US Fed bails out AIG with $85bn

NEW YORK - US insurance firm AIG - which controls more than a trillion dollars of assets - has been taken under the control of the Federal Reserve. The Fed provided an $85 billion bailout on September 16 after the institution's share price plummeted amid mounting liquidity problems. US President Bush said the move was necessary "to promote stability in the financial markets". It came only a week after the nationalisation of mortgage lenders Freddie Mac and Fannie Mae, and only a day after US authorities allowed investment bank Lehman Brothers to file for bankruptcy. Under the plan, authorities will receive equity equivalent to a 79.9% stake in AIG. In return, the insurer receives a two-year bridge loan of $85 billion to keep it afloat until it can dispose of billions of dollars in assets. AIG's liquidation could cause more than $180 billion of losses for financial institutions, reportedly leaving European banks particularly exposed.

Some blame the EU Basel II capital requirements regulation for AIG's increased exposure. As well as direct exposure to an array of credit default swaps on the insurer's books, AIG also carried extensive exposure from banks, as Basel II encourages banks to insure their exposure to structured products, allowing them to carry less capital. Basel II says: "A bank will be allowed to recognise the risk-mitigating impact of insurance in the measures of operational risk used for regulatory minimum capital requirements". The Basel Committee on Banking Supervision has yet to conclude changes to its capital rules to offset structured products.