.1% of mortgages are sub prime and account for 55% of foreclosures.

Last week the government had to go in and purchase preferred stock of Fannie Mae and Freddie Mac to show foreign investors that they are backed by the government. Lehman Bros. showed a 7 billion dollar write off from its residential and commercial real estate leading to its cash crunch and no buyers.

Now A.I.G. which insured those mortgages against failure is being downgraded on its credit rating which is forcing them to cover $14.5 billion in obligations and potentially another $5.4 billion in terminated contracts because of the downgrade.

They and others have enough assets and are not insolvent but just have no cash and further more these are accounting losses not real losses. They have not sold these and taken a real loss, however, regulations force them to reflect real value and this is the loss being shown.
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