Fed lends $85 billion to rescue AIG

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In addition to the loan, New York insurance regulators provided AIG with regulatory relief, enabling the insurer to borrow $20 billion in cash from subsidiaries.

“While we do not generally support government intervention in these situations, in this case we do support the Federal Reserve being part of a private-sector effort to stabilize AIG,” said New York Attorney General Andrew M. Cuomo.

“Given AIG’s interconnections, its failure would pose serious hardships to many companies and individuals. The Fed’s leadership and collaboration is therefore essential.”

As an alternative to lowering interest rates, the Fed attempted to calm stressed markets with a massive joint operation with the European Central Bank, infusing $140 billion of cash into the critical funding markets where banks obtain the cash they need to lend to businesses and individual consumers.

Fear about a rash of bankruptcies has caused those markets to freeze, with the interest rates paid by banks for overnight loans doubling in London and surging wildly in New York, while corporate borrowing costs soared.

“The problems are the clogged pipelines in the credit markets,” said Sung Won Sohn, economics professor at California State University. “Lower interest rates at this time would not solve any problems in the financial markets. The market is not short of liquidity; it is short of confidence.”

The Fed views its other actions, including the cash infusion and a move over the weekend to broaden the number of credit instruments it will accept as collateral at its loan discount window for banks and Wall Street firms, as “substitutes for rate cuts,” he said.

The Fed acknowledged Wall Street’s turmoil, saying “strains in financial markets have increased significantly and labor markets have weakened further.” Combined with “tight credit conditions and the ongoing housing contraction,” it said, the crisis is likely to slow growth in coming months.

But the Fed said the substantial cuts in interest rates it provided earlier this year should suffice to keep the economy growing at a moderate rate. It added that it still has “significant concern” that inflation will worsen, despite a rare energy-induced decline in the Consumer Price Index reported by the Labor Department earlier Tuesday.

Richard Yamarone, an economist with Argus Research Corp., said the Fed may have decided against cutting rates because it wants to reserve the option of taking action if more major bankruptcies rock the financial markets in coming days.

“It may be the case that the Fed is keeping its powder dry in the event AIG or some other major bank failure wallops the markets, which could be the looming fear that would force the Fed to slash rates,” he said. There could be “something much bigger than Lehman and Merrill Lynch looming in the wings.”

On Capitol Hill, a key congressional Democrat said the turmoil on Wall Street is prompting consideration of a broad federal market rescue that could include a new government entity to take over collapsed financial institutions and sell off their assets, as lawmakers did during the 1980s savings and loan crisis.

Rep. Barney Frank, Massachusetts Democrat and chairman of the House Financial Services Committee, said a body like the Resolution Trust Corp. - the largely taxpayer-financed company that seized and liquidated the savings and loans - might be needed in coming months to stabilize markets and prevent more implosions at major financial institutions.

His panel plans a hearing Sept. 23 to hear from economists and others “to begin the process of thinking about” the idea.

In a more immediate step designed to help regulators deal with the credit crisis, Democrats said they have agreed to give the Federal Reserve authority to pay interest on commercial bank reserves, a move that could give the central bank better control over interest rates. The measure, which Mr. Frank said would cost $300 million over the next two years, is likely to become part of the final spending package Congress passes this month before adjourning.

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