The US government ripped up its eight-week-old rescue deal for AIG and signed a new $150bn (£96bn) plan that it hopes will be more likely to save the insurance giant from bankruptcy.
An original $85bn loan agreed in September, topped up by a further $38bn last month, had failed to plug the growing black hole at the heart of the company's derivatives insurance business, the US Treasury conceded yesterday.
Instead, in the biggest handout from its $700bn Wall Street bailout fund, the government will buy a $40bn stake in AIG, and make a further $60bn available in the form of a loan on less onerous terms than those previously agreed.
And in an initiative that other participants in the disaster-struck mortgage derivatives market will watch closely, the Federal Reserve will buy up the toxic assets that have brought AIG to the brink of bankruptcy.
The insurer, for years one of the most respected names in the life, car and home insurance business, branched into insurance of complex financial derivatives, but it failed to prepare for the big losses that its clients would face on products linked to US mortgages, which have collapsed in value because of the housing market slump. Many major banks and hedge funds rely on AIG to hedge some of their most dangerous investments and the Treasury had feared that the company's failure would cause a chain reaction throughout the finance industry. On 16 September, it in effect nationalised the company, advancing the initial loans and taking an 80 per cent stake, which will not change under the new arrangements.
Neel Kashkari, the Treasury official and former Goldman Sachs executive who is administering the $700bn bailout fund, known as the Troubled Asset Relief Programme (TARP), said the restructuring of the AIG deal was "necessary to maintain the stability of our financial system".
"We recognise that the financial system remains fragile and we continue to stand ready to prevent systemic failures. We worked with the Congress to ensure the TARP included sufficient flexibility to do just this," he said.
The Federal Reserve is putting $42.5bn into two special investment vehicles that will buy mortgage-related assets and other derivatives on AIG's books. Market participants said they would be keen to see what price the government would set for these instruments. That could cause holders of similar assets to adjust their values, potentially leading to a new round of losses.