On September 17 the U.S. government took control of American International Group Inc. (AIG), one of the world’s largest insurers.  The $85 billion deal indicates the government’s concerns about the effect of the failure of such a large company on the financial system and represents a departure from its earlier resistance to requests for an emergency loan or intervention to prevent AIG from filing for bankruptcy.  A few days earlier the government decided not to provide financial support to Lehman Brothers Holdings Inc. in order to prevent the large investment bank from collapsing. 

In exchange for the loan of $85 billion, the federal government will receive, in effect, a 79.9 percent stake in AIG in the form of warrants known as equity participation notes.  The loan, for a period of two years carrying an interest rate of Libor (London interbank offered rate) plus 8.5 percentage points, is secured by AIG’s assets, including its insurance operations.  If AIG recovers, the federal government could receive a substantial profit from its equity stake.

The highly unusual takeover is authorized under the Federal Reserve Act, which allows the Federal Reserve Bank to provide loans to nonbanks, an authority invoked by the bank in its bailout of Bear Stearns Cos. in March.  As part of the negotiations, Treasury Secretary Henry Paulson insisted that Robert Willumstad give up his position as AIG’s chief executive officer, and Paulson is reported to have personally phoned Willumstad about the decision.  Edward Liddy, the former head of insurer Allstate Corp., will succeed Willumstad as chief executive of AIG.

Federal Reserve Statement on $85 Billion AIG Loan Plan
 
Emergency Loan Effectively Gives Government Control of Insurer

September 17, 2008