WASHINGTON - The US central bank late Tuesday agreed to bail out the insurance giant American International Group (AIG) with 85 billion dollars, an unprecedented move aimed at propping up a company with worldwide tentacles in the finance industry.
Fearing a
possible second major Wall Street bankruptcy this week, the Federal Reserve
Board engineered an AIG rescue through a two-year loan that gives the government
a stake of 79.9 per cent in the conglomerate.
The board
determined that a 'disorderly failure of AIG' could add to financial market
fragility, lead to 'substantially higher borrowing costs' and erode household
wealth and economic performance, the Federal Reserve said in a statement.
The
decision is the latest in a series of interventions by the federal government to
stave off collapses in the US finance industry amidst a record rate of home
foreclosures that has decimated Wall Street's market for mortgage-backed
securities.
Just two
weeks ago, the Fed pledged to spend up to 200 billion dollars of taxpayer money
to help rescue the government-chartered mortgage giants Fannie Mae and Freddie
Mac. Earlier this year, it backed a 29-billion-dollar loan for the purchase of
troubled investment banking firm, Bear Stearns, by JP Morgan Chase.
European
banks were particularly at risk from an AIG bankruptcy by owning three-quarters
of the 441 billion dollars in unregulated complex security instruments protected
by AIG, the New York Times reported. The securities are tied to the plunging
subprime mortgage market.
A
bankruptcy filing by AIG, a huge world player in insuring risk for institutions,
would have had an even greater impact on the US and global finance system than
Monday's 600-billion-dollar bankruptcy by Lehman Brothers Holdings Inc, industry
experts warned.
The
Federal Reserve said late Tuesday that it expects the loan to be paid off from
cash raised by the sale of AIG assets. They include its consumer lender,
American General Finance, a stake in the reinsurer Transatlantic Holdings Inc
and an aircraft leasing unit International Lease Finance Corp.
As part of
the deal, the government gains veto power over dividend payments to common and
preferred shareholders.
The Fed
said the move was intended to 'assist AIG in meeting its obligations' and to
help facilitate AIG's liquidation of 'its businesses in an orderly manner, with
the least possible disruption to the overall economy.'
It said
the interests of taxpayers were protected because the loan was 'collateralized
by all the assets of AIG and of its primary non-regulated subsidiaries.'
The
Federal Reserve stepped in after five days of hard talks with leading Wall
Street firms. It had hoped that companies like JP Morgan Chase and Goldman Sachs
would put together a private 75-billion-dollar deal to float AIG, but the firms
said they could not raise the capital, according to the New York Times.
Fed chief
Ben Bernanke and Treasury Secretary Henry Paulson met with congressional leaders
late Tuesday to explain the bailout, media reports said.
Hours
before the deal was announced, the rate-setting central bank voted against
loosening monetary policy despite Monday's 600-billion-dollar bankruptcy of
Lehman Brothers, AIG's uncertain fate and a 4-per-cent-plus fall in US stock
markets.
As Tuesday
dawned, AIG was already tottering after three major US credit rating agencies
downgraded its standing. The move devalued the debt securities it had guaranteed
to worldwide financial firms and made it more difficult for the struggling
insurance giant to raise capital on financial markets to meet its obligations.
At the
heart of the problem is the record rate of home foreclosures that have decimated
Wall Street's market for mortgage-backed securities. Similarly, AIG got involved
in selling so-called credit-default swaps - unregulated contracts it sold to
protect the mortgage-backed securities.
As the
debt risk in mortgage securities soared, AIG conceded last month it had sold the
swap instruments too cheaply compared to the real risks.
The
practices that brought the US financial sector to this woeful state -
repackaging questionable mortgages into enticing investments - has some corners
questioning whether Wall Street will ever fully recover.
The US
central bank earlier this year opened up billions of dollars in Treasury-backed
securities to investment banks struggling to stay afloat. As collateral, the Fed
has accepted the mortgage-related assets that are at the heart of the credit
crisis.
On Sunday
it broadened the range of damaged securities it will accept in return for loans.
The Fed has to be careful about putting too much of its own reserves on the line, Benn Steil of the Council on Foreign Relations warned on Monday. Too great an exposure to the credit crisis could prompt international investors and governments to pull their own holdings out of the United States, prompting a run on the dollar.