http://online.wsj.com/article/SB122156561931242905.html?mod=djemalert

U.S. Plans Rescue of AIG to Halt Crisis;
Central Banks Inject Cash as Credit Dries Up
$85 Billion Loan for Giant Insurer Aimed at Averting Collapse;
Historic Move Would Cap 10 Days That Reshaped U.S. Finance

The U.S. government was moving toward an emergency rescue of American International Group Inc. -- one of the world's biggest insurers -- signaling the intensity of its concerns about the danger a collapse could pose to the financial system.

It's a dramatic turnabout for the federal government, which has strongly resisted overtures from AIG for an emergency loan or some intervention that would prevent the insurer from falling into bankruptcy. Just last weekend, the government effectively pulled the plug on Lehman Brothers Holdings Inc., allowing the big investment bank to fail instead of giving it financial support.

The precise details of the government's plans were still being formulated late Tuesday. The primary option being hammered out involved the Fed providing AIG with a short-term "bridge" loan of $85 billion, according to people familiar with the situation. In exchange, the government would receive warrants in AIG representing the right to buy its stock, under certain conditions. That could put the government in a position to potentially control a private insurer, a historic move, particularly considering that AIG isn't directly regulated by the federal government.

The moves capped a day of high drama in Washington. Treasury Secretary Henry Paulson and Federal Reserve Chairman Ben Bernanke convened in the early evening an unexpected meeting of top congressional leaders, including Sen. Harry Reid of Nevada, the majority leader, top members of the Senate Banking Committee and leaders, too, from the House.

Sen. Richard Shelby of Alabama said he didn't receive a "satisfactory" answer from Mr. Paulson in an early conversation about the ultimate scope of government intervention. "I laid out -- where do you stop? Where do you draw the line?"

The Federal Reserve appeared to be motivated in part by worries that Wall Street's financial crisis could begin to spill over into seemingly safe investments held by small investors, such as money-market funds that invest in AIG debt.

Indeed, on Tuesday the $62 billion Primary Fund from the Reserve, a New York money-market firm, said it "broke the buck" -- that is, its net asset value fell below the $1-a-share level that funds like this must maintain. Breaking the buck is an extremely rare occurrence. The fund was pinched by investments in bonds issued by now collapsing Lehman Brothers.

Money-market funds are supposed to be among the safest investments available. No fund in the $3.6 trillion money-market industry has lost money since 1994, when Orange County, Calif., went bankrupt. A number of money-market funds own securities issued by AIG. The firm is also a big insurer of some money-market instruments.

AIG's financial crisis intensified Monday night when its credit rating was downgraded, forcing it to post $14.5 billion in collateral. The insurer has far more than that in assets that it could sell, but it could not get the cash quickly enough to satisfy the collateral demands. That explains the interest in obtaining a bridge loan to carry it through. AIG's board approved the rescue Tuesday night.

The final decision to help AIG came Tuesday as the federal government concluded it would be "catastrophic" to allow the insurer to fail, according to a person familiar with the matter. Over the weekend, federal officials had tried to get the private sector to pony up some funds. But when that effort failed, Fed Chairman Bernanke, New York Fed President Timothy Geithner and Treasury Secretary Paulson concluded that federal assistance was needed to avert an AIG bankruptcy, which they feared could have disastrous repercussions.

Staff from the Federal Reserve and Treasury worked on the plan through Monday night. President George W. Bush was briefed on the rescue Tuesday afternoon during a meeting of the President's Working Group on Financial Markets.

That the government would prop up AIG financially offers a stark indication of the breadth of the insurer's role in the global economy. If it were to have trouble meeting its obligations, the potential domino effect could reach around the world.

For one thing, banks and mutual funds are major holders off AIG's debt and could take a hit if the insurer were to default. In addition, AIG was a major seller of "credit-default swaps," essentially, insurance against default on assets tied to corporate debt and mortgage securities. Weakness at AIG could force financial institutions in the U.S., Europe and Asia that bought these swaps to take write-downs or losses.

AIG's millions of insurance policyholders appear to be considerably less at risk. That's because of how the company is structured and regulated. Its insurance policies are issued by separate subsidiaries of AIG, highly regulated units that have assets available to pay claims. In the U.S., those assets can't be shifted out of the subsidiaries without regulatory approval, and insurance is also regulated strictly abroad.

Tuesday afternoon, after the market closed, AIG put out a statement saying its basic insurance and retirement services businesses are "fully capable of meeting their obligations to policyholders." AIG said it was trying to "increase short-term liquidity in the parent company," but said that didn't "include any effort to reduce the capital of any of its subsidiaries or to tap into Asian operations for liquidity." Asia is one AIG's largest markets.

Where the company is feeling financial pain is at the corporate level, even while its insurance operations are healthy. If a bankruptcy filing did ensue, the insurance subsidiaries could continue to operate while in Chapter 11, or could also be sold.

