Capping an extraordinary day in financial markets, U.S. authorities pieced together an emergency $85 billion rescue of insurance company American International Group Inc to stave off a bankruptcy that could have thrown world markets into deeper turmoil.
AIG's rescue calls for the U.S. Federal Reserve to lend up to $85 billion to AIG for two years in exchange for a 79.9 percent equity stake. It comes just two days after U.S. authorities refused to bail out investment bank Lehman Brothers Holdings Inc, forcing it into bankruptcy court despite pleas from Wall Street's chiefs.
AIG will pay interest at a steep 8.5 percentage points above the three-month London Interbank Offered Rate, making the current rate equal to about 11.4 percent. That gives AIG a big incentive to embark on a massive asset sale program to pay back the loan quickly.
"Thank God," exclaimed Daniel Fuss, an influential bond manager who oversees more than $100 billion at Loomis, Sayles & Co in Boston. "AIG is interwoven with so many people and touches many companies around the world. This is a huge relief to many parts of the financial markets."
Around the time the AIG deal was announced, British bank Barclays Plc gave Wall Street another boost: It agreed to buy several parts of Lehman, the Wall Street investment bank that went bankrupt on Monday, for $1.75 billion.
Initial news of the AIG package pushed up U.S. stocks in after-hours trading, sent the dollar higher and boosted Japanese stocks. U.S. stocks earlier had clawed back from their largest one-day drop in seven years on speculation about the AIG and Lehman deals. The two largest U.S. investment banks, Goldman Sachs Group Inc and Morgan Stanley, also reported better-than-expected earnings.
The bailout keeps AIG from surpassing Lehman as the largest U.S. corporate failure ever. It comes on the heels of a government bailout just over a week ago of mortgage finance companies Fannie Mae and Freddie Mac, and six months after the Fed helped to finance the fire sale of failed investment bank Bear Stearns to JPMorgan Chase & Co.
AIG's bailout brings to about $700 billion the total of U.S. rescue efforts to stabilize the financial system and housing market. Authorities may get much of that sum back provided asset prices don't continue to slide.
"In current circumstances, 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.
President George W. Bush was briefed on the plan during a Tuesday afternoon meeting, which included Fed Chairman Ben Bernanke, U.S. Treasury Secretary Henry Paulson and U.S. Securities and Exchange Commission Chairman Christopher Cox.
AIG's management would be replaced, including Chief Executive Robert Willumstad, who only held the reins for three months, a person briefed on the matter said.
AIG faced a cash crunch after $18 billion of losses over three quarters, largely because of complex securities that are tied to mortgages, and which plunged in value as the nation's housing crisis deepened.
Investors and credit rating agencies grew more doubtful that AIG could offset its losses with enough capital, which became prohibitively costly to raise as its share price plunged.
AIG's life insurance, property and casualty insurance and aircraft leasing operations are considered healthy. The insurer, founded in Shanghai 89 years ago, now employs about 116,000 people and operates in more than 100 countries.
"The Administration is approaching an unprecedented step, but unfortunately we are living in unprecedented times," New York Sen. Charles Schumer said. "The alternatives are much worse."
Shares of AIG fell $1.15, or 31 percent, to $2.60 in after-hours trading, after dropping 79 percent in the prior three trading days.
"This would mean another shareholder wipeout," said David Ader, head of government bond strategy at RBS Greenwich Capital in Greenwich, Connecticut, referring to the bailout.
The AIG deal overshadowed a Fed decision earlier in the day to hold its benchmark interest rates steady.
"The Federal Reserve obviously thought the systemic risk from a major insurance company was too great to let go," said Chris Orndorff, who helps oversee $50 billion at Payden & Rygel Investment Management in Los Angeles.
"AIG not only does major business with Wall Street and the financial markets but also Main Street," he added. "That is why the Fed stepped in. It would have been disruptive, in no uncertain terms, if AIG went bankrupt."
An AIG collapse could have cost financial institutions $180 billion, or 50 percent of the capital they have raised since the credit crunch began last year, RBC Capital Markets analyst Hank Calenti wrote.
Barclays' purchase includes Lehman's North American sales, trading, and research and investment banking businesses, as well as its midtown Manhattan headquarters and two New Jersey data centers.
About 10,000 of Lehman's 26,000 employees would join Barclays. Barclays said the purchase requires bankruptcy court approval, and that it can walk away if the deal is not completed by Sept. 24.
"This is a once-in-a-lifetime opportunity for Barclays," Barclays President Robert Diamond said in a statement. "We will now have the best time and most productive culture across the world's major financial markets, backed by the resources of an integrated universal bank."
The announcement was notable in that it made no mention of the future of Richard Fuld, Lehman's longtime chief executive.
In a sign of how much U.S. authorities have been trying to prop up the markets, the Federal Reserve Bank of New York took the unusual step of providing some $87 billion in financing to help underpin trading with Lehman units to prevent disruption as customers fled, court documents showed.