The U.S. government late Tuesday seized control of American International Group, stepping in to save the insurance giant from a bankruptcy that many feared would spark a global financial crisis.
The government takeover, with an $85 billion bailout, came just two days after the government refused to save Wall Street icon Lehman Brothers from a similar fate and is the latest in a series of government and private sector steps that have remade the U.S. financial system.
The move reignites the debate about whether or not some companies are “too big to fail,” and highlights the extent to which unregulated trade in risk has threatened global economic stability.
AIG (AIG) had been on the brink of bankruptcy as a private market solution to the nation’s largest insurer’s problem failed to materialize after Goldman Sachs (GS) and J.P. Morgan Chase (JPM) said they were unable to put together a government-requested lending facility for AIG of between $70 billion and $75 billion.
“A disorderly failure of AIG could add to already significant levels of financial market fragility,” the Fed said in a prepared statement. Interest rates would likely have risen, lowering consumer buying power, and weakening the economy.
Edward Liddy, former chief executive of Allstate will replace Robert Willumstad, who was named AIG CEO in June. The Wall Street Journal reported Wednesday that Willumstad’s ouster came at the insistence of U.S. Treasury Secretary Henry Paulson as part of the government’s takeover of the insurance giant.
AIG shares fell 36% in early trade, to $2.38.
The government’s deal dilutes current shareholders by giving the government a 79.9% stake in the insurance company, with the power to eliminate dividends.
A statement from the Federal Reserve stressed that taxpayer interests would be protected.
Various government officials have repeatedly stressed that it is not bailing out shareholders in the various deals it has structured to help firms like Bear Stearns, Fannie Mae, and Freddie Mac.
“This loan will facilitate a process under which AIG will sell certain of its businesses in an orderly manner,” the Fed said.
AIG has two years to pay back the loan, and is likely to sell assets including its majority stake in reinsurer Transatlantic Holdings (TRH) as well as the aircraft-leasing business ILFC to meet the terms.
AIG said late Tuesday it would not reduce capital at any of its subsidiaries or tap into Asian operations for liquidity.
AIG’s life insurance, general insurance, and retirement services businesses, including its large Asian operations, continue to operate normally, remain adequately capitalized and are capable to meeting obligations to policyholders, the company explained.
Derivatives issues dealt death blow
AIG didn’t mention its big derivatives business, the main source of its problems.
AIG has been hammered by derivatives exposure to the housing bust and mortgage meltdown.
The insurer has been hit hard by the housing crisis and credit crunch because its derivatives unit sold guarantees on mortgage-related securities known as collateralized debt obligations, or CDOs, using credit-default swaps.
As house prices fall and the credit crunch deepens, the market for these CDO exposures is disappearing, forcing AIG to report big write-downs.
AIG reported a quarterly net loss of more than $5 billion in August as it wrote down these exposures and suffered impairments on some of its mortgage-related investments.