WASHINGTON — The Federal Reserve Board stepped in Tuesday night to provide an $85 billion emergency loan to American International Group in return for a nearly 80 percent stake in the teetering insurance and finance giant.
In another unprecedented move to shore up the fragile global financial system, the Fed did what two days ago seemed unthinkable. It made the huge loan to AIG, which has assets valued at more than $1 trillion and effectively took ownership of in a company that isn't the kind of institution it regulates.
"The board determined 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," the Fed said in a statement that was supported by the Treasury Department.
The Fed's action provided little comfort to investors on Wednesday, however, as the Dow Jones Industrial Average tumbled 447 points, or 4 percent.
AIG policyholders are now sure to have no interruption in their coverage, but shareholders will see the remaining value of their holdings further diluted.
The decision will be controversial. The Fed in March brokered the sale of investment bank Bear Stearns in a single weekend under the guise of preventing a breakdown of the global financial system. Earlier this month, the Treasury Department took over mortgage giants Fannie Mae and Freddie Mac under a similar argument.
Monday, however, when the federal government refused to bail out investment bank Lehman Brothers, a takeover of AIG seemed improbable — despite the company's argument that it was solvent and simply lacked access to short-term lending because of the widening credit crisis.
Now, the federal government effectively will control AIG, with covenants allowing it to veto important decisions such as whether to sell off lucrative assets including the company's aircraft-leasing business. It's a venture by the government into uncharted territory.
The Fed insisted in its statement that taxpayers were being protected in the unusual rescue of AIG.
"The interests of taxpayers are protected by key terms of the loan. The loan is collateralized by all the assets of AIG, and of its primary non-regulated subsidiaries," the Fed said. "These assets include the stock of substantially all of the regulated subsidiaries. The loan is expected to be repaid from the proceeds of the sale of the firm's assets."
Senior Fed officials, speaking on the condition that they wouldn't be identified because of ongoing negotiations, said it wasn't yet determined whether the AIG portfolio will rest at Treasury the Fed. The officials said that AIG stock will serve as collateral for the loan.
Defending the lifeline for AIG, the Fed officials said that the insurance giant posed unique threats to the global finance system. Financial markets, they said, had Securities and Exchange Commission procedures for the failure of securities firms, but not for insurance behemoths. AIG is active in a number of global markets and has extensive retail activities in the U.S.
AIG is a multinational insurance company with tentacles in everything from aircraft leasing to retirement planning and life insurance — and even insurance for pleasure boats. Over the 24-month life of the loan, the company is expected to sell off assets in an orderly fashion to repay the loan.
Treasury Secretary Henry Paulson on Tuesday had frowned on the possibility of the government providing a bridge loan to AIG, and investors feared the storied company could be bankrupt by Wednesday, especially after rating agencies downgraded the company Monday night.
Paulson issue a brief statement Tuesday night.
"These are challenging times for our financial markets. We are working closely with the Federal Reserve, the SEC and other regulators to enhance the stability and orderliness of our financial markets and minimize the disruption to our economy," said Paulson, who earlier in the day had briefed senior lawmakers on his plans. "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."
Fed officials disputed characterization of its majority stake in the company as a controlling interest. AIG's senior management will be replaced, although officials didn't disclose who the new managers would be or how they'd be selected.
The officials didn't say whether AIG would proceed with plans to pay shareholders an expected dividend on Friday.
Democrats promised congressional hearings soon on the AIG rescue.
Senate Banking Committee Chairman Christopher Dodd, a Connecticut Democrat, promised in a statement to "ask some crucial questions on behalf of the American people: How will this action affect taxpayers — who have already been asked to commit hundreds of billions of dollars to help stabilize large financial institutions? To what extent will it calm the markets — or just add to the uncertainty?"
(David Lightman contributed to this article.)
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