Fed Bails out Wall St. Insurer with $85 Billion "Loan"

Posted by Steven Rosenfeld at 11:00 PM on September 16, 2008.

The Federal Reserve Bank of New York announced Tuesday night that it would "loan" up to $85 billion to American International Group, an insurer of arcane investments on Wall Street. It made the announcement after unsuccessfully trying to find a private buyer for the past several days, various financial news services reported.

The Federal Reserve action, which would give the government -- taxpayers -- a nearly 80 percent stake in AIG, would be repaid as the firm is broken up and sold in the next 24 months, the Federal Reserve said in a short press release.

"The interests of taxpayers are protected by key terms of the loan," the agency said. "The loan is collateralized by all the assets of AIG, and of its primary non-regulated subsidiaries. These assets include the stock of substantially all of the regulated subsidiaries. The loan is expected to be repaid from the proceeds of the sale of the firm's assets. The U.S. government will receive a 79.9 percent equity interest in AIG and has the right to veto the payment of dividends to common and preferred shareholders."

The reaction in Congress, where leaders were briefed on the bailout early Tuesday, was of begrudging acceptance, according to news services. Key Democrats, such as House Speaker Nancy Pelosi, called the $85 billion figure a "staggering sum," while Rep. Barney Frank (D-MA), the House Financial Services Committee Chairman, said the bailout showed the private sector needed to be regulated.

Just how the government -- taxpayers - will recover the billions the Federal Reserve will "loan" AIG is only the first of many questions that will be raised in the days and weeks ahead. If AIG is insuring losses caused by the collapse of the housing market and loans whose balances are less than property values, it is hard to see how taxpayers will not absorb billions in losses. The loan to AIG is one-sixth the cost of the war in Iraq.

Other questions concern how many other large lending institutions will fail. Buried in news accounts of the crisis on Wall Street are caveats, such as qualifiers saying it will take some time for various financial institutions to "unwind their positions." In simple terms, that means that many lenders and other investors have not yet reported -- or publicly disclosed -- losses that are on their books, such as properties surrendered in bankruptcy filings that have not been resold at a loss.

Just how the ongoing meltdown in financial markets will affect middle- and working-class Americans also remains to be seen, although recent months have seen credit and borrowing terms become tighter. As stock values decline, so too does the value of life savings, retirement income, pensions, and so on. As many middle-class Americans suddenly feel more financially precarious, it remains to be seen how perceptions of political and economic 'leadership' and 'accountability' will be affected.

With less than two months before the presidential election, you can expect that both major party candidates will focus more on economic issues. Whether their remarks rise to the level of an adult conversation or sink to meaningless sound bites is another open question. Both campaigns have financial supporters from the investment sector.

(Here is a link to contact your representative in Congress, as one reader suggested).