Top lawmakers generally expressed support for the plan. But the bailout is likely to prove controversial, because it effectively puts taxpayer money at risk while protecting bad investments made by AIG and other institutions it does business with.
What frightened Fed and Treasury officials was not simply the prospect of another giant corporate bankruptcy, but AIG's role as an enormous provider of financial insurance, which effectively requires it to cover losses suffered by other institutions in the instance of defaults of securities that they have purchased. That means AIG is potentially on the hook for securities that were once considered safe.
If AIG had collapsed - and been unable to pay all of its insurance claims - institutional investors around the world would have been instantly forced to reappraise the value of billions of dollars in debt securities, which in turn would have reduced their own capital and the value of their own debt.
"It would have been a chain reaction," said Uwe Reinhardt, a professor of economics at Princeton University. "The spillover effects could have been incredible."
Financial markets, which had plunged Monday over worries about AIG's possible collapse, reacted with relief to the news of the bailout. In anticipation of a deal, stocks rose about 1 percent in the U.S. yesterday and were up about 2 percent in early trading in Asian markets this morning.
Still, the move will likely spark an intense political debate during the presidential election campaign over who is to blame for the financial crisis that prompted the rescue.
The decision was a remarkable turnabout by the Bush administration and Paulson, who had flatly refused over the weekend to risk taxpayer money to prevent the collapse of Lehman Brothers or the distressed sale of Merrill Lynch to Bank of America. Earlier this year, the government bailed out another investment bank, Bear Stearns, by engineering a sale to JPMorgan Chase that left taxpayers on the hook for up to $29 billion of bad investments by Bear Stearns.
News of the federal action should spark a stock rally when the market opens today, said John Buckingham, chief executive at Al Frank Asset Management in Laguna Beach, Calif. He noted that rumors of an AIG rescue sparked a rally this afternoon even in the face of investor disappointment over the Fed's failure to cut interest rates.