Still, a collapse of the parent company would have huge ripple effects. The urgency of federal aid came into stark relief Tuesday as other options fell off the table and pressures continued to build. On Tuesday, AIG's attempt to raise as much as $75 billion from private-sector banks failed. The banks advising the firm concluded it would be all but impossible to organize a loan of that size, making the government AIG's chief hope.

The AIG bailout caps a tumultuous 10 days that have remade the American financial system. In that time, the government has engineered rescues that insert it deep into the housing and insurance industries, while Wall Street has watched two of its last four big independent brokerage firms exit the scene.

The U.S. on Sept. 6 took over mortgage-lending giants Fannie Mae and Freddie Mac as they teetered near collapse. This Sunday, the U.S. refused to bail out Wall Street pillar Lehman Brothers, which filed for bankruptcy and is now being sold off in pieces. That same day, another struggling Wall Street titan, Merrill Lynch & Co., sold itself to Bank of America Corp..

As a result of AIG's credit downgrades, the insurer has to post $14.5 billion in collateral to bolster its credit rating. In the debt markets, AIG also has to post additional collateral to investment banks and others it trades with.

Adding to AIG's woes, investors continued to pummel the company's stock on Tuesday, pushing the share price down another 21%, to $3.75. It was the third double-digit percentage decline in the last three trading days.

Federal officials worked throughout the day to help the company forestall a possible bankruptcy filing. Insurance regulators in New York, where AIG is based, are also working on a plan to let AIG move some assets into and out of its subsidiaries in order to be able to borrow up to $20 billion against some of them. But a spokesman says the department is confident it is protecting policyholders.

"Our deal is contingent on a broader solution to AIG's problems," says the department spokesman, David Neustadt.

AIG's cash squeeze is driven in large part by losses in a unit separate from its traditional insurance businesses. That financial-products unit, which has been a part of AIG for years, sold the credit-default swap contracts designed to protect investors against default in an array of assets, including subprime mortgages.

But as the housing market has crumbled, the value of those contracts has dropped sharply, driving $18 billion in losses over the past three quarters and forcing AIG to put up billions of dollars in collateral. AIG raised $20 billion earlier this year. But the ongoing demands are straining the holding company's resources.

That strain contributed to the ratings downgrades on Monday. Those downgrades, in turn, ratcheted up the pressure on the company to come up with more cash, quickly.

Most insurance companies don't have financial-products units like these. But over nearly four decades, former CEO, Maurice R. "Hank" Greenberg built AIG into a firm that resembled no other. He transformed its insurance business, both by expanding abroad -- notably in China, where AIG has its roots -- and by buying up other firms.

Mr. Greenberg pushed into areas that have little to do with bread-and-butter businesses like selling life insurance or protecting companies against property losses. In 1990, for instance, he bought International Lease Finance Corp., which leases planes to airlines.

But in 2005, Mr. Greenberg stepped down amid an accounting scandal. But Mr. Greenberg, who is fighting civil charges related to the scandal and has denied wrongdoing, didn't fade from the scene. He still heads a firm that is AIG's largest shareholder, and on Tuesday, he sent a letter to current CEO, Robert Willumstad, saying he was "ready to offer any assistance that I can."

As confidence in AIG's fate has plummeted, the amount of money it feels compelled to raise to calm its many constituents continues to rise. Though $40 billion was the figure over the weekend, it climbed to 75 billion on Monday and, according to a person close to the company, to $100 billion on Tuesday.

The rapid escalation in its potential needs has raised the spectre of bankruptcy. In preparation for a possible bankruptcy filing, AIG has hired New York law firm Weil Gotshal & Manges to advise it. Weil is also working for Lehman Brothers Holdings, which filed for bankruptcy protection earlier this week.

The ratings downgrades also triggered a provision in some of AIG's large commercial insurance policies that allow holders to cancel the policies and recoup some of the premiums they paid, according a person familiar with the matter. It's not clear whether policyholders are exercising that right.

But insurance brokers are contending with worried clients who have policies issued by AIG. Daniel Glaser, the head of the brokerage unit at Marsh & McLennan Cos. (and a former AIG executive) posted a letter to customers on the company's Web site saying that AIG is "facing a liquidity crisis." Nonetheless, Mr. Glaser wrote that AIG meets the broker's "financial guidelines," despite recent rating downgrades. "Therefore, we have no restrictions on the use of AIG insurance company subsidiaries for client placements," Mr. Glaser wrote.

In Asia, where AIG operates a wide network of businesses, its affiliates sought to reassure clients that they had sufficient capital to meet all policy claims. Regulators in India, Hong Kong, Singapore and Thailand said local AIG units have enough capital to cover their obligations. Regulators in China said they were monitoring the situation.

Customers outside the U.S. accounted for 79% of AIG's insurance premiums for life insurance and retirement services last year. Japan and Taiwan are among AIG's largest markets.

Despite reassurances from regulators that their policies were covered and warnings that cancellations could lead to losses, dozens of people lined up outside AIG-affiliated offices in Singapore. Some waited for three hours to be attended by staffers. Others said that they wanted to make sure that their policies are safe, while others said they would cancel their policies.