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Fed Runs To Rescue Of AIG

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By ELLEN SIMON

The Associated Press

Published: September 17, 2008

NEW YORK - The Federal Reserve forged an extraordinary $85 billion rescue Tuesday night of insurance giant American International Group Inc., offering a respite from two days of chaos in the American financial system.

The move came hours after the Fed resisted a cut in interest rates to buoy Wall Street, which staged a slight rebound anyway from Monday's biggest point drop in the Dow Jones industrials since the 2001 terrorist attacks.

Investors had feared that a failure of AIG, the world's largest insurer, would set off even more financial turmoil than the collapse the day before by venerable investment house Lehman Brothers.

AIG does business with almost every financial institution in the world and insures $88 billion worth of assets, including mortgages and corporate loans.

Under the plan orchestrated by the Fed during a day of crisis talks, the U.S. government will provide an emergency $85 billion loan. In return, it will receive a 79.9 percent equity stake in the company, similar to the way the government took control of faltering mortgage giants Fannie Mae and Freddie Mac.

The Fed said in a statement that an AIG failure could "lead to substantially higher borrowing costs, reduced household wealth and materially weaker economic performance."
Treasury Secretary Henry Paulson said in a statement that the Bush administration was working closely with the Fed, the Securities and Exchange Commission and other government regulators to "enhance the stability and orderliness of our financial markets and minimize the disruption to our economy."

"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 taxpayers," Paulson said.

AIG stock swung wildly Tuesday as the company's fate hung in the balance. It was down as much as 60 percent, closed down 20 percent and then lost another 45 percent in after-hours trading.

AIG's Ratings Cut

The pressure had grown when all three major credit rating agencies cut AIG's ratings at least two notches late Monday night. New York Gov. David Paterson had agreed to allow AIG to use $20 billion of assets held by its subsidiaries to pay for its business - essentially giving it a bridge loan from itself - but indicated the company had only 24 hours to find the cash needed to stay in business.

A collapse of AIG would force Wall Street to untangle the complex credit derivatives markets and send the market scrambling to figure out who owes what to whom - or even who owns what.

"Regulators knew that if Lehman went down, the world wouldn't end," money manager Michael Lewitt wrote in an op-ed column Tuesday in The New York Times. "But Wall Street isn't remotely prepared for the inestimable damage the financial system would suffer if AIG collapsed."

The Fed stepped in hours after it decided, in its first unanimous vote this year, to keep the closely watched federal funds rate unchanged at 2 percent. At the same time, the Fed said that strains on the market have "increased significantly" and said it was ready to act if needed.

Stocks slumped immediately after the Fed announcement. The Dow initially dropped about 100 points but rallied to finish the day up 141, and back over 11,000.

As AIG teetered, central bankers around the globe scrambled to revive credit markets. The Fed injected $70 billion into the American financial system. The European Central Bank pumped one-day financing of nearly $100 billion into the 15-nation zone. The Bank of Japan added $24 billion, and England's central bank almost $36 billion.

Cash Leaves World Markets

Cash left world markets Monday like an outgoing tide. The interest rate banks charge each other for overnight loans soared as high as 6 percent, far above the Fed's target rate of 2 percent and a sign banks didn't trust each other enough to make even 12-hour loans.

Meanwhile, British bank Barclays PLC said it had agreed to acquire Lehman Brothers' North American investment banking and capital markets businesses for $250 million in cash, just two days after walking away from a deal to purchase all of Lehman's. The British bank will buy Lehman's New York headquarters and its two data centers in New Jersey for $1.5 billion.

Separately, Bank of America Corp. began to work out how it will digest its $40 billion acquisition of Merrill Lynch.

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