By David Hilzenrath

Washington Post Staff Writer

Monday, September 15, 2008; 2:57 PM

New York's governor said today that the state will allow AIG, the nation's largest insurer, to use $20 billion from its own insurance subsidiaries to ease a financial crunch.

By posting the assets as collateral, AIG can borrow money to run its day-to-day operations, Gov. David Paterson said at a news conference. The move involves loosening a state restriction meant to protect an insurance company's financial stability.

Paterson said he hoped the step paved the way for the federal government to assist AIG, and he urged the federal government to act. Paterson said today's action could also help the federal government influence other financial institutions to get involved.

"It's no secret that the company has been talking to the feds and talking to us," Paterson said. "They asked us what assistance we could provide, and this is our idea," Paterson said.

The announcement came after a weekend of scrambling by AIG failed to produce a private solution, leaving the company in peril. Leaders of AIG were trying to pull together a sweeping restructuring plan to save their firm, said sources who spoke on condition of anonymity because of the fluid nature of the unfolding events. The effort was likely to include selling subsidiaries to raise cash, the sources familiar with the restructuring said.

AIG also sought assistance from the Federal Reserve, according to news reports.

Paterson said his move was not a bailout and did not involve taxpayer money. In effect, the company would tide itself over by providing a loan to itself, he said.

An aide to Paterson said at the news conference the action will not put policyholders of the AIG subsidiaries at risk.

"At this point the insurance companies are financially strong and solvent and fully able to meet any claims," David Neustadt, a spokesman for New York state insurance superintendent Eric R. Dinallo, said before the announcement.

AIG is based in New York, where it employs many workers and is critical to business, Paterson said.

Before the market opened today, Standard & Poor's downgraded its rating of the company's stock to "sell" from "hold," citing unconfirmed news reports that the firm was seeking to raise $40 billion in capital and that it would likely sell its aircraft leasing business. The ratings agency said it was lowering its 12-month target share price to $8 from $20. In morning trading, AIG shares were selling for less than the analyst's new $8 target.

The immediate threat facing AIG was that an anticipated downgrade of its debt could force it to come up with more collateral to back some of its complex insurance policies -- something it would have been hard-pressed to do.

Asked about the risk to policyholders, AIG spokesman Peter Tulupman said by e-mail: "The insurance policies written by AIG companies are direct obligations of our regulated insurance companies around the world. These companies are well capitalized and meet or exceed local regulatory capital requirements. These companies continue to operate in the normal course to meet our obligations to our policyholders."

AIG executives huddled at their Manhattan headquarters over the weekend with potential private investors including J.C. Flowers, KKR and TPG and representatives of Paterson, including the insurance superintendent, according to a source close to the discussions. AIG was also talking to Warren Buffett's Berkshire Hathaway, the source said.

AIG sells a type of insurance known as credit default swaps to cover losses on investments in certain kinds of securities. AIG made a big business of selling these swaps to cover losses in securities backed by mortgages.

As the mortgage market has melted down, AIG has been on the line to cover more of the losses, eating away at the firm's capital. Over the past nine months, AIG has posted $18.5 billion in losses.

Last week, its shares fell sharply on fears that it would have to raise tens of billions of dollars more capital to offset losses. The company's shares fell 31 percent alone on Friday. Today, shares were down 51 percent to $5.86 at 12:23 p.m. but then rose slightly after the Paterson press conference to $6.63 at 1:12 p.m.

"They have been dragged down by the subprime mortgage crisis that has hit so many," Paterson said, adding that "the infection in the financial markets is going into other areas."

Paterson spoke as Lehman Brothers, a major New York investment bank, sought bankruptcy protection.

"There are other institutions that are just short of realizing the same situation," Paterson said.