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.
The new loan is the latest and by far the most dramatic step that Washington has taken to try to help the financial world catch its footing since mortgages for people with sketchy credit histories began to fail in large numbers in late 2006.
When the financial crisis intensified in March, the Fed financially supported an acquisition of troubled Bear Stearns Cos. by JPMorgan Chase. The central bank also expanded its program of direct lending for commercial banks to include big Wall Street firms.
At the beginning of last week, the Treasury and federal regulators seized control of publicly chartered, privately owned mortgage giants Fannie Mae and Freddie Mac and agreed to invest up to $100 billion in each firm. The government forced out the companies’ top executives and said it would drastically shrink the firms after temporarily expanding their operations to help the housing market recover.
But last weekend, Treasury and Fed officials declined to come to the aid of Lehman or Merrill Lynch & Co. Lehman filed for bankruptcy protection Monday, and Merrill agreed to be acquired by Bank of America Corp.
AIG’s situation rapidly deteriorated Monday night when its credit rating was cut, requiring it to put up $14.5 billion in collateral on its obligations. Although its $1 trillion in assets easily exceed that sum, the company could not sell the necessary amount quickly enough to meet the collateral requirement, forcing executives to seek an emergency loan.
According to people familiar with the discussions, AIG executives notified the Fed that unless the company received government aid by Tuesday night, the firm would file for bankruptcy.
AIG will pay the Fed a variable rate of interest that is currently nearly 12%, more than double the rate at which the soundest corporate borrowers can obtain loans.
It wasn’t certain whether the current board of directors would remain in place.
In any case, the new CEO will report to the board and not directly to the government.
There were reports late Tuesday that former Allstate Insurance Co. CEO Edward M. Liddy would be named AIG’s new chief executive.
The staffers said that all of the insurance companies owned by AIG will remain in place and retain their assets so that they can pay claims on policies. The Fed will take the stock of these subsidiaries and all other assets of AIG as collateral for the loan.
In a statement posted on its website Tuesday before the loan was announced, AIG said that its “life insurance, general insurance and retirement services businesses . . . continue to operate normally and remain adequately capitalized and fully capable of meeting their obligations to policyholders.”
The effect of the loan on AIG’s stockholders is unclear. AIG’s shares, which traded at $70 in October, closed at $3.75 a share Tuesday, down $1.01. The stock fell further in after-hours trading as investors assessed the government plan.
New York-based AIG has hundreds of subsidiaries and does business in every state and 80 foreign countries. Its best-known California unit is 21st Century Insurance Co., a Woodland Hills-headquartered low-cost auto insurer.
AIG controls about 11% of California’s workers’ compensation insurance market, ranking it second in size to only the government-backed State Compensation Insurance Fund.
The list of AIG’s products and services range from humdrum insurance policies for commercial property, automobile liability and workers’ compensation to exotic mortgage-backed securities and a fleet of 900 leased airplanes. The company also offers life insurance, annuities, mutual funds and private banking.
Founded in 1919 with 116,000 employees and 2007 revenues of $110 billion, AIG has developed somewhat of a swashbuckling reputation in a traditionally staid insurance industry.
The company’s longtime former chief executive, Maurice R. “Hank” Greenberg turned AIG into “an aggressive and unusual insurance company,” said Jim Rogers, a Redwood City consultant. “Everybody kind of admired and feared them at the same time because they stuck their fingers in everything. You could never tell which piece was connected to another.”