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%.
