WASHINGTON, September 17 – The Federal Reserve agreed to an unprecedented 85-billion-dollar loan to American International Group to avert a collapse expected to lead to a global financial calamity. The deal sealed in a late evening agreement Tuesday gives the US government a stake of 79.9 percent in the insurance behemoth in exchange for the loan.
The move came as AIG appeared to be a death spiral after over a week of panic and turmoil in financial markets that led to the failure of investment giant Lehman Brothers and a sale of Wall Street rival Merrill Lynch.
It also came just nine days after the US government nationalized two other giants of the financial system, Fannie Mae and Freddie Mac, drowning from the collapse of the US real estate market.
A central bank statement Tuesday said the Federal Reserve Board made the decision "with the full support of the Treasury Department" under Section 13(3) of the Federal Reserve Act with terms that "protect the interests of the US government and taxpayers."
The 24-month line of credit will carry an interest rate equivalent to the London interbank rate plus 850 basis points — or 8.5 percentage points above the rate used for most interbank loans.
"The interests of taxpayers are protected by key terms of the loan. The loan is collateralized by all the assets of AIG, and of its primary non-regulated subsidiaries," the central bank said.
"These assets include the stock of substantially all of the regulated subsidiaries. The loan is expected to be repaid from the proceeds of the sale of the firm\’s assets."
The government will have the right to veto the payment of dividends to shareholders.
Treasury Secretary Henry Paulson said he approved the deal.
"These are challenging times for our financial markets," he said in a statement. "I support the steps taken by the Federal Reserve tonight to assist AIG in continuing to meet its obligations, mitigate broader disruptions and at the same time protect the taxpayers."
Senator Christopher Dodd, chairman of the senate banking committee, said that action "is a clear sign that the financial crisis — which is a direct consequence of this administration\’s neglect and wayward economic policies — continues to deepen."
After being briefed on the plan, Senator Charles Schumer, another banking committee member, said "You have to stop to catch your breath. But upon reflection, the alternatives are much worse."
Some analysts had argued that an AIG collapse could trigger a wave of failures in the global financial system and deepen the credit crunch.
Robert Brusca at FAO Economics said the deal appears structured in a way similar to the one that bailed out Chrysler in the 1980s.
He said the loan is at "an extremely high rate" and will encourage AIG to quickly sell off assets to pay back the loan.
"It\’s likely going to ensure the survival and orderly disposition of the units that AIG would like to sell," he said.
"The government has taken an institution that was too big to fail and too interconnected to fail and lent it the money it needs to liquidate its assets."
Shares in AIG — a company with one trillion dollars in assets and tentacles in many markets — went on a roller-coaster ride on Tuesday, sliding 70 percent at the open, swinging into positive territory and then closing down 21 percent after a 60-percent plunge Monday.
New York Governor David Paterson earlier said AIG had one day to raise up to 80 billion dollars to stave off bankruptcy and avoid financial calamity.
In a statement earlier, AIG said its insurance, retirement and other financial services were operating normally.
AIG said its businesses "including its extensive Asian operations, continue to operate normally and remain adequately capitalized and fully capable of meeting their obligations to policyholders."
Far more than other insurers, AIG has been a big player in a complex parallel market called credit default swaps (CDS), financial instruments in which Wall Street companies take out a form of market insurance against the risks of bond default.
These products, often linked to the US real estate market, are at the heart of the current banking crisis and have led to massive write-downs of assets around the world.
AIG alone has written off 25 billion dollars amid spiking defaults on US mortgage payments in the United States.