WASHINGTON -- The Federal Reserve and Treasury Department on Monday upped the stakes in the government's role in American International Group aig to more than $150 billion with a restructuring of its loan package that includes $40 billion from the financial rescue package and other measures to help the firm.
The ailing insurance giant, which has essentially been under government control since mid-September, is now the largest recipient of government aid in the financial crisis, which has led economic slowdowns around the globe.
"This action was necessary to maintain the stability of our financial system," Neel Kashkari, the interim head of the Treasury Department's finanical relief program said in a speech. "We recognize that the financial system remains fragile and we continue to stand ready to prevent systemic failures."
California State University economics professor Sung Won Sohn says the government continues to prop up AIG because the consequences of the company's failure are too dire.
"AIG has extensive reach not only in the United States, but in 100 countries," he says. "If AIG were to go down, this would create turmoil around the world."
The changes to the 2-month-old rescue plan will "keep the company strong and facilitate its ability to complete its restructuring process successfully," the Fed said. "These new measures establish a more durable capital structure, resolve liquidity issues, facilitate AIG's execution of its plan to sell certain of its businesses in an orderly manner, promote market stability, and protect the interests of the U.S. government and taxpayers."
Senior Fed staff in a conference call with reporters said they expect the loans will be repaid in full once the economy, and the value of the company's assets, improve.
Sohn agreed. "I expect (the government) to make money, not lose money," he said.
As the Fed and Treasury were announcing their plan Monday, AIG said it had a net loss of $24.47 billion or $9.05 per diluted share, in the third quarter.
• The Treasury Department will buy $40 billion of newly issued AIG preferred shares. The purchases will be funded under the $700 billion Troubled Asset Relief Program passed by Congress. As a result, the Fed is cutting a previously announced loan to AIG to $60 billion from $80 billion.
• The Fed is reducing the interest rate on its loans to AIG by 5.5 percentage points. The loans now carry a rate of 3 percentage points plus the going rate for the three-month London Interbank Offered Rate or LIBOR, the rate large banks charge each other for short-term unsecured loans. The loans now will be for five years vs. two.
• In two new programs, the Fed will help AIG remove assets from its balance sheet, where the company has been sustaining heavy losses.
The Fed will provide six-year loans of up to $22.5 billion to a newly formed limited liability company (LLC) to fund the purchase of residential mortgage-backed securities from AIG's portfolio.
AIG will make a $1 billion loan to the LLC and bear the risk for the first $1 billion of losses, if any. The loans will be repaid from cash produced by the assets and from proceeds of any sales of assets. A previously announced $37.8 billion program established by the New York Fed Oct. 8 will be repaid and ended because of the new program.
In the second program, the Fed will lend up to $30 billion to a newly formed LLC to fund the purchase of collateralized debt obligations, which are securities that package mortgage and other debt and are sold to investors. AIG will make a $5 billion loan to that LLC and bear the risk for the first $5 billion of any losses.
AIG Chairman and CEO Edward Liddy called the new plan a "quantum improvement" from the earlier aid program and argued the company is not getting a handout. "We are paying a lot of money for the money we are receiving," he said in an interview on CNBC.
Fed staff members say the decision to change the AIG rescue program came after consultation with AIG's new management brought in after the Fed stepped in to prop up the firm in September.
At the time, the government did not have the authority to buy equity stakes in companies, a strategy that has the potential to provide more bang for the buck while better protecting taxpayers than just providing loans, staff said. Passage of the $700 billion financial rescue plan gave the government more leeway.
An outside investment advisory company was brought in by the Fed to help determine the probability that the government would be repaid under the newly designed program.
The Treasury had already allocated $250 billion of the $700 billion to inject cash into banks and said it was considering buying stakes in other firms. Other industries, including the auto manufacturers, are asking for aid.
The Federal Reserve in mid-September said it would provide AIG with an $85 billion emergency loan, putting the government in control of the flailing insurance giant. Less than a month later, the Fed added $37.8 billion to the deal, borrowing investment-grade, fixed-income securities from AIG as collateral in return for cash.
The loan has come under scrutiny from lawmakers who criticized AIG after it was discovered that the insurance company spent $443,000 on a week-long event, which included spa services, for insurance agents at a California resort less than a week after the initial package was announced.
The Treasury Department said AIG would be subject to limits on executive compensation under the financial rescue package. "AIG must comply with the most stringent limitations on executive compensation for its top five senior executive officers," the department said. "Treasury is also requiring golden parachute limitations and a freeze on the size of the annual bonus pool for the top 70 company executives."
In the earnings release, Liddy expressed confidence in the company: "Reported earnings are not indicative of the underlying core earnings power of our insurance businesses, which remain solidly capitalized. Retention of our customers remains strong."
Contributing: Kathy Chu