Updated: May 3, 2013 12:14PM
The Fed said it wouldn't bail out another financial firm, but when the chips were down the prospect of a bankruptcy for AIG, one of the largest insurers in the world with 74 million clients in 130 countries, was too daunting for global financial markets.
After a day of intense negotiations in an effort to get the private sector to front a bid for the $1 trillion assets of the giant insurer, the Federal Reserve on Tuesday night finally authorized the Bank of New York to lend up to $85 billion to AIG. Officially, it's not a handout, because in return the government will own a 79.9 percent stake in the company.
The transaction is technically a loan for two years -- at a steep annual interest rate of 11.3 percent. The loan will be backed by the assets of the company, and will be repaid as those assets are sold. It's reminiscent of the government's 1979 bailout of Chrysler, in which taxpayers guaranteed $1.2 billion of loans that were eventually repaid.
The Fed's major concern was a convoluted web of swaps and financial transactions that would have unraveled had AIG declared bankruptcy.
But individual clients of the giant insurer are also relieved. They include homeowners in flooded Texas communities, wondering if their AIG policies would pay for damage, along with millions of teachers who own retirement annuities through AIG subsidiary VALIC and worried that their retirement plans would go down the drain in a bankruptcy.
Now, it's likely that these profitable insurance subsidiaries will be purchased by other, stronger insurance companies. In that case, all the policies would continue intact under the original contracts. And until the assets are sold, the loan will allow AIG to continue to manage its insurance business.
The deal also gives AIG time to unwind the complex mortgage and credit transactions, whose value will likely continue to fall under the pressure of selling. But other markets are expected to rebound, now that the fate of AIG is being resolved.
The government has now managed a rescue for both Fannie and Freddie, as well as Bear Stearns and AIG. Only Lehman employees and shareholders must be wondering why they didn't qualify, too. The Fed drew a line in the sand, and then the tide came in and washed it away -- along with billions of dollars in shareholder value. And when the tide goes back out, it is the American taxpayer who is likely to ultimately pay for this rescue.