The Rescue of American International Group Module A: The Revolving Credit Facility

The Revolving Credit Facility, approved and announced on September 16, 2008, a day after the bankruptcy of Lehman Brothers, was the first of what would be a large package of assistance established by the government to address the insurance giant’s severe liquidity and capital issues (FRB 2008b; FRBNY 2008a). Interventions would be funded by the FRBNY and Treasury; would include direct loans, asset purchases, and capital injections; and would become the government’s largest intervention for any one entity, totaling $182.3 billion (Treasury 2013, 14).

AIG was in dire need for liquidity to meet collateral calls and satisfy large cash demands from securities borrowers. On September 16, AIG’s board approved borrowing $14 billion through a demand note from the FRBNY, as well as additional demand notes, “as any Authorized Officer determines is necessary or appropriate to meet the liquidity needs of [AIG] prior to the execution of the definitive documentation of the Credit Facility.” (US Court of Federal Claims 2015, 22–23). Secretary Geithner, in his memoir, Stress Test, stated that AIG had originally said it would need $4 billion to meet incoming collateral calls for the morning of the 16th but that AIG underestimated its cash needs and required $14 billion in immediate funds (Geithner 2014a, 196). Ultimately, through September 19, the FRBNY advanced $37 billion, evidenced by four Demand Notes payable to the FRBNY and secured by a range of AIG assets, prior to the execution of the Credit Agreement (FRBNY 2008b, 1).

In an interview YPFS conducted with Sarah Dahlgren, Head of the Supervisory Group at the FRBNY, Dahlgren said the decision to gradually extend the amounts over the course of four days was to ease into the FRBNY’s exposure to AIG (YPFS 2018b). Stress scenarios and valuations were updated daily by Ernst & Young (EY) specialists and reported to then–President Geithner and the rest of the FRBNY’s AIG team each morning, who would decide whether or not they were comfortable extending an additional advance (YPFS 2018b).

The Congressional Oversight Panel’s June 2010 Oversight Report noted that between the announcement of the RCF and the actual implementation, Morgan Stanley and EY, whom the FRBNY hired for collateral valuation services in part due to their insurance expertise, completed their assessments of AIG’s business (COP 2010, 227). While these assessments were in progress, the FRBNY was capable of securing any advances on the collateral that they valued as “satisfactory” for the amount extended (COP 2010, 227). The FRBNY argued that the ability to advance funds on interest-bearing notes and/or credit agreements was part of the Section 13(3) lending authority, which allows the Reserve banks to “discount” or purchase paper with interest (COP 2010, 226–227).

At the execution of the Credit Agreement, the FRBNY transferred over any existing credit and payments due from the advances to the RCF and then canceled the four demand notes (FRBNY 2008b, 1–2).

Originally having discouraged AIG from seeking a loan based on Section 13(3), the FRBNY over the September 13–14 weekend considered other routes of assistance for AIG. These included providing access to the Primary Dealer Credit Facility, seeking financing through the Federal Home Loan Bank System, and finding a private sector solution for funding via acquisition (US GAO 2011b, 19–31). FRBNY officials told the US Government Accountability Office (US GAO) that the amount of credit required by the parent would be too large for any AIG subsidiary to obtain, and that, at that point, the timing was too tight to consider alternatives to the Fed credit line (US GAO 2011b, 19–24, 42–43).

Nevertheless, once Lehman Brothers failed, the Federal Reserve Board authorized the FRBNY to enter into the RCF pursuant to Section 13(3) of the Federal Reserve Act, the Board’s emergency lending authority, which has three basic requirements: (i) the Board must determine that “unusual and exigent” circumstances exist, by the affirmative vote of at least five members; (ii) the loans must be secured to the satisfaction of the lending reserve bank; and (iii) the lending reserve bank “must have obtained evidence that adequate credit was not available from other banking institutions” (GPO 2007a, 112). In determining that exigent and unusual circumstances existed, the Board considered the size of AIG and that it “faced the imminent prospect of declaring bankruptcy.” Further, it also considered “the effect of AIG's disorderly failure on financial markets, the position of the Department of the Treasury on an extension of credit to AIG, and the circumstances presented by this situation as compared with situations recently confronted by the Board.” In light of these facts, the Board concluded “that the disorderly failure of AIG was likely to have a systemic effect on financial markets that were already experiencing a significant level of fragility and that the best alternative available was to lend to AIG to assist it in meeting its obligations in an orderly manner as they came due” (FRB 2008a, 3–4).

