The US Federal Reserve announced that it will lend AIG up to $85bn in emergency funds in return for a government stake of 79.9 per cent and effective control of the company - an extraordinary step meant to stave off a collapse of the giant insurer that plays a crucial role in the global financial system.
Under the plan, the latest dramatic intervention by the US government to combat the global credit crisis, the existing management of the company will be replaced and new executives - as yet unnamed - will be appointed. It also gives the US government veto power over major decisions at the company.
The authorities will receive equity giving them a 79.9 per cent stake in AIG. In return, the insurer would receive a bridge loan of $85bn to keep it afloat until it could dispose of billions of dollars in assets. The Fed said the loan was expected to be repaid by the proceeds of selling AIG operating companies. A senior Fed staffer said the most likely outcome was an orderly liquidation of AIG, though it was possible that the firm could survive as an ongoing business.
The loan is at a punitive interest rate of three-month Libor plus 850 basis points, giving AIG a strong incentive to repay it as soon as possible. It will be secured on all AIG’s assets, including those of its subsidiary companies.
The Fed said it was acting to prevent “a disorderly failure of AIG” which would “add to already significant levels of financial market fragility and lead to substantially higher borrowing costs, reduced household wealth and materially weaker economic performance”.
The issuance of the equity participation note to the government is designed to prevent existing shareholders from profiting from a rescue of the company, which has been hobbled by the losses on complex securities backed by mortgages and other assets.
President George W. Bush said the rescue was “to promote stability in the financial markets”.
The emergency moves came after earlier plans for a private sector bail-out were dashed by a further 21 per cent slump in AIG’s shares, reducing the market capitalisation of one of the biggest insurance companies in the world to just over $7.5bn (£4.2bn).
The AIG crisis fuelled another day of turmoil on global markets on Tuesday sparked by the weekend failure of Lehman Brothers and the rushed takeover of Merrill Lynch by Bank of America. Despite the turbulence, marked by brutal conditions in European money markets, the Federal Reserve kept interest rates unchanged at 2 per cent on Tuesday night.
“We are working closely with the Federal Reserve, the SEC and other regulators to enhance the stability and orderliness of our financial markets and minimise the disruption to our economy,” said Hank Paulson, Treasury secretary. “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.”
But even as the plan was being being mapped out, there were already signs of political opposition. “I hope they don’t go down the road of a bailout, because where do you stop?’’ Richard Shelby, top Republican on the Senate Banking Committee, told Bloomberg Television.
Charles Schumer, the New York Democrat who chairs the congressional Joint Economic Committee, said: “The administration is approaching an unprecedented step, but unfortunately we are living in unprecedented times.
”You have to stop to catch your breath. But upon reflection, the alternatives are much worse.’’
During a day of emergency meetings at the New York Fed, the Treasury and Fed reversed initial reluctance to bail out another financial institution.
In March, the Fed helped JPMorgan Chase buy Bear Stearns by providing a $29bn credit line. Earlier This month, the Treasury seized control of troubled US mortgage giants Fannie Mae and Freddie Mac.
But at the weekend the authorities refused to back Lehman Brothers and encouraged Merrill Lynch to sell itself to a rival. Lehman filed for bankruptcy early Monday morning, rocking the financial system, while Merrill announced a $50bn takeover by Bank of America the same day.
AIG’s plans for a private sector capital infusion were dashed by a further slump in its shares on Tuesday after sharp cuts in the insurer’s credit ratings on Monday threatened to fuel a liquidity crisis and push it into bankruptcy.
Tim Geithner, president of the New York Fed, skipped the Fed’s interest-setting meeting to focus on AIG – a sign of the regulators’ heightened state of alert over the insurer’s plight.
Amid increasingly desperate lobbying for government help, David Paterson, New York governor, had said the beleaguered insurer which lost billions of dollars on derivatives and mortgage-backed securities, had “a day” to solve its problems.
AIG’s fight for survival came as Hank Greenberg, AIG’s former chief executive and the company’s biggest shareholder, announced said he was considering a bid to take over all or part of the company.
Mr Greenberg has sent a letter to AIG’s board and its chief executive, Robert Willumstad, complaining about their its refusal to take up his repeated offers to help the company group he ran for decades.
In a letter published in Wednesday’s Financial Times, Mr Greenberg urged urged the US government to step in to provide a loan if private lenders could not be found. He said said AIG needed a temporary bridge loan in order to prevent further ratings cuts “which would likely prove fatal” and “pose systemic risk to the US and international financial systems”.
