So… now the world’s two biggest mortgage companies AND the world’s largest insurer are the property of the U.S. government?

Velcom to Amerika.

Here’s the quick and dirty of the Fed’s terms for the AIG bailout:

• Fed will offer up to an $85 billion 2-year loan to (AIG)

• In exchange, the Fed assumes 80% ownership of the firm

• All money borrowed is to be repaid at 3-month Libor, plus 850 bps… about 11% interest rate

• AIG will conduct an “orderly” sale of its assets until the loan is repaid.

Nice deal for the Fed, eh?

“I just loaned $283 to AIG,” declares Eric Fry, “I and every other American. And the funny thing is no one asked our permission. The Federal Reserve simply took our money and handed it to a group of individuals who have demonstrated the ability to lose billions of dollars faster than almost anyone on the planet.

“I would rather have tossed the money in a wishing well…not only for the wishes, but also because the wishing well will repay the loan sooner. The Fed’s $85 billion ‘investment’ in AIG is just the latest chapter of the American financial tragedy — a sordid tale that begins with the extreme greed of a few and ends with the widespread suffering of the many.

“The Fed did what it had to do. It protected the millions of individuals and institutions who relied on the insurance policies of one of the world’s largest insurance companies. But let’s hope the tragedy does not end with an $85 billion bailout. Let’s hope our sordid story contains a few more tragic chapters, like ones that feature tales of AIG’s executive officers shedding tears of remorse on their prison dungarees.”

Heh, amen. For more from Eric, read your daily Rude Awakening.

“Why save AIG and not Lehman?” Dan Denning asks from down under. “AIG was a major seller of credit default swaps (CDS). It was easy money for a while. You sell default insurance on mortgage-backed bonds. You collect the premium and never have to make good on the default… because… you know… what are the chances of that?

“These are unprecedented financial times. Lehman is also a major counterparty in the credit default swap market. Yet the Fed judged AIG’s role as a major seller of CDS more critical to the financial system. Why?

“One answer is that most of AIG’s customers are overseas. Not only would a bankruptcy trigger chaos is the CDS market, but many foreign customers insured by AIG would be in doubt about the value of their normal insurance policies. Just like with Fannie and Freddie, foreign creditors may have again forced the hand of the Treasury to use American taxpayer dollars to guarantee the value of their financial investments in the U.S.”

Dan forwarded us this picture of a line in front of an AIG subsidiary in Singapore this morning:

That’s a three-hour line queuing up in front of an AIG customer service center. Courtesy of The Straits Times.

An AIG bankruptcy would have cost the global financial industry at least $180 billion, chimed in RBC Capital Markets. AIG insured over $441 billion in fixed-income investments, many of which were held by the world’s biggest governments and organizations. Nearly $60 billion of those “investments” insured by AIG were subprime-related securities.

Until yesterday, AIG had $1.1 trillion in assets, 116,000 employees and 74 million clients in 130 nations. They insured people, property and businesses. They were in the consumer finance industry. Retirement management. Annuities. Money management. Risk management (ha!). Mutual funds. Private banking. They even leased airplanes.

“I’m afraid we are not through it at all,” commented George Soros yesterday. “In some ways, we are still heading into the storm, rather than heading out of it. We are at a very precarious moment.”

Finance has “grown too big, it has taken up too big a share of the world’s resources. Now it is shaking, and I think when it becomes once again regulated, it will be less profitable.”

“From an options trading perspective,” notes our options analyst Wayne Burritt, “the recent market-forced consolidation around Wall Street is a good thing: Weaker companies that make over-the-top bets are being weeded out and the risk they absorbed spread out. That provides buying companies with low-priced quality assets — such as asset management units — and should provide more systemic stability in the long run.

“That said, the fact is the subprime mess is going to weigh heavy on investors and markets until things get straightened out. And while no one has a crystal ball, my feeling is once the key real estate metrics begin to recover — including housing starts and existing home sales — we’ll begin to breathe a sigh of relief.”

Wayne was well insured for AIG’s blowout. His readers sold their S&P 500 SPDR Depository Receipts puts Tuesday for 150% gains… in just 14 days. Have Wayne help you survive this volatile market by trading options, here.

Housing starts in the U.S. plummeted 6% in August, to a fresh 17-year low.

At the current rate, “only” 895,000 homes will be built in the U.S. this year. Housing starts haven’t been that slow since 1991… when there were nearly 50 million fewer Americans

Yet mortgage applications skyrocketed last week. The Mortgage Bankers Association’s index of purchase or refinance applications shot up 33% last week, to the highest level since May.

Refis alone jumped 88%, the biggest gain since 2001. Again, you can thank Uncle Sam for that one. The average 30-year fixed loan fell from 6% to a five-month low of 5.8% after Fannie and Freddie were nationalized.

In the stock market, “investors” were somehow emboldened yesterday by the Fed’s decision to do nothing to lending rates. Immediately after the FOMC’s decision, markets surged into the black… the Dow and Nasdaq finished up 1.3%, and the S&P 500 shot up 1.7%.

Heh. You can’t beat the logic. Last year, lowering rates created a buying opportunity because they “showed that the Fed was worried about the market.” Today, holding rates steady is a buying opportunity, because it “shows that the Fed isn’t worried about the market.”

Right.

The dollar continues to defy logic itself. Despite all the shenanigans by the Fed and AIG and Merrill and Goldman and the Treasury… the dollar index remains stalwart, at just under 79.