On Tuesday, AIG announced that the Federal Reserve Bank of New York would trade $25 billion in AIG debt for a stake in two life companies, American International Assurance Company Ltd. (AIA) and American Life Insurance Company (ALICO). AIG said it is positioning the two companies for an initial public offering.

Under the debt for equity trade agreement, the Federal Reserve will have first rights to liquidation of $16 billion for AIA and $9 billion for ALICO, meaning, when the companies are sold in the IPO, the government receives the proceeds first.

The deal relieves AIG of its burdensome debt, which now stands at $17 billion to the FRBNY with the debt for equity agreement, from approximately $42 billion.

Sen. Grassley pointed to several troubling financial developments in the relationship between the government's holdings of AIG.

He said primarily he is concerned that American taxpayers would not be repaid for the billions of dollars the government has lent AIG.

The company has failed to pay dividends on $30 billion in preferred AIG stock that the government holds on four occasions and does not have to pay the missed payments. The senator also noted a Government Accountability Office report saying that AIG repayment is "uncertain."

"There seems to be no reason for this give-away of taxpayer funds other than to manipulate the rating agencies into giving AIG an artificially higher rating than it deserved," the senator said. "However, I would greatly appreciate getting a detailed explanation about how and why this decision was made."

He asked Mr. Geithner and Mr. Dudley for their plans to ensure AIG pays dividends. He also asked how the preferred stock purchase will be unwound and taxpayer's investment recouped.

Sen. Grassley asked for a response to his letter by Wednesday.

A spokesman for the Treasury Dept. said the department will respond to the senator first before sharing its comments with the press. He said a response would come some time next week.