Thus, the Board authorized the FRBNY to extend the RCF consistent with the general terms also approved by it, although the Board did not approve the ultimate terms that were included in the Credit Agreement, some of which differed from the term sheet approved by the Board (FRB 2008a, 3–4; US Court of Federal Claims 2015, 20).

Former FRBNY President Geithner has provided further elaboration on the Board’s decision. When Lehman Brothers filed for bankruptcy on September 15, it was received like a hurricane heightening panic throughout financial markets and causing already tightened credit markets to all but freeze. (US GAO 2011b, 7). Over the prior week, AIG’s extreme liquidity needs, had worsened and two rounds of seeking a private sector solution had failed; it did not seem that there was adequate private funding available to meet AIG’s needs (US GAO 2011b, 35). In the case of aiding an individual firm, and more specifically,  a nonbank institution such as AIG, the objective in Geithner’s view was to “minimize or mitigate the damage to the economy” (Geithner 2014b, 1708).

Finally, authorization under Section 13(3) also required that the credit could be “secured to the satisfaction” of the lending Reserve Bank (GPO 2007a). Different from the case of Lehman, where its assets were difficult to assess and were ultimately deemed by FRBNY inadequate to serve as collateral against a loan of the size needed, AIG’s insurance subsidiaries were believed to be relatively sound and could continue to provide strong cash flows or could be sold to make up for any losses on the overall company and repay any federal assistance (Geithner 2014a, 193; Geithner 2019, 23). By taking a security interest in the majority of AIG’s assets, including the equity in its insurance subsidiaries, FRBNY believed that its loan would be adequately secured.

The RCF was administered by the FRBNY. As it was similar to other types of lending that the Reserve Bank did, the RCF, per se, did not at first pose particular administrative challenges. However, as discussed in Wiggins et al. 2021, because of the size and nature AIG’s businesses, being a nonbank insurance company not usually dealt with by the FRBNY, certain challenges arose in managing the AIG stakeholders and later other elements of the government’s response.

Consistent with standard practice, Section 5.04 the Credit Agreement signed in September 2008 required AIG to provide the FRBNY with certain financial statements on a periodic basis so that it could monitor its operations—“its consolidated balance sheet and related statements of income, stockholders’ equity and cash flows showing the financial condition of [AIG] and its consolidated Subsidiaries” within 90 days of the end of the fiscal year, with unaudited reports coming sooner (FRBNY 2008a, 35–36). Section 5.05 also imposed detailed additional reporting requirements, such as in the case of a default, a change in AIG’s corporate rating, or judicial proceedings made against AIG or its subsidiaries. (FRBNY 2008a, 38–39).

Given the size of the RCF and the overall government assistance to AIG, there has been much disclosure and interest in its details. Often, the terms, details, and utilization of the RCF were discussed in connection with other government action. However, from the beginning, there were also singular communications regarding it.

In testimonies to the Congressional Oversight Panel (COP), officials at FRBNY and Treasury repeatedly stated they had a “binary” choice between letting AIG fail or rescue the entire institution (COP 2010, Executive Summary). Tom Baxter, who was the General Counsel at the FRBNY, agreed with this sentiment and suggested that the consequences of bankruptcy would have been far worse than a wholesale rescue (COP 2010, Section 254).     

Then–Federal Reserve Board Chairman Ben Bernanke testified in front of the Senate Committee on Banking, Housing, and Urban Affairs on the RCF’s impact on the firm. “To mitigate concerns that [the loan] would exacerbate moral hazard and encourage inappropriate risk-taking in the future, the Federal Reserve ensured that the terms of the credit extended to AIG imposed significant costs and constraints on the firm’s owners, managers, and creditors” (Bernanke 2008). However, significant internal discussions about the punitive pricing of the initial terms of the loan were had at the FRBNY. (See Key Design Decisions No. 9 for more details.)

Bernanke, in October of 2008, gave a speech at the National Association for Business Economics that also framed the Fed’s loan to AIG in a more systemic way. Bernanke explained that, “In the case of AIG, the Federal Reserve and the Treasury judged that a disorderly failure of AIG would have severely threatened global financial stability and the performance of the US economy” (Bernanke 2008).

