US hopes to reassure markets with AIG bailout

Business Materials 17 September 2008 21:50 (UTC +04:00)

The United States government hoped to reassure investors Wednesday that its unprecedented 85-billion-dollar loan and effective takeover of insurance giant American International Group Inc (AIG) would keep the credit crisis from spreading across the industry, reported dpa.

Fearing a possible second major Wall Street bankruptcy this week, the Federal Reserve Board late Tuesday engineered an AIG rescue through a two-year loan that gives the government an 80-per-cent stake 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 US central bank said in a statement.

US Treasury Secretary Henry Paulson said the takeover would help "mitigate broader disruptions and at the same time protect the taxpayers." The hope is that AIG will be able to raise cash by selling off assets in the coming months, allowing the Fed to come out on top by the end of the two-year period.

The Fed's move did not appear to prevent another sell-off of Wall Street stocks on Wednesday. The Dow Jones Industrial Average was down 280 points, or 2.5 per cent and the broader Standard & Poor's 500 fell 3 per cent in morning trading.

AIG shares were down nearly 50 per cent in New York.

AIG 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.

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 government refused to bail out Lehman Brothers at an emergency meeting over the weekend.

Amid the flood of rescues and the potential for more in the future, US presidential candidates and congressional leaders vowed to push for greater regulation of the financial industry in future.

"We should never again allow the United States to be in this position," Republican candidate John McCain said in a statement Wednesday. The financial crisis was the result of "failed regulation, reckless management and a casino culture on Wall Street."

Democratic rival Barack Obama placed the blame squarely on the current administration and promised to "restore confidence" in the financial sector.

"The fact that we have reached a point where the Federal Reserve felt it had to take this unprecedented step ... is the final verdict on the failed economic philosophy of the last eight years," Obama said.

European banks were particularly at risk 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.

In a statement late Tuesday, AIG conceded it had "serious liquidity issues" but said it believed the loan would "protect all AIG policyholders, address rating agency concerns and give AIG the time necessary to conduct asset sales on an orderly basis."

The Federal Reserve stepped in after five days of hard talks with leading Wall Street firms. It failed to convince companies like JP Morgan Chase and Goldman Sachs to put together a private 75-billion- dollar loan.

Three major US credit rating agencies downgraded AIG's standing on Tuesday, lending even greater urgency to AIG's rush to secure fresh capital.

As part of the deal, the government gains veto power over dividend payments to common and preferred shareholders. The Fed 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 US central bank already has billions of dollars in loans to struggling financial firms. Earlier this year the Fed opened up Treasury-backed securities to investment banks struggling to stay afloat. As collateral, it has accepted the mortgage-related assets that are at the heart of the credit crisis.