March 18, 2009

Economic Outlook: Fallout from AIG

The U.S. Federal Reserve will come out of a two-day meeting Wednesday to face a city embroiled in embarrassment over bailout funds used for executive bonuses.

American International Group Inc. Chief Executive Officer Edward Liddy is to testify Wednesday in Washington to explain to angry members of Congress how a company with $170 billion in taxpayer funds propping it up could justify paying $165 million in bonuses, after losing upward of $40 billion last year.

The repercussions go beyond one company and a sum that is about equivalent to the cost of a corporate jet. The AIG fiasco may be the catalyst that turns lawmakers toward serious regulatory reform -- for the public a sleep-inducing discussion point that rarely, in turn, excites sustained effort in Washington.

But, a triumvirate of policymakers, including U.S. Treasury Secretary Tim Geithner, Federal Reserve Chairman Ben Bernanke and House Financial Services Committee Chairman Barney Frank, D-Mass., backed by international support, could find the public has the emotional staying power needed to slap reform into place.

Analysts expect reform to include less wiggle room for financial firms to shop around for the most lenient regulator, increased requirements for capital reserves for big banks and increased transparency for transactions between banks.

Beyond those relatively palatable items, expect policy makers to battle for more control of hedge funds and possible shift of insurance companies to federal oversight. In addition, consumer protection may be a key issue. Some have suggested a board similar to the Consumer Product Safety Commission that would cover financial products -- some of which in the modern era have proved too complex for even bankers to evaluate.

With key lending rates at historic lows, some say the Fed on Wednesday could make a bold move of pumping money into the economy with the purchase of Treasury bonds. In addition, analysts expect the Fed to consider increasing their support for the U.S. housing market by purchasing more bundled Federal Home Loan Mortgage Corp. and Federal National Mortgage Association securities.

U.S. investors, after a run of five positive days in the past six trading sessions, will be keeping an eye on the Fed's move. The Fed, in turn, will be keeping an eye on investors.