The Fed would dramatically alter the terms of the RCF in a Restructuring Plan that was released at 6:00 a.m. on November 10, 2008, the same day AIG’s earnings release was made because officials anticipated that AIG would show large losses and be a prime target for a ratings downgrade (US GAO 2011b, 52–53). Even with less certainty around a downgrade, FRBNY officials explained that, “government action still would have been necessary, because markets would have punished AIG when it released its earnings report (US GAO 2011b, 53).”

The private sector term sheet contained the condition that any possible investment in AIG must include the “replacement of AIG senior management, including the chief executive officer” (US GAO 2011b, 27).

Secretary Geithner later stated that the market’s lack of confidence in AIG, or the market’s perception, influenced the government’s decision to change AIG’s management and replace CEO Willumstad in September 2008 (Geithner 2014b, 1777–1778).

Secretary Geithner later recalled that Secretary Paulson had suggested Ed Liddy to replace Willumstad as AIG CEO “because he was judged as a person with enough relevant, credible experience because [Liddy] managed a large insurance company” and because Secretary Paulson and his special adviser, Ken Wilson, “had a lot of confidence in [Liddy’s] judgment” (Geithner 2014b, 1810). Liddy had experience serving as CEO of Allstate, another major insurance company, for eight years. (Geithner, 2014b, 1810).

As a condition of the RCF, AIG was required to issue to the government a 79.9% equity interest in the company, which would be held by an independent trust established by FRBNY for the benefit of the Treasury. (See Buchholtz and Lawson 2021b.) This feature had several purposes: (1) to provide compensation to the government for the risks it was taking, (2) to address moral hazard, and (3) to provide the government some control over the company and protect its interests, and (4) to provide some upside benefit to the taxpayers if the company should rebound. (Geithner 2010, 1775-81, 1811-23). Treasury’s Chief Restructuring Officer, Jim Millstein, said the equity interest was included “to provide additional compensation to taxpayers for their assistance, and to penalize the shareholders of [AIG] for the fact that [AIG] had no alternative but to ask the government for extraordinary assistance” (Millstein 2010, 7).

AIG’s board of directors met on September 21, 2008, with the expectation that they would be issuing to the US government a set of warrants with nonvoting rights.^FNThe “equity kicker” as originally conceived was also similar to the government’s terms in the rescues, earlier that month, of Fannie Mae and Freddie Mac, where the government received preferred stock for its loan commitments and also received warrants to purchase common stock representing 79.9 % of the common stock of each government-sponsored enterprise (Jester et al. 2018, 10; Millstein 2010, 71–72). In the Starr International case, the trial court found that the term sheet approved by the Board of Governors did not include key features; it originally stated that the form of equity would be warrants not convertible, nonvoting preferred stock, and that the stock would be held by an independent trust (US Court of Federal Claims 2015, 20–26). However, after a proposal by the FRBNY, they agreed upon the issuance of preferred stock instead of warrants (US Court of Federal Claims 2015, 25–26). Preferred stock granted Treasury voting rights once the stock was issued, while warrants would have granted voting rights only after they were exercised (US Court of Federal Claims 2015, 25). To exercise the warrants, Treasury would have had to pay an estimated strike price of $30 billion (US Court of Federal Claims 2015, 25).

The 79.9% equity stake in AIG was included in the private sector term sheet, according to the COP (COP 2010, 72). Although it was extraordinary for the Federal Reserve to insist on government equity as a condition for a loan, the FRBNY believed that “the taxpayer should receive the same terms and conditions that the private sector wanted,” according to the COP (COP 2010, 72). Additionally, a maximum 79.9% stake allowed the trust the largest share of ownership without requiring the government to consolidate AIG’s debts and assets onto its own balance sheet, as would be required by generally accepted accounting principles (GAAP). This approach was similar to the government stakes in rescues earlier that month of Fannie Mae and Freddie Mac. In addition to the preferred stock, the government also received warrants to purchase common stock representing 79.9% of the common stock of each government-sponsored enterprise (COP 2010, 71-72).

