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FINANCIAL CRISIS: RESCUES AND RISKS

Fed rescues giant insurer AIG

$85-billion loan, the largest such bailout in U.S. history, signals depth of crisis

September 17, 2008|Peter G. Gosselin and Maura Reynolds | Times Staff Writers

WASHINGTON — In the U.S. government's largest single intervention in the private sector and in a measure of the depths of the global financial crisis, the Federal Reserve agreed late Tuesday to lend American International Group Inc. $85 billion to finance the insurance giant's likely liquidation over the next two years.

The loan is expected to prevent AIG's immediate collapse, which analysts said could have intensified the broad credit woes stemming from the sharp downturn in the housing and mortgage markets.

The action represents an abrupt about-face for the government, which last weekend appeared to signal an end to federal rescues of private firms by allowing Lehman Bros. Holdings Inc. to go belly up.

In a statement, the central bank said it acted "with the full support of the Treasury Department" after concluding that "in current circumstances, a disorderly failure of AIG could add to already significant levels of financial market fragility and lead to substantially higher borrowing costs, reduced household wealth and materially weaker economic performance."

Senior Fed officials briefing reporters said the central bank acted because AIG insures the houses, cars, retirements and lives of millions of Americans, and its demise could threaten those protections, although many are backstopped by state insurance laws.

It appears the chief reason behind the Fed action was fear that the company's failure could weaken or destroy nearly a half-trillion dollars' worth of financial protection that AIG provides Wall Street firms and the biggest companies of Europe and Asia.

In addition, the Fed seemed concerned that an AIG collapse could cause the financial crisis to begin bleeding into seemingly rock-solid instruments held by small investors, such as money market mutual funds, some of which have invested heavily in AIG debt or are insured by AIG.

In a development that could undermine confidence in money market funds, the asset value of one such fund dropped below the standard $1 a share Tuesday because of expected losses on Lehman Bros. debt securities.

The government's intervention came a day after the Dow Jones industrials plunged more than 500 points partly on fear of an AIG failure. The rescue took some of the spotlight off the Fed's decision earlier Tuesday to leave its short-term lending rate unchanged at 2%.

The Dow Jones industrials dropped 100 points immediately after the rate decision was announced. But as rumors circulated that government officials and AIG executives were meeting in New York on a rescue package, the market reversed course. The Dow ended the day up 141.51 points, or 1.3%, at 11,059.09.

The AIG loan could trigger a strong stock rally today.

The financing effectively will give the government control of AIG, the country's second-largest insurer as measured by premiums and a firm with $1 trillion in assets, $110 billion in revenue last year and 116,000 employees.

The U.S. will replace AIG's top management, including Chairman and Chief Executive Robert Willumstad, and probably the company's board of directors. The government also will have veto power over all major corporate decisions, including whether to pay dividends to shareholders.

In lending the money, the government will be placed at the front of the line ahead of all other creditors and stockholders to be paid. In addition, in return for the loan, the government will receive warrants giving it the right to buy 79.9% of AIG's stock for a token amount.

Capping a day of high drama, Fed Chairman Ben S. Bernanke and Treasury Secretary Henry M. Paulson Jr. went to Capitol Hill at 6:30 p.m. EDT to discuss the loan with top House and Senate leaders in the offices of Senate Majority Leader Harry Reid (D-Nev.). People familiar with those discussions said they occurred after the Fed and the Treasury Department had approved the loan.

Privately, lawmakers of both parties signaled deep wariness about the loan, but generally kept their public comments muted.

"Hearing of these plans, you have to stop to catch your breath," said Sen. Charles E. Schumer (D-N.Y.), chairman of Congress' Joint Economic Committee. "But upon reflection, the alternatives are much worse."

Sen. Christopher Dodd (D-Conn.), chairman of the Senate Banking Committee, accused the Bush administration of contributing to the crisis by being too lax in regulating financial markets and said he would hold hearings on the loan as early as Thursday.

"This decision is a clear sign that the financial crisis . . . continues to deepen," Dodd said. "Actions that were inconceivable just days ago are now occurring in a manner and at a pace that is certainly cause for concern."

The White House said President Bush was briefed on the emergency loan and had given his blessing.

"These steps are taken in the interest of promoting stability in financial markets and limiting damage to the broader economy," said White House spokesman Tony Fratto.

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