Kelvin Khoo Online

A central bank statement said the Federal Reserve Board made the decision “with the full support of the Treasury Department” under Section 13(3) of the Federal Reserve Act.

“The secured loan has terms and conditions designed to protect the interests of the US government and taxpayers,” the statement said.

All of AIG’s assets would be pledged to secure the loan while the Fed would retain a nearly 80-per-cent stake in the company, the Fed announced.

The move came after federal officials reportedly tried but failed to persuade private firms over the weekend to put up funds to save AIG.

With the vast insurance firm facing bankruptcy, Treasury Secretary Henry Paulson, Fed Chairman Ben Bernanke and Fed President Timothy Geithner decided that a federal lifeline was needed to prevent a disastrous fall-out in the financial markets.

The final decision came on Tuesday, as officials agreed it would be “catastrophic” to allow the company to fail, the Wall Street Journal reported, quoting an unnamed source familiar with the deal.

Paulson and Bernanke reportedly went to Capitol Hill late Tuesday to meet with top leaders of Congress, and an influential New York senator, Charles Schumer, confirmed a historic move was in the works.

“The administration is approaching an unprecedented step, but unfortunately we are living in unprecedented times,” Schumer said in a statement after meeting regulators about New York-based AIG.

“Hearing of these plans, you have to stop to catch your breath. But upon reflection, the alternatives are much worse,” said the Democrat, a member of the Senate Banking Committee.

Shares in AIG - a company with US$1 trillion in assets and tentacles in many markets - went on a roller-coaster ride on Tuesday, sliding 70 per cent at the open, swinging into positive territory and then closing down 21 per cent after a 60-per-cent plunge Monday.

New York Governor David Paterson earlier said AIG had one day to raise up to US$80 billion to stave off bankruptcy and avoid financial calamity.

In its first public statement since its shares went into a freefall on bankruptcy fears, AIG said earlier its insurance, retirement and other financial services were operating normally.

AIG said its businesses “including its extensive Asian operations, continue to operate normally and remain adequately capitalised and fully capable of meeting their obligations to policyholders.”

The statement added that AIG “continues to pursue alternatives to increase short-term liquidity in the parent company.”

David Kotok, chief investment officer at Cumberland Advisors, said earlier the US central bank had to act to avert a collapse at AIG that would be a calamity for markets - which went into shock after the Lehman Brothers’ bankruptcy Monday.

“This has the appearance of a cascade or a contagion. Failure of Lehman Brothers has created contagion because of counter-party risk that was not contained by the Fed,” Kotok added. “Failure of AIG will make this much worse.”

But Liz Ann Sonders, chief strategist at Charles Schwab & Co., said a Fed bailout might set a bad precedent. She said “other companies would undoubtedly look in the Fed’s direction for help.”

In blow after blow late Monday, the three main rating agencies - Standard & Poor’s, Moody’s and Fitch - lowered AIG’s credit score in a sign of solvency troubles for AIG.

Sonders said that according to AIG regulator filings, the rating cuts are likely to trigger up to 17 billion in collateral calls.

Far more than other insurers, AIG has been a big player in a complex parallel market called credit default swaps (CDS), financial instruments in which Wall Street companies take out a form of market insurance against the risks of bond default.

These products, often linked to the US real estate market, are at the heart of the current banking crisis and have led to massive write-downs of assets around the world.

AIG alone has written off US$25 billion amid spiking defaults on US mortgage payments in the United States.

- AFP/yb