In the same vein, the original 79.9% equity stake of the Series C Preferred Stock decreased to 77.9% after Treasury’s November 2008 TARP investment provided a warrant to purchase up 2% of AIG common stock (COP 2010, 71–72). The equity stake was decreased to maintain the FRBNY’s overall equity stake in AIG under 80% (COP 2010, 71–72). To read more information about the Series C Preferred Stock and the AIG Credit Facility Trust, please refer to Buchholtz and Lawson 2021b.

Ultimately, with time playing a major factor, the FRBNY recommended extending a loan to AIG on a set of terms that was influenced by the $75 billion term sheet created by the unsuccessful private consortium (US GAO 2011b, 34–35). The FRBNY stated that it wanted to adhere to terms similar to those that the private sector group would have received in order to ensure taxpayers would receive a deal of equal or greater value (COP 2010, 71). However, some terms were altered by the FRBNY.

While the term sheet had proposed lending AIG $75 billion, the FRBNY added $10 billion as a “cushion … in anticipation of looming liquidity concerns, and because the FRBNY did not want to increase the line of credit at a later date” (COP 2010, 71). Also, the term was extended, the interest rate was increased, and the commitment fee was decreased. (See Key Design Decisions Nos. 9–11 below for further discussion of these terms.)  

According to Federal Reserve Board staff, the loans provided by the RCF were to be utilized to “meet preexisting liquidity needs and not for investment in assets that would generate returns” (US GAO 2011b, 128). During a hearing of the House Committee on Oversight and Government Reform, Secretary Geithner noted that while this initial $85 billion credit line “stemmed the bleeding by satisfying AIG’s immediate liquidity needs,” it was not enough and required further restructuring and intervention by the government (Geithner 2010, 7).

According to Section 13(3) of the Federal Reserve Act, any Federal Reserve Bank, in this case the FRBNY, making a loan pursuant thereto, must secure any such loan “to the satisfaction of the Federal Reserve bank” (GPO 2007a). Geithner, who in 2008 was President of the FRBNY further explained this: “In the case of AIG, however, we believed there was a reasonable chance that AIG’s assets in the form of its insurance businesses around the world were stable enough and valuable enough to support a loan large enough to prevent default.” (Geithner 2014a, 193) By taking a security interest in the majority of AIG’s assets, including the equity in its insurance subsidiaries, FRBNY believed that its loan would be adequately secured  (Geithner 2019, 23).

Prior to the execution of the RCF on September 22, 2008, the FRBNY sent a team to AIG to “monitor collateral valuation practices, risk management, and exposures of various subsidiaries.” Part of their job was to ensure that any funds AIG utilized from the RCF did not exceed the value of the collateral (US GAO 2011b, 43).

In exchange for the credit extended under the RCF, the FRBNY placed a lien on a large portion of the assets of the parent company, AIG International Group, Inc., and equity interests in AIG’s domestic and foreign regulated subsidiaries (–FRBNY 2008b, Section 3). FRB General Counsel Scott Alvarez said that proceeds from the sales of assets would help AIG repay the FRBNY all debt under the RCF (Alvarez 2010, 8). Treasury’s Chief Restructuring Officer, Jim Millstein, said the value of the assets would protect taxpayers if AIG did not maintain its viability in the long run (Millstein 2010, 7).

In addition to the collateral posted under the Guarantee and Pledge Agreement, as additional consideration for the RCF, the 100,000 shares of Series C Preferred Stock issued also secured the loan (FRBNY 2008b, 16–18).

During a crisis, central banks typically lend at interest rates that are lower than market rates but high compared to rates in normal times. However, the Fed initially set the interest rate and undrawn commitment rate on AIG’s RCF at a level that would be called punitive. (US GAO 2011b, 123–126).

The original interest rate of the RCF was three-month LIBOR plus 8.5%, totaling 12%, which was greater than the rate the private sector consortium included on its term sheet, which was (unspecified) LIBOR plus 6.5% (US GAO 2011b, 125) (Also See Figure 5.) The rationale for the increase, according to a GAO analysis of FRB records and interviews with FRBNY officials, was to “impose terms sufficiently high to provide incentive for [AIG] to repay assistance, whether it borrowed all available or not” (US GAO 2011b, 90). According to FRBNY officials, many aspects of the initial terms resembled bankruptcy financing, and reflected the company’s condition, the nature of its business, and the large exposure the government faced (US GAO 2011b, 126). The officials stated that the RCF’s interest rate was higher than the rate the private sector had proposed because the loan had become riskier since origination of the private sector’s term sheet, which was prior to Lehman Brothers’ bankruptcy, and thus, the terms were intended to be onerous (US GAO 2011b, 126).

