Bernanke seeks review of rules to deal with crisis

GLOBAL REACH - Why AIG had to be saved:FEDERAL RESERVE chairman Ben Bernanke is seeking a review of US government regulations to deal with the crisis in the financial system after he used emergency powers to lend some $85 billion to the giant insurer AIG.

This decision reversed the Fed's previous refusal to throw a lifeline to the ailing company.

Although Mr Bernanke wants an overhaul of regulations, Senate majority leader Harry Reid said congress was unlikely to pass new legislation this year because "no one knows what to do".

While Mr Bernanke and treasury secretary Hank Paulson are "trying to come up with ideas", he said neither knew what to do. "We are in new territory. This is a different game," Mr Reid said.

As US stocks slumped and bank lending seized in the aftermath of the takeover, such remarks illustrate the extent to which the crisis has perplexed the US authorities.

With the US government taking a 79.9 per cent stake in AIG in the rescue package, the nationalisation of the firm came only two days after Mr Paulson decided to allow investment bank Lehman Brothers to go into insolvency rather than provide public guarantees to the bank to facilitate a sale.

Amid fear that the Fed's loan to AIG would overstretch its own balance sheet, the treasury said yesterday it was creating a supplemental funding programme to ensure that the central bank was not constrained by its existing level of funding. "The programme will consist of a series of treasury bills, apart from treasury's current borrowing programme, which will provide cash for use in the Federal Reserve initiatives," the treasury said.

As AIG's efforts to stay afloat by raising up to $75 billion in new capital ran aground on Tuesday, the Fed said four hours after markets closed that it had decided to intervene to avoid a "disorderly" collapse of the company.

"The board determined that a disorderly failure of AIG could add to already significant levels of financial market fragility and lead to substantially higher borrowing costs, reduced household wealth, and materially weaker economic performance," the Fed said.

"The purpose of this liquidity facility is to assist AIG in meeting its obligations as they come due. This loan will facilitate a process under which AIG will sell certain of its businesses in an orderly manner, with the least possible disruption to the overall economy.

"The AIG facility has a 24-month term. Interest will accrue on the outstanding balance at a rate of three-month Libor plus 850 basis points. AIG will be permitted to draw up to $85 billion under the facility."

The move was supported by Mr Paulson, whose refusal to support Lehmans was interpreted as a sign that the US government wants to rein in use of the safety net to ease turmoil in the financial system after rescuing mortgage giants Fannie Mae and Freddie Mac.

"These are challenging times. We are working closely with the Federal Reserve, the Securities and Exchange Commission and other regulators to enhance the stability of our markets," he said.

- (Additional reporting: Bloomberg, Financial Times service)