Fed Rescues AIG With $85 Billion Loan

The Federal Reserve Board threw a life preserver to keep American International Group Inc. from drowning last night, as the Fed agreed to have the U.S. government take a 79.9 percent stake in AIG in exchange for the Federal Reserve Bank of New York providing up to $85 billion in emergency financing.

The 11th-hour deal means AIG will continue to do “business as usual,” rather than have to seek bankruptcy court protection, as had been cited as the worst-case scenario, a Fed official noted.

Meanwhile, New York Insurance Superintendent Eric Dinallo confirmed that Edward Liddy, the former chief executive officer for Allstate Corp., is under consideration to run AIG’s day-to-day operations as its new CEO.

Mr. Liddy, 62, was CEO of Northbrook, Ill.-based Allstate from 1999 until 2005. He would replace Robert Willumstad, still AIG’s chairman, who took on the added CEO role in June when Martin Sullivan—who had replaced Maurice Greenberg—stepped down.

As for the loan package, the Fed said it has authority under Section 13(3) of the Federal Reserve Act to approve the deal with AIG and is proceeding with the full support of the Treasury Department.

“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.

“The purpose of this liquidity facility is to assist AIG in meeting its obligations as they come due,” the Fed said. “This loan will facilitate a process under which AIG will sell certain of its businesses in an orderly manner, with the least possible disruption to the overall economy.”

The AIG board issued a statement welcoming the move by the Federal Reserve and the New York Fed to set up the $85 billion revolving credit facility.
The AIG board added that it “approved this transaction, based on its determination that this is the best alternative for all of AIG’s constituencies, including policyholders, customers, creditors, counterparties, employees and shareholders.”

The board said that “AIG is a solid company with over $1 trillion in assets and substantial equity, but it has been recently experiencing serious liquidity issues. We believe the loan—which is backed by profitable, well-capitalized operating subsidiaries with substantial value—will protect all AIG policyholders, address rating agency concerns and give AIG the time necessary to conduct asset sales on an orderly basis.”

AIG investors have been expressing confusion about whether the Fed really will be taking ownership of 79.9 percent of AIG, or simply treating that percentage of AIG as collateral—only getting the 79.9 percent stake if AIG misses payments.

However, the AIG board said in its statement that “American taxpayers will receive a substantial majority ownership interest in AIG.”

The proceeds of subsequent asset sales should be enough for AIG to repay the loan in full, the board said.

“Policyholders of AIG companies around the world can rest assured that AIG’s commitments will continue to be honored,” the board added.

There were reports in New York Newsday that New York Insurance Superintendent Eric Dinallo-—who was heavily involved with all the efforts to keep AIG from having to declare bankruptcy—will head up a national task force of state regulators overseeing the sale of any of AIG’s insurance assets.

In an effort to provide further cash to AIG, New York Gov. David Paterson on Monday announced that the state would allow AIG to move up to $20 billion in capital from its insurance subsidiaries to the parent firm to help shore up its finances.

With the Federal Reserve loan deal now in place, however, that move might no longer be necessary, although Gov. Paterson said it had helped stabilize AIG’s position while negotiations for a more permanent solution continued.

The New York Fed credit facility “has terms and conditions designed to protect the interests of the U.S. government and taxpayers,” the Fed noted.

The New York Fed’s AIG credit facility has:
• A 24-month term.
• An $85 billion maximum.
• A variable interest rate that will equal the London Interbank Offered Rate, plus 8.5 percentage points.
• The initial interest rate would be 11.3 percent, but AIG apparently would have to pay interest only on the amounts that it draws from the facility.

“The loan is collateralized by all the assets of AIG and of its primary nonregulated subsidiaries,” the Fed explained. “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.”

In addition to getting a 79.9 percent equity interest in AIG, the government will have the right to veto the payment of dividends to common and preferred shareholders, the Fed noted.

The Fed also will get veto power over “important management decisions,” such as sales of subsidiaries, a Fed official said.

The “government” has not yet decided whether the Fed or the Treasury Department will be in charge of appointing new management at the holding company level, the Fed official said.

