Feds Give AIG Another Lifeline

The U.S. government is reworking the terms of its aid to troubled insurance company American International Group.

The Treasury Department and Federal Reserve jointly announced Monday that the Treasury will use $40 billion to buy new preferred shares in AIG (nyse: AIG - news - people ). The money will come from the $700 billion in funds the government has authorized to bail out beleaguered banking and insurance firms.

The Fed is also opening up two new lending facilities to help the company. The moves essentially replace the terms of recent government loans to the company, which totaled $123 billion.

The news comes as AIG announced a third-quarter loss of $24.5 billion.

"These new measures establish a more durable capital structure, resolve liquidity issues, facilitate AIG's execution of its plan to sell certain of its businesses in an orderly manner, promote market stability and protect the interests of the U.S. government and taxpayers," the Fed said in its statement.

In September the government loaned AIG $85 billion, part of a chain of events that led to the government's bailout. Last month, the feds granted AIG another $38 billion.

But markets are still in a tailspin, and AIG--which has been deemed too big to fail--is still on the ropes. The equity stake announced by the Treasury Monday allows the Fed more wiggle room in extending funds to AIG, as it cuts the original amount of funds loaned to the company from $85 billion to $60 billion.

At the same time, the terms of that loan are being modified to help stabilize the company. The loan is being extended from two to five years, and the interest rate is being significantly reduced. The old rate was the three-month London interbank offered rate plus 850 basis points. The new rate will be the three-month Libor rate plus 300 basis points. In addition, the government is slashing the rate on undrawn funds from 850 basis points to just 75 basis points.

Of the two new lending facilities the Fed is granting AIG, the first allows the New York Fed to lend up to $22.5 billion to a newly limited liability company that is being established to buy mortgage-backed securities from AIG. The second allows the New York Fed to lend up to $30 billion to another LLC that will be used to buy collateralized debt obligations insured by AIG.

Both new lending facilities require the insurance company to put up cash and bear risk for the new lending facilities. In the first case, AIG has to make a $1 billion subordinated loan to the LLC; in the second case, the loan amount from the company is $5 billion.

"The U.S. government intends to exit its support of AIG over time in a disciplined manner consistent with maximizing the value of its investments and promoting financial stability," the Fed said in its statement.