Government Nationalizes AIG; Fed Leaves Rates Unchanged

Federal Reserve lends $85 billion to biggest insurer

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The Federal government essentially nationalized the American International Group, the world's largest insurer, on Tuesday night, Sep. 16, via an announcement by the Federal Reserve that it, with the support of the Treasury Dept., would make a secured, $85 billion two-year loan to AIG so it could sell some of its businesses "with the least possible disruption to the overall economy." Interest will accrue on the amount drawn by AIG at a rate of three-month Libor plus 850 basis points; it will be paid back from proceeds of the asset sales. Under terms of the loan, the government will own nearly 80% of the company, and will have the right to suspend dividend payments on AIG's common and preferred stock.

The Fed said it took the action to protect the financial markets, which would have been devastated by the failure of a company whose operations touch so many parts of those markets, particularly in its insurance contracts on debt held by numerous institutions.

Earlier Sep. 16, the Federal Reserve Open Market Committee announced that it would leave rates unchanged, keeping its target for the federal funds rate at 2%. An FOMC statement noted that inflation has been high, and while it expects it to "moderate later this year and next," it argued that the outlook for inflation remains "highly uncertain." It acknowledged that economic growth has slowed lately, but said the "substantial easing of monetary policy, combined with ongoing measures to foster market liquidity, should help to promote moderate economic growth."

The involvement of the government in taking over AIG is sure to have political repercussions in Congress and in the Presidential election campaign. Democratic lawmakers were quick to criticize the plan, and Senator Chris Dodd of Connecticut said that his Senate Committee on Banking, Housing, and Urban Affairs will hold hearings on the plan Sep. 23.

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