Fed takes over AIG with $ 85 billion bailout (Update4)

The U.S. government took control of American International Group Inc. in a ransom of $ 85 billion to avoid bankruptcy of the largest insurer in the nation and the worst financial collapse in history.

The Federal Reserve will provide a two-year loan, take 79.9 percent of the shares of the New York-based company and replace its management because `` a disorderly failure of AIG could add to already significant levels of market weakness financial''according to a statement by the central bank yesterday afternoon.

AIG fell apart as the worst housing crisis since the Great Depression led to more than $ 18 billion of losses in the past year. A merger could have cost financial industry $ 180 billion, according to RBC Capital Markets, because AIG provided insurance on more than $ 441 billion of fixed-income investments held by the world's largest institutions, including $ 57.8 thousand million in securities linked to subprime mortgages.

`` Nobody really knows what they have meant had he been allowed to fail, but there was an enormous amount of systemic risk,''said David Havens, a credit analyst at UBS AG in Stamford, Connecticut. `` It's a huge relief.''

The government is lending AIG the money at 8.5 percentage points higher than the rate at three months London interbank offered, or a current rate of around 11.5 percent.

The agreement will give the company, which sells insurance in over 130 countries, time to sell assets `` orderly''AIG said in a statement. Chief Executive Robert Willumstad, 63, will be replaced by former Allstate Corp. CEO Edward Liddy, 62, according to a person familiar with the plans who asked not to be identified because the change had not been announced formally.

Shares fall

AIG fell 45 percent to $ 2.05 at 4:15 pm in New York, after falling 80 percent last week on concern the company into bankruptcy. The crisis in credit markets and more than $ 500 million of losses related to subprime mortgages forced the government to take control of Fannie Mae and Freddie Mac, which control nearly half the U.S. $ 12 billion mortgage loans, and drove Lehman Brothers Holdings Inc. into bankruptcy.

`` I'm flat,''said former Treasury counsel Peter Wallison in an interview. `` No one could have imagined this, perhaps, a few months ago. I can not imagine why the Fed would do this if I were sure AIG's failure posed systemic risk.''

Credit Downgrades

The survival of the insurance company 89 years of age, fell into doubt when Standard & Poor's and Moody 's Investors cut its rating on 15 September. The reduction of threat to force AIG to post more than $ 13 billion in collateral when the company was already short of money. AIG could not raise money by selling shares after the stock fell to less than $ 4 a share from $ 70.11 in October last year.

`` There may be a greater need for capital,''apart from the $ 85 billion, New York Insurance Superintendent Eric Dinallo told CNBC today, adding that the loan will give AIG time to sell the units.

The loan will `` be sufficient to meet the needs of AIG colaterales''y allow the insurer to refinance debt that comes due, said Wachovia Corp. analyst John Hall in a note.

Federal Reserve loans does not require the sale of assets or liquidation of the company, although these are the most likely AIG will pay the Fed, the central bank staff officials told reporters on condition of anonymity. Blackstone Group LP advised AIG on the transaction.

'Punitive' Interest Rates

The `` castigo''tasa interest loan `` makes it very clear that this is not a subsidy extended to keep the company afloat but rather a domain that AIG unviable while ensuring that their obligations are met ,''said Marco Annunziata, an analyst at UniCredit SpA, in a note to clients. `` This is to all extents and purposes a controlled bankruptcy.''

The Fed does not have an expectation that AIG will be smaller, nonexistent or similar to its current form at the end of the loan, employees said.

The Fed or Treasury will end up holding the AIG share, employees said. The Fed bailed out AIG while refusing aid to Lehman, which collapsed earlier this week, because financial markets were more prepared for Lehman, an official of the Fed staff said.

The Fed stepped in after JPMorgan Chase & Co. and Goldman Sachs Group Inc., which were brought in to help assess AIG, not to reach a solution, according to a person familiar with the talks. Liddy is currently on the board of Goldman, the company Henry Paulson ran for president before becoming secretary of the U.S. Treasury in 2006.

CEO Turnover

Willumstad, former Citigroup Inc. president who left the bank in 2005 to seek a CEO position, was named to AIG's top post in June. His predecessor, Martin Sullivan, was chief for three years until being ousted after two record quarterly net losses. Maurice `` Hank Greenberg''reinaba at AIG for almost four decades until he was forced to retire in 2005 amid regulatory probes.

Greenberg, who remains one of the largest shareholders of the company, said the company needed a bridge loan instead of a plan that put the company under government control. A group of investors led by Greenberg said in a federal filing hours before the rescue was announced they want to buy the company or some units or make loans to AIG.

`` Why do you want to end up with shareholders when you just need a bridge loan?''Greenberg, 83, said in an interview before the announcement. `` It makes no sense.''Greenberg declined to comment after the Fed announcement, spokesman Glen Rochkind said.

Banks, Annuities

Companies that can be sold as American General Finance Corp., the division that makes loans for housing and automotive, said Citigroup analyst Joshua Shanker. The unit generated $ 2890 million in revenue last year, about 2.6 per cent of AIG. Other candidates include U.S. AIG's equity business, and a 59 percent stake in reinsurer Transatlantic Holdings Inc., said.

Asset manager AIG Investments, with 5.1 percent of AIG's revenue, could also be sold, said Gary Ransom of Fox-Pitt Kelton Cochran Caronia Waller.

American General Finance price may be more than $ 6 million if the unit sold for twice its book value. AIG Investments could fetch more than $ 3 billion if it sold for 2.5 percent of client assets under management. The Transatlantic stake is worth about $ 2.3 billion, based on share price yesterday. The variable annuity results are not divided, making an estimate difficult, said Shanker. AIG acquired the business a decade ago when it bought SunAmerica for $ 19.7 billion in shares.

Aircraft Leasing

Aircraft leasing unit International Lease Finance Corp. AIG may be acquired by investors led by the founder of the unit, Steven Udvar-Hazy, the Wall Street Journal, citing unnamed sources. Udvar-Hazy has been in talks with potential investors since Sept. 14, the Journal said.

AIG may also find buyers for life insurance outside the U.S., where competitors such as Hartford Financial Services Group Inc., MetLife Inc., Prudential Financial Inc. and Manulife Financial Corp. of Canada have been adding customers.

`` In developing insurance markets around the world, growth rates are, on average, twice what the growth rates in the U.S. are,''said Chief Financial Officer William Wheeler MetLife September 10. `` When properties come up for sale around the world, is very competitive.''