U.S. announces plans to lend up to $85B to AIG

— -- The Federal Reserve said Tuesday night it would lend up to $85 billion to flailing insurance giant American International Group, saying the move was necessary to protect the financial system.

The action averts a bankruptcy filing by AIG aig, which has been struggling to raise capital after crippling losses on protection it sold to investors in mortgage-backed securities. It also faced additional pressures to meet collateral calls from investors after its credit rating was downgraded by four rating agencies Monday night.

The senior management of AIG will be tossed out, and the government will effectively be in control of the company.

The government will have a 79.9% equity interest in AIG and the right to veto the payment of dividends to common and preferred shareholders.

The Fed's decision, made with the Treasury Department's support, came just days after the Treasury and Fed refused to bail out investment bank Lehman Bros. The main difference between the two situations: AIG is so huge and its operations so intertwined in the financial system that the Fed feared an AIG failure could harm the broader economy.

"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 said in a statement.

Until Tuesday, the government had downplayed the possibility of another government bailout after its rescue of Fannie Mae and Freddie Mac and its engineering of Bear Stearns' sale to JPMorgan Chase in March. During a news conference Monday, Treasury Secretary Henry Paulson said, "What's going on in New York is a private sector effort."

Analysts said the move was necessary after an effort by JPMorgan Chase and Goldman Sachs to raise a fund for AIG failed. "If AIG had gone bankrupt and not been able to make payments," said Clifford Gallant, managing director at Keefe Bruyette & Woods, "the domino effect would have been devastating and unprecedented."

Nearly every Fortune 500 company has an AIG-related policy, he said, and the average person has some exposure to AIG policies or firms doing business with the insurer.

The central bank said the loan will assist AIG in meeting its obligations as they come due — and facilitate a process under which AIG will sell some of its businesses in an orderly manner, "with the least possible disruption to the overall economy."

The AIG loan will be in place for 24 months, and AIG will be permitted to draw up to $85 billion. The loan will be backed by all the assets of AIG and its primary non-regulated subsidiaries, including the stock of substantially all of its regulated subsidiaries. The government expects the loan to be repaid from the proceeds of the sale of the firm's assets.

Its action represents another dramatic intervention in a private company. Two weeks ago, the government took control of mortgage giants Fannie Mae and Freddie Mac, replacing their managements and agreeing to guarantee their debt. In exchange, the government received warrants that could give it a nearly 80% stake in both companies.

AIG shares closed at $3.75, down $1.01, in regular trading Tuesday. Its shares have lost 94% of their value this year.

AIG had $110 billion in revenue last year and does business in more than 130 countries.