Tuesday, September 16, 2008

The most expensive band-aid ever

It cost us taxpayers a whopping $85 Billion. And yet all it does is buy us some time and some breathing room. But it sure is better than the alternative. If AIG would have been left to go under (like Lehman Brothers), we would have seen massive loss of wealth, and possibly the next major worldwide depression.

U.S. to Take Over AIG in $85 Billion Bailout

The U.S. government seized control of American International Group Inc. -- one of the world's biggest insurers -- in an $85 billion deal that signaled the intensity of its concerns about the danger a collapse could pose to the financial system.

The step marks a dramatic turnabout for the federal government, which had been strongly resisting overtures from AIG for an emergency loan or some intervention that would prevent the insurer from falling into bankruptcy. Just last weekend, the government essentially pulled the plug on Lehman Brothers Holdings Inc., allowing the big investment bank to go under instead of giving it financial support. This time, the government decided AIG truly was too big to fail.

[Businessmen leave an American International Group office building, Tuesday, Sept. 16, 2008 in New York. Worries about AIG] Associated Press

Businessmen leave an American International Group office building Tuesday in New York.

The U.S. negotiators drove a hard bargain. Under terms hammered out Tuesday night, the Fed will lend up to $85 billion to AIG, and the U.S. government will effectively get a 79.9% equity stake in the insurer in the form of warrants called equity participation notes. The two-year loan will carry an interest rate of Libor plus 8.5 percentage points. (Libor, the London interbank offered rate, is a common short-term lending benchmark.)

The loan is secured by AIG's assets, including its profitable insurance businesses, giving the Fed some protection even if markets continue to sink. And if AIG rebounds, taxpayers could reap a big profit through the government's equity stake.

"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 Fed said in a statement.

It puts the government in control of a private insurer -- a historic development, particularly considering that AIG isn't directly regulated by the federal government. The Fed took the highly unusual step using legal authority granted in the Federal Reserve Act, which allows it to lend to nonbanks under "unusual and exigent" circumstances, something it invoked when Bear Stearns Cos. was rescued in March.

As part of the deal, Treasury Secretary Henry Paulson insisted that AIG's chief executive, Robert Willumstad, step aside. Mr. Paulson personally told Mr. Willumstad the news in a phone call on Tuesday, according to a person familiar with the call.


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