In exchange for the two-year bridge loan, the Federal Reserve is acquiring 79.9 per cent interest in AIG, one of the world's largest insurance firms with tentacles reaching into all areas of international finance.
Its downfall came from the protections it sold to worldwide investment firms and institutions for billions of dollars in unregulated complex security instruments tied to the plunging US subprime mortgage market.
Had AIG gone into bankruptcy, the financial industry would have faced losses of up to 180 billion dollars, according to RBC Capital Markets.
AIG said it was a "solid company with over 1 trillion dollars in assets and substantial equity."
After being briefed on the decision by the Federal Reserve and the US Treasury, Democratic leaders in Congress indicated resigned acceptance but warned of a complete overhaul of regulations of the industry.
Speaker of the House of Representatives Nancy Pelosi, a Democrat, blasted the Republican administration of US President George W Bush for "eight long years of failed deregulation policies" that have left "American taxpayers on the hook potentially for billions of dollars."
"An 85-billion-dollar loan is a staggering sum and is just too enormous for the American people to bear the risk," Pelosi said.
"Congress will demand answers to prevent this from happening again."
Pelosi questioned why foreign stakeholders were not helping with the bailout.
Many experts were stunned by how the Bush administration reversed itself, after turning down AIG's request late last week for a reported 20-billion-dollar bridge loan. AIG tottered on the brink of collapse early Tuesday when three major rating firms downgraded its credit standing as its rescue price climbed to 85 billion dollars.
"It's extraordinary, I am floored," former Treasury counsel Peter Wallison told Bloomberg financial news agency. "No one could have possibly imagined this a few months ago. I can't imagine why the Fed would do this unless they were sure AIG's failure posed systemic risk. It does speak to the fears in the market."
The Fed's intervention is the latest in a series by the federal government to stave off collapses in the US finance industry amidst a record rate of home foreclosures that has decimated Wall Street's market for mortgage-backed securities.
Just two weeks ago, the Fed pledged to spend up to 200 billion dollars of taxpayer money to help rescue the government-chartered mortgage giants Fannie Mae and Freddie Mac. Earlier this year, it backed a 29-billion-dollar loan for the purchase of troubled investment banking firm, Bear Stearns, by JP Morgan Chase.