[buwaya]

The financial loss seems to have mostly (the bulk of it) landed in Fannie and Freddy, as they are holding the paper. Therefore it has landed on the Feds.

The rest of the losses are hurting elsewhere because of the leverage problems, but they seem to be getting absorbed through equity losses.

[JasonC]

Um no. The instant Fannie and Freddie were driven to zero, the short sellers who made billions driving them there bet every dime they just made, against Lehman, Washington Mutual, Merrill and AIG. Which is what broke Lehman's back. Lehman's losses were not absorbed by equity, precisely because the Treasury refused to backstop its mortgage positions. That instantly spread the losses over Lehman's counterparties. Lehman has $600 billion in debt.

Today the central banks had to inject $150 billion in new bank credit and the fed fund rate still closed at double its target level. These injections were dramatically oversubscribed - banks sought $400 billion in funds and many got nothing, which is why fed funds stayed so high. Understand, every bank has to make adequate funds on deposit at the Fed by the day's close (or it is breaking the law, and can't open the next day).

Markets sold off huge amounts, yes that is equity losses. But it isn't remotely over and it required massive central bank intervention - many times the size any bailout would have been - just to let banks open tomorrow morning. AIG in particular has disclosed that it needs $70 billion in capital to be in compliance with its swap contract collateral obligations, as well as its regulatory required capital for its policyholders (the latter are segregated and protected first, like bank depositers more or less). AIG doesn't have it. There isn't equity to take that full hit, which is a direct result of Lehman failing and not paying all its obligations (to AIG, and to others that AIG guaranteed if it couldn't).

The Fed and Treasury have said they will not lend to AIG to cover this. If no one does, AIG will follow Lehman into bankruptcy in less than a week, and the very same losses will remain unallocated and will hit AIG's counterparties next. The larger banks are trying to put together a loan to let AIG do this. AIG has valuable assets it could sell, if it can get the time. But it won't have the time without a loan.

The likely resolution is that the other banks will give a big loan to AIG until it can sell assets - and they will borrow the money for it from guess who, the Fed. The Fed will say it isn't lending to AIG to save it, but in effect that is what will happen.

The alternative, "burn 'em all down" approach, is flat nuts. It has already cost the authorities 10 times as much in one day as an orderly liquidation of Lehman would have caused.