For the moment, the official said, the AIG board will remain the same.

Insurance subsidiaries and affiliates will remain subject to state regulation.

The Fed decided to acquire 79.9 percent of AIG rather than 80 percent or more, because 80 percent control would have triggered accounting mandates that would have complicated running the business, the Fed official explained.

Another source who requested anonymity said state insurance regulators would have to approve any change in control over AIG insurance subsidiaries but would not have to approve the Fed’s financing arrangement.

Despite the change in control, when AIG opens for business on Sept. 17 “it will be business as usual for AIG,” the Fed official said.

AIG, one of the largest financial services companies in the world, has been suffering for months from the effects of economic turmoil on mortgage loans and other loans.

The upheaval has caused billions of dollars in losses at the company’s credit default swaps operation, which insures bond holders against defaults.

Last week, when Lehman Brothers Inc. began sliding toward bankruptcy court, AIG warned the Fed that a Lehman Brothers failure could cause the rating agencies to cut its own ratings, triggering massive collateral calls that AIG had too little ready cash to meet.

AIG managers warned the Fed that the absolute last day the company would have to act would be Tuesday, the Fed official said.

Credit rating agencies behaved as AIG had predicted. They cut AIG’s ratings, exposing AIG to the threat of calls for more than $14 billion in collateral as well as to the threat of contract cancellations.

The price of AIG shares fell 46 percent last week, and closed Friday at $12.14 per share.

On Sept. 16, the price of AIG shares opened at $1.85 and closed at $3.75. Shares were selling overnight for $2.60 in after-hours trading.

More than 1.2 billion shares traded on the New York Stock Exchange on Tuesday.

In Singapore, news organizations carried reports of customers lining up to withdraw funds from a unit of AIG.

The Monetary Authority of Singapore said it is watching the local AIG subsidiary’s investments carefully, but noted that the assets linked to insurance products sold in Singapore are segregated from the general assets of AIG.

On Tuesday afternoon, Bloomberg News reported that the Fed was thinking about putting AIG in a conservatorship, as it has done with the Federal National Mortgage Association and the Federal Home Loan Mortgage Corp.

However, although the government will control AIG, “this is not a conservatorship,” the Fed official said.

Senior officials from the Fed and Treasury Department briefed key members of Congress on the arrangement.

AIG executives and government officials signed documents concerning the deal just after 9 p.m. on Tuesday.

The senior Fed official said the government decided to provide access to cash for AIG but not for Lehman Brothers, which filed for bankruptcy protection on Monday, because AIG constituted a “systemic risk” to the financial system.

The markets and regulators seem to be more prepared for the failure of an investment bank than for the insolvency of a complex insurance company, the official explained.

“AIG is a complicated firm, which offers for sale substantial products, such as retail financial products, insurance, guaranteed investment contracts and annuities outside regulated insurance entities,” the official said.

Treasury Secretary Henry Paulson put out a statement noting his interest in working with the Fed, the Securities and Exchange Commission, and other regulators to enhance the stability and orderliness of the financial markets and minimize the disruption to the U.S. 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 the taxpayers,” Mr. Paulson said in the statement.

Ken Crerar, president of the Council of Insurance Agents & Brokers, also welcomed the Fed’s move.

“We applaud efforts to help stabilize financial markets, and particularly AIG’s holding company, in order to ensure that going forward, the company’s promises to our members’ clients are kept and protected,” Mr. Crerar said. “AIG has been an important and substantial player in the insurance market, and whatever happens, the first concern of our members is their clients.”

Democratic presidential candidate Sen. Barack Obama, D-Ill., and Republican nominee Sen. John McCain, R-Ariz., said over the weekend that they oppose federal efforts to rescue struggling financial services companies.

Sens. Richard Shelby, R-Ala., and Christopher Dodd, D-Conn., also have criticized the idea of the government helping AIG and other struggling financial services companies.

In Japan, the Tokyo Stock Exchange has responded to news of the U.S. Fed financing arrangement by halting trading in AIG shares.