However, later reports reveal that there was concern about rates, called "onerous," although there were no changes by the time the FRB approved the loan to AIG on September 16 (US GAO 2011b, 126). FRBNY discount window staff felt they were "extremely high and a burden to AIG and thus...contrary to the idea of trying to sustain the firm," according to the GAO (US GAO 2011b, 125). The Fed substantially lowered RCF rates in the first restructuring plan of November 2008, after significant internal discussions. Prior to the November 2008 restructuring, significant figures, such as Dan Jester from Treasury, made their opinions of the terms known. Jester “asked FRBNY to ‘rethink the terms of the deal; deal was onerous” (US Court of Federal Claims 2015, 31–32). Tom Baxter even characterized the rate as “[m]ore of a loan shark” rate (US GAO 2011b, 32). However, FRBNY officials recounted that they “intended the original Revolving Credit Facility terms to be onerous, as a way to motivate AIG to quickly repay FRBNY and to give AIG an incentive to replace the government lending with private financing” (US GAO 2011b, 126).

Chairman Bernanke noted in a September 2008 Senate hearing that the high rates were justified to mitigate concerns that the extension of the $85 billion credit line “would exacerbate moral hazard and encourage inappropriate risk-taking in the future” (Bernanke 2008). Additionally, the FRBNY included a LIBOR floor rate of 3.5% to ensure that even if LIBOR rates fell throughout the RCF lifetime, the FRBNY would still be receiving adequate interest payments from AIG (US GAO 2011b, 125).

Per the FRB, the government reduced the RCF interest rate to three-month LIBOR plus 3.0% in November 2008 in the First Restructuring Plan in order “to enhance AIG’s ability to repay the credit extended in full” (FRB 2008d, 6). The GAO reported that FRBNY believed that lowering the interest rate and the commitment fee (see Key Design Decisions No. 9 and No. 10), “reflected AIG’s stabilized condition and outlook” after Treasury’s $40 billion investment in new equity shares (US GAO 2011b, 129).

Through the Second Restructuring Plan, the government removed the LIBOR floor to help further lower the cost of borrowing under the RCF for AIG (US GAO 2011b, 129–130). Based on the then-current LIBOR rates and the outstanding balance on the RCF at the time, AIG estimated that the removal of the LIBOR floor would save AIG $1 billion in interest costs annually, further alleviating the insurance firm’s ongoing liquidity problems (AIG 2009c).

Sources: US GAO 2011b.

The initial commitment fee was 2% of the aggregate amount available under the RCF. This came out to about $1.7 billion dollars (FRB 2008c, 4). While the terms of the FRBNY loan were generally harsher than those that the private sector proposed, the commitment fee was far less than the 5% that it would have been under the private plan (US GAO 2011b, 125).

Under the Credit Agreement, the FRBNY charged AIG a commitment fee of 8.5% per annum of the daily amount of the Commitment that was undrawn, payable on a quarterly basis, despite such a fee not being included in the original, private sector initiative that had existed prior to Lehman’s failure (FRBNY 2008a, 21; US GAO 2011b, 124–126). The GAO reported that the FRBNY included the fee to ensure that taxpayers were being compensated “whether AIG used the facility or not” (US GAO 2011b, 126).

The motives to reduce the commitment fee during the First Restructuring Plan were similar to the reason for reducing the interest rate (discussed in Key Design Decisions No. 9), to increase the insurer’s capacity to repay its loan (FRB 2008d, 6). Per an FRBNY fact sheet circulated in November 2008, the lower interest rate and commitment fee were a sign that AIG had begun to stabilize based on the possible impact of a $40 billion equity investment in the firm made by Treasury under TARP (US GAO 2011b, 129).

The initial government term sheet presented to AIG lengthened the private sector maturity date of the RCF from 18 months to 24 months in order to provide AIG with additional time to repay any borrowings from the FRBNY and to allow AIG ample time to sell off its life insurance subsidiaries and securities (US GAO 2011b, 125).

