American International Group will get an $85 billion loan from the federal government in exchange for an 79.9 percent stake in itself.
The deal calls for the U.S. Federal Reserve to lend up to $85 billion to AIG for two years in exchange for that 79.9 percent equity stake. AIG will pay interest at a steep 8.5 percentage points above the three-month London Interbank Offered Rate, making the current rate equal to about 11.4
This gives AIG a big incentive to embark on a massive asset sale program to pay back the loan quickly. The deal also severely dilutes existing shares of the company.
Index futures pointed to a higher market open on Wednesday after the news.
Former Allstate Corp CEO Edward Liddy will be named the new chief executive of AIG, replacing Robert B. Willumstad.
AIG had been racing against the clock to avoid a bankruptcy filing on Wednesday, making efforts to work out a deal with the Federal Reserve to shore up its finances.
Treasury Secretary Henry Paulson and Federal Reserve Chairman Ben Bernanke met with Senate and House leadership Tuesday night to discuss how to assist AIG, sources said.
The Fed's financial aid for the troubled insurer marks a reversal of its decision on Monday to refuse a bridge loan to AIG.
The Fed met with the company's advisers throughout Tuesday and came to a better understanding of what is needed to help the company through its current crisis, people familiar with the negotiations told CNBC. (See the accompanying video for CNBC analysis of the federal government and AIG.)
"The President supports the agreement announced this evening by the Federal Reserve. These steps are taken in the interest of promoting stability in financial markets and limiting damage to the broader economy", said Tony Fratto, Deputy Press Secretary.
AIG's recue was necessary, in contrast to Lehman Brothers, because the insurer has extensive ties to other firms and retail products, senior Fed staff said. AIG was deemed to be a very complicated firm with extensive links to many parts of the financial sector, including retail financial products, such as insurance and guaranteed annuities, officials added.
In addition, AIG has substantial business interests that would not have been protected by states, an official said.
AIG Stock on Rollercoaster Ride
AIG shares swung wildly all day Tuesday in heavy volume.
The shares, which are a component of the Dow Jones Industrial Average, at one point were down more than 50 percent in the wake of a cut in the insurer's credit rating, which only served to heighten the concerns that it would file for bankrupcy and further upset the troubled global financial system.
AIG shares fell as much as 48 percent in after-hours trade on these bailout reports which could wipe out shareholders.
The plunge in AIG shares has been the biggest drag on the Dow this week.
Latest in a String of Victims
AIG, one of the world's largest insurers, is the latest company to be convulsed by a mortgage and credit crisis that this week led to a bankruptcy filing by Lehman Brothers and the sale of Merrill Lynch to Bank of America.
The liquidation of AIG's assets is the most likely way the company could pay off the loan, but it could also pay off the loan through operations as well, a Fed official said.
The government loan is the most senior obligation in the deal, the officials said. The new management of the company will decide which assets will be sold off to repay the loan.
Fed staff denied that the deal represents a nationalization of the insurer. The government has provided liquidity to the company to allow it to fund its operations in an orderly fashion, they said.
-Charles Gasparino, On-Air Editor; David Faber, CNBC anchor and reporter; Steve Liesman, senior economics reporter; Dylan Ratigan, 'Fast Money' and 'Closing Bell' anchor, and Reuters contributed to this report.