This is the language of the statute relied upon by the Fed:

In unusual and exigent circumstances, the Board of Governors of the Federal Reserve System, by the affirmative vote of not less than five members, may authorize any Federal reserve bank, during such periods as the said board may determine, at rates established in accordance with the provisions of section 14, subdivision (d), of this Act, to discount for any individual, partnership, or corporation, notes, drafts, and bills of exchange when such notes, drafts, and bills of exchange are indorsed or otherwise secured to the satisfaction of the Federal Reserve bank: Provided, That before discounting any such note, draft, or bill of exchange for an individual, partnership, or corporation the Federal reserve bank shall obtain evidence that such individual, partnership, or corporation is unable to secure adequate credit accommodations from other banking institutions. All such discounts for individuals, partnerships, or corporations shall be subject to such limitations, restrictions, and regulations as the Board of Governors of the Federal Reserve System may prescribe.

It seems rather straight forward, and not imaginative, to say that this allows the Fed to open the discount window to any corporation based on security that meets the satisfaction of the Fed. In this case, the security was equity in AIG.

Apparently the deal is on the same terms as were offered by a private party and rejected by AIG. AIG held out for a federal bail-out. The Fed couldn't let AIG fail, because the results would be disastrous, not just for this country but internationally. So instead it is sending a strong message to Wall Street - next time, take the private deal.

And Commentor is absolutely right about the legal basis.

The Wall Street Journal implies that were AIG to go under, it would have pulled Citigroup or Bank of America (and therefore also Merrill Lynch) down. And then, the Fed would not have had enough money to bail them out, putting in jeopardy the full faith and credit of the United States.
Sure, the Fed could have gone to Congress for more authority, but, gee, I betcha that would open a political can of tapeworms.

In response to Vintner, it has been a few years since I looked at this (I used it in a Chapter 11 debt for equity swap to save about $80 million in NOLs), but it used to be (and I believe still is) the case that an 80% change in equity ownership triggered limitations on the use of a Corporation's Net Operating Loss carryforwards for tax purposes -- in other words, assume AIG had $4 Billion in Net Operating Losses this year that resulted in it having no federal income tax liability - assuming no changes, it could use those NOLs in future years to shelter the equivalent amount of taxable income. An 80% change doesn't cause AIG to lose the NOLs, but it puts severe limits on how much they can use in any year (it is a rather complicated formula, as I recall). In Bankruptcy, AIG could trade equity for debt (as long as it is "old and cold" debt) without triggering the limitations, but if there is an active claims trading market, any claims sold during the bankruptcy lose their status as "old and cold" debt, and AIG would run the risk of triggering limitations on its use of NOLs.

DiverDan, thanks for the information, I see the point.