Emergency Loan to AIG on September 17, 2008

On September 17, 2008, the U.S. Federal Reserve announced an emergency loan to American International Group (AIG), one of the largest insurance companies in the world. This decision was made amidst the height of the global financial crisis, as AIG faced an imminent risk of collapse due to its entanglement in the subprime mortgage market and related financial products.

Background

In the years leading up to the crisis, AIG had aggressively expanded its financial services, particularly in credit default swaps, which are a form of insurance on debt securities. This expansion made the company vulnerable as the housing market began to decline. By 2008, the collapse of Lehman Brothers and the weakening financial sector intensified panic in global markets, creating enormous pressure on AIG, which faced a liquidity crisis as its credit ratings were downgraded.

The Federal Reserve’s Intervention

The Federal Reserve’s intervention came in the form of an $85 billion loan, effectively giving the U.S. government a 79.9% equity stake in AIG. The loan aimed to stabilize the financial system by preventing the disorderly failure of AIG, which was deemed “too big to fail” due to the systemic risk it posed. The interconnectedness of AIG with numerous financial institutions worldwide meant that its collapse could have triggered a cascade of failures throughout the global finance network.

Terms of the Loan

• Loan Amount: $85 billion
• Interest Rate: LIBOR plus 850 basis points (which was significantly high, reflecting the risk and urgency of the situation)
• Duration: Initially for two years, eventually extended
• Equity Stake: 79.9% provided to the federal government as collateral
• Objective: Stabilize AIG, manage its debts, and allow controlled dismantling of its financial obligations

Impact and Aftermath

The intervention marked a significant shift in U.S. government policy during the crisis, reflecting an unprecedented involvement in private sector affairs. It highlighted the vulnerability of large, interconnected financial institutions and prompted further regulatory scrutiny of the insurance and financial sectors.

Following the bailout, AIG implemented a restructuring plan, including selling off assets to repay the loan. Over time, the government recouped its investment, turning a profit of approximately $22.7 billion when all had settled. The intervention underscored the need for financial reforms, eventually leading to significant legislative changes, such as the Dodd-Frank Wall Street Reform and Consumer Protection Act.

The AIG bailout remains one of the defining moments of the 2008 financial crisis, illustrating the challenges of managing systemic risks in a globalized financial system.