AIG: Uncle Sam's do-over

[Neil D]

Does this sound familiar? How do you feel about this?

Fed restructures loan and creates 2 programs to rescue insurance giant from bad bets. Treasury buys $40 billion in shares. AIG quarterly loss: $25 billion.

NEW YORK (CNNMoney.com) -- Troubled insurer American International Group got a reworked $152.5 billion deal from the federal government Monday, as the Federal Reserve and Treasury Department made significant changes to the terms of the company's original bailout.

The Fed announced that it will reduce AIG's original $85 billion bridge loan to $60 billion, and it will cut the interest rate by 5.5 percentage points.

In addition, the Treasury will use its special authority under last month's $700 billion bailout law - the so-called Troubled Asset Relief Program - to purchase $40 billion in preferred stock.

The new bailout was worked out between government officials and AIG executives over the weekend. AIG was having difficulty paying back its original bridge loan, which it intended to use to sell off many of its subsidiaries to restore the company to a stable condition. But the credit crisis has proven to be a difficult environment to spin off assets.

"The original bailout was just too onerous for the timing and the cycle," said Andrew Barile, an insurance consultant at Andrew Barile Consulting Corporation. "People also underestimate the time it takes to selloff assets of an insurance company, which takes months and months."

Furthermore, the company's investors continued to demand that the insurer post collateral to back its credit default swap agreements - essentially insurance contracts that AIG had sold to customers worldwide - forcing AIG to borrow more and more from the government. As the company drew down billions, the high interest rate on the original loan became too punitive.

"The Treasury determined AIG was a systemically significant institution," a Treasury official said. "Bringing more equity to the company puts AIG in a better position to dispose of its assets, and it was done to protect the taxpayer."

To keep the company operational, and to ensure that the government gets repaid and can eventually divest from the company, the Fed will also create a new program that will purchase up to $22.5 billion of AIG's troubled mortgage-backed securities. It will also post $30 billion to backstop its credit default swap agreements, taking place of a $37.8 billion lending facility it previously offered the company.

Like many other financial institutions, AIG's mortgage-backed securities have turned into "toxic" balance sheet assets. The government, by purchasing the troubled assets and backstopping its credit default swap agreements, hopes investors will stop requesting collateral increases so the company can focus on spinning off its other companies.

"We cannot continue to hemorrhage cash in posting collateral for credit default swaps," said AIG Chief Executive Edward Liddy on a conference call with analysts. "We need to stop that, and we need to stop that now."

Barile said the bailout will help ease AIG's need to continue to post more collateral, but he said the company will continue to have trouble selling off its subsidiaries. In the current environment, other smaller companies may rather pluck talent away from AIG than assume its unwanted companies.

A win-win deal?