The Federal Reserve forged an extraordinary $85 billion rescue of insurance giant American International Group Inc., offering a respite from two days of chaos in the American financial system that shook markets across the world.
The move came hours after the Fed resisted a cut in interest rates to buoy Wall Street, which staged a slight rebound anyway from Monday's biggest point drop in the Dow Jones industrials since the Sept. 11, 2001 terrorist attacks.
But the Federal Reserve helped allays fears of further financial turmoil with an $85 billion emergency loan to shore up AIG, the huge U.S. insurer reeling from billions of dollars in souring mortgage debt.
The Fed said Tuesday night that it was acting after determining that a disorderly failure of the company, whose financial dealings stretch around the world, could hurt the already delicate markets and the economy.
Asian stock markets partly recovered Wednesday after the U.S. government announced the bailout plan for AIG, but later dipped as the news failed to persuade many investors that the financial turmoil would ease soon. European shares were higher in early trade, and U.S. stocks headed for a lower open as investors nervously looked to the future.
Investors had feared that a failure of AIG, the world's largest insurer, would set off even more financial turmoil than the collapse the day before by venerable investment house Lehman Brothers.
AIG, a company little known off Wall Street, does business with almost every financial institution in the world and insures $88 billion worth of assets including mortgages and corporate loans.
Under the plan orchestrated by the Fed during a day of crisis talks, the U.S. government will provide an emergency $85 billion loan and in return receive a 79.9 percent equity stake in the company, similar to the way the government took control of faltering mortgage giants Fannie Mae and Freddie Mac.
The Fed said in a statement that an AIG failure could "lead to substantially higher borrowing costs, reduced household wealth and materially weaker economic performance."
Treasury Secretary Henry Paulson said in a statement that the Bush administration was working closely with the Fed, the Securities and Exchange Commission and other government regulators to "enhance the stability and orderliness of our financial markets and minimize the disruption to our economy."
"I support the steps taken by the Federal Reserve tonight to assist AIG in continuing to meet its obligations, mitigate broader disruptions and at the same time protect taxpayers," Paulson said.
AIG stock swung wildly Tuesday as the company's fate hung in the balance. It was down as much as 60 percent, closed down 20 percent and then lost another 45 percent in after-hours trading.
The pressure already had grown when all three major credit rating agencies cut AIG's ratings at least two notches late Monday night. New York Gov. David Paterson had agreed to allow AIG to use $20 billion of assets held by its subsidiaries to pay for its business - essentially giving it a bridge loan from itself - but indicated that the company had only 24 hours to find the cash needed to stay in business.
A collapse of AIG would force Wall Street to untangle the complex credit derivatives markets and send the market scrambling to figure out who owes what to whom - or even who owns what.
"Regulators knew that if Lehman went down, the world wouldn't end," money manager Michael Lewitt wrote in an op-ed column Tuesday in The New York Times. "But Wall Street isn't remotely prepared for the inestimable damage the financial system would suffer if AIG collapsed."
The Fed stepped in hours after it decided, in its first unanimous vote this year, to keep the closely watched federal funds rate unchanged at 2 percent. At the same time, however, the Fed noted that strains on the market have "increased significantly" and said it was ready to act if needed.
Stocks slumped immediately after the Fed announcement. The Dow initially dropped about 100 points but rallied to finish the day up 141, and back over 11,000. That followed a drop of more than 500 points in the Dow on Monday following the Lehman bankruptcy filing.
As AIG teetered, central bankers around the globe scrambled to revive credit markets. The Fed injected $70 billion into the American financial system. The European Central Bank pumped one-day financing of nearly $100 billion into the 15-nation zone. The Bank of Japan added $24 billion, and Britain's central bank almost $36 billion.
Cash left world markets Monday like an outgoing tide. The interest rate banks charge each other for overnight loans soared as high as 6 percent - far above the Fed's target rate of 2 percent and a sign banks did not trust each other enough to make even 12-hour loans.
Meanwhile, British bank Barclays PLC said Tuesday it had agreed to acquire Lehman Brothers' North American investment banking and capital markets businesses for $250 million in cash, just two days after walking away from a deal to purchase all of Lehman's.
The British bank will also purchase Lehman's New York headquarters and its two data centers in New Jersey for $1.5 billion.
The deals require approval from the bankruptcy court.
Meanwhile, Lehman executives continue to negotiate a potential sale of its prized investment management division, which includes money manager Neuberger Berman. The division was once valued by as much as $10 billion by Wall Street analysts, but now could fetch much less considering Lehman's bankruptcy proceedings.
A person familiar with the negotiations, who spoke on condition of anonymity because the talks are ongoing, said Lehman was focusing on trying to sell the business to private-equity firms. The sale is expected to happen in a matter of days, the person said.
Lehman Brothers filed the largest bankruptcy in American history on Monday. The Barclays deal will require approval from the bankruptcy court.
Separately, Bank of America Corp., which in July bought battered Countrywide Financial Corp., began to work out how it would digest its $40 billion acquisition of Merrill Lynch after its shotgun wedding with the brokerage on Sunday.
In the wings, Goldman Sachs Group Inc., which began the year as one of five large investment banks and is now one of two, reported its worst profit drop since going public in 1999. Goldman's third-quarter profit dropped 71 percent to $810 million, while revenues plummeted 50 percent.
The only other major U.S. investment bank left standing, Morgan Stanley, had better news. It reported solid quarterly profits - though down 7 percent from a year earlier - and surpassed Wall Street's expectations.
Earlier this year, the federal government engineered the sale of Bear Stearns to JPMorgan Chase, and earlier this month the government assumed control of mortgage giants Fannie Mae and Freddie Mac.
On the campaign trail, Republican presidential nominee John McCain called for a commission to study the economic crisis. Democrat Barack Obama laughed the idea off as "the oldest Washington stunt in the book."
"This isn't 9/11," Obama told a noisy crowd of more than 2,000 at the Colorado School of Mines, dismissing the idea of a need for study. "We know how we got into this mess. What we need now is leadership that gets us out. I'll provide it. John McCain won't."
McCain, campaigning in Florida, promised reforms, too, to expose and end the "reckless conduct, corruption and unbridled greed" on Wall Street that he said had caused the financial crisis.