Reinsuring A.I.G.

Washington rewrites the bailout playbook. Is that a good thing?

Things change so quickly in this financial crisis that a bailout created in mid-September is already getting a complete overhaul.

The U.S. government is essentially throwing out the old $85 billion rescue (later raised to $123 billion) of American International Group for a new $150 billion rescue. At a time when automakers and others are looking in vain for federal help, the revised A.I.G. bailout raises many questions about how Washington is choosing winners and losers in the economy.

The Treasury is buying a $40 billion stake in A.I.G., allowing the Federal Reserve to cut its now five-year credit line to the insurance company to $60 billion from $85 billion. And that lending will be less punitive than before, with the interest rate on the borrowed money being reduced to the three-month Libor rate plus 300 basis points, down from 850 basis points previously.

More important, the new deal creates two vehicles to buy troubled assets. One will buy residential mortgage-backed securities from A.I.G., backed by a loan of $22.5 billion from the Federal Reserve Bank of New York. The company is lending $1 billion and will bear the risk for the first $1 billion in losses.

The second vehicle will involve buying collateralized debt obligations on which A.I.G. has written credit default swap contracts. The New York Fed will lend as much as $30 billion to this effort, while A.I.G. will kick in $5 billion. A.I.G. is also on the hook for the first $5 billion in losses.

"These new measures establish a more durable capital structure, resolve liquidity issues, facilitate A.I.G.'s execution of its plan to sell certain of its businesses in an orderly manner, promote market stability, and protect the interests of the U.S. government and taxpayers," the Federal Reserve said in a statement.

The revised deal is an admission that the original bailout was not working. And while the recent focus of Treasury has been on pumping equity into financial institutions, the new bailout shows that that the original intent of the $700 billion TARP-buying troubled assets-may be just as important.

Even with the $85 billion infusion in September, A.I.G. still had to scramble to come up with collateral to counterparties on its credit default swaps. The new government-funded company to buy the underlying C.D.O.'s should go a long way toward propping up A.I.G. and steadying the financial system.

As the Financial Times' Alphaville blog notes, A.I.G. is no longer an insurance company, but "a slightly more sophisticated TARP."

"Taxpayers' capital will continue to go towards meeting collateral calls on C.D.S. contracts: These calls will be direct liquidity-like cash infusions into the banking system. Meeting such calls will also allow the C.D.S. contracts to remain in place, which will allow banks to pretend they don't own any risky assets, as far as regulatory risk-weighting and capital requirements are concerned."

No longer an insurance company? One is tempted to say that after the company reported an ugly loss of $24.5 billion for its third quarter.

Visit for the latest business news and opinion, executive profiles and careers.© 2007 Condé Nast Inc. All rights reserved.