Treasury stated that the November 2008 extension of the RCF’s maturity date to five years (September 22, 2013) was intended to provide AIG “… adequate time to affect its asset disposition plan in a manner most likely to achieve favorable returns for the sale of its various businesses” (FRB 2008d, 6). Donald Kohn, Vice Chairman of the FRB, testified that the actions taken on November 10 were “designed to facilitate AIG's execution of its divestiture plan in an orderly manner, and thereby protect the interests of the taxpayers, both by preserving financial stability and by giving AIG more time to repay the Federal Reserve and return the Treasury's investment” (Kohn 2009).

As mentioned in Key Design Decisions No. 12 the government extended the term of the RCF under the Second Restructuring Plan from a two-year to a five-year period, with a new maturity date of September 22, 2013. Yet, the Commitment was reduced in an aggressive manner, so that all loans outstanding under the RCF were repaid and the RCF terminated by January 14, 2011. According to Sarah Dahlgren, the reductions of the Commitment were all aimed at satisfying the credit rating agencies and, therefore, about “trying to get AIG to the right balance sheet structure, [and make AIG] an ongoing company that looked like a normal company” (YPFS 2018a).

Formal reductions of the Commitment and repayment of outstanding loans were enacted through two restructurings and a Recapitalization Plan agreed to by AIG, the FRBNY, and Treasury, which implemented amendments to the Credit Agreement and provided additional government investments in AIG. Restructurings “reduced AIG’s degree of indebtedness and improved its ability to cover interest payments,” two crucial aspects utilized by “the marketplace and rating agencies in assessing AIG’s future risk” (US GAO 2011b, 129). Dahlgren stated that for any repayment toward the RCF through the restructurings, the FRBNY always considered the impact on the balance sheet’s capital structure, what AIG would look like to external parties like the credit rating agencies and investors, and how the government’s risk exposure would change (YPFS 2018a).

The first formal decrease of the Commitment from $85 billion to $60 billion came after a large portion of Treasury’s TARP investment in November 2008 paid down part of AIG’s outstanding debt balance under the RCF (US GAO 2011b, 129). Per FRBNY officials, the announcement of this first restructuring was intended to coincide with the reporting of AIG’s third quarter results, assuming that quarterly losses would result in additional downgrades by rating agencies and would thus hinder the government’s and AIG’s effort to stabilize the company (US GAO 2011b, 52–53).

The government aimed to reduce the Commitment and AIG’s outstanding loans under the RCF even further under the Second Restructuring Plan in March 2009. However, the debt reduction did not formally occur until December of that year, after the FRBNY accepted $25 billion worth of preferred interests in both the AIA SPV and the ALICO SPV (Webel 2017, 14). According to Scott Alvarez, the FRB’s General Counsel, the FRB considered the SPVs “incidental to the collection of debt” under the banking concept of debt previously contracted, where the equity interest could be sold as a way of recouping debt on the RCF (YPFS 2018b).

FRBNY officials stated that the March 2009 plan more heavily focused on “AIG’s asset sale plans and the performance of its insurance subsidiaries,” with credit ratings continuing to effect the FRBNY’s decisions surrounding AIG assistance (US GAO 2011b, 53). Based on an interview conducted by the GAO with an FRBNY advisor, on the Second Restructuring Plan (US GAO 2011b, 53): “… potential losses, combined with AIG’s deteriorating business performance, difficulties selling assets, and a volatile market environment, meant that a ratings downgrade was likely unless the government took additional steps to assist the company … a main rating agency concern was whether AIG could successfully execute its restructuring plan over the multiyear period envisioned.”

Finally, the Recapitalization Plan reduced the Commitment to zero following the repayment of the RCF on January 14, 2011, well in advance of its September 2013 maturity date (Treasury 2011). For more details on the sources of the reductions, please refer to the Outcomes section and Figure 4.

The FRBNY’s Head of the Supervisory Group, Sarah Dahlgren, said that the FRBNY’s investment would only be exited once AIG was believed to be stable, where it could operate as a “normal company.” According to Dahlgren, some people in the FRBNY believed that exiting the RCF sooner, within six months to a year, was in the best interest of protecting the taxpayer. However, it was also understood that unwinding the company through the sale of various assets to make AIG look like a normal company again would take time. Moreover, the FRBNY wanted to ensure that its exit would not leave AIG in a position where it would revert back to its original problems and eventually fail (YPFS 2018a).