Risk Management

Fed Rescues AIG in $85 Billion Takeover

Fearing a disorderly failure of AIG, the government lends the struggling insurance giant $85 billion in exchange for an 80 percent equity stake and...
Tim ReasonSeptember 16, 2008

In a stunning move, the Federal Reserve announced at 9 p.m. Tuesday that it would take over failing insurance giant AIG and lend it $85 billion.

“The [Federal Reserve Board of Governors] 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 explained in its official announcement.

The loan is intended to give AIG time and liquidity to meet its obligations while it moves to sell many of its businesses in order to shore up its capital. A rating downgrade Monday night made it look increasingly unlikely that AIG would be able to complete those sales in time to meet its obligations. In its announcement, the Fed said it expected the loan to be repaid by the sale of AIG’s assets.

The two-year loan, extended by the Federal Reserve Bank of New York, is secured by all the assets of AIG and its subsidiaries, and the government is charging a steep rate of interest of three-month Libor plus 850 basis points. In exchange for the loan, the U.S. government will receive a 79.9 percent equity interest in AIG and has the right to veto the payment of dividends to shareholders of common and preferred stock.

In its announcement, the Federal Reserve said it was acting under Section 13(3) of the Federal Reserve Act, which authorizes the Fed in “unusual and exigent circumstances” to “discount for any individual, partnership, or corporation, notes, drafts, and bills of exchange” provided they are “secured to the satisfaction of the Federal Reserve” and provided that the recipient “is unable to secure adequate credit accommodations from other banking institutions.” It was not immediately clear if the Fed meant to cite that portion of the act. Another provision, Section 13(13), directly authorizes the Fed to “make advances to any individual, partnership or corporation on the promissory notes of such individual, partnership or corporation secured by direct obligations of the United States.” That provision, however, explicitly limits the term of such advances to 90-day periods.