AIG US: An Overview
American International Group Inc. is a multi-line insurance firm. The company provides a variety of life insurance, property and liability insurance, retirement programmes and other financial services to individuals and businesses. It provides products for general liability, directors and officers' liability, property, workers' compensation, maritime, aerospace, environmental, commercial, automotive liability, term life, universal life, fidelity, fiduciary liability, cyber risk, and errors and omissions insurance.
Personal auto insurance, vacation insurance, political risk insurance, accident and health insurance, and individual and group retirement solutions are also available. The group offers and distributes its products through brokers, captive and independent agents, affinity partners, retailers, airlines, and travel agencies, among others. AIG US does business across the Americas, Europe, Africa, the Middle East and Asia-Pacific.
Information on the 2008 AIG Bailout: AIG Reports
On September 16, 2008, the Federal Reserve provided AIG with an $85 billion two-year loan to save the company from going bankrupt and putting an additional burden on the global economy. In exchange, the Fed purchased 79.9% of AIG's equity. As a result, it had the authority to alter the management, which it did. It also had the power to veto any key decisions, such as the sale of assets or the distribution of dividends.
The Wall Street bailout occurred exactly one day after US Treasury Secretary Henry Paulson promised no future bailouts would be made. That action put Lehman Brothers, an investment bank, into bankruptcy.
What Caused AIG to Fail?
The corporation's use of credit default swaps, which cost AIG $30 billion, is generally seen as having a substantial role in the collapse. They were not, however, the only perpetrators. The authors concluded that securities lending, a less-discussed element of the company, cost AIG $21 billion and is mostly to blame.
McDonald and Paulson also investigated AIG's assurance that the underlying mortgage-backed securities in its transactions would not default. According to McDonald, "after the crisis, there was a claim that these assets had been money-good, or safe investments that may have had a short-term drop but were secure overall. I was quite interested to find out if that was true."
AIG Bailout
Case Study
How did AIG announce the greatest corporate loss in history?
On March 2, 2009, AIG announced its greatest loss in corporate history. It lost over $62 billion in the final three months of 2008. As a result of AIG's loss, the Dow fell nearly 300 points to close at 6,763.29. That was the lowest close since April 25, 1997, when it finished at 6,738.87. It was also lower than the previous recession's low of 7,197 in October 2002. Since October 9, 2007, when it reached an all-time high of 14,164 points, the Dow has lost more than half its value.
Furthermore, the lack of scale in President Obama's economic stimulus package scared investors. Citigroup requested the third round of government negotiations.
Conclusion
The AIG bailout was not without controversy. Some questioned the government's use of public cash to purchase a failing insurance firm. The use of government monies to reward AIG executives sparked particular outrage. Others, on the other hand, argued that because of the interest paid on the loans, taxpayers benefited from the bailout in the long term. The sale yielded $22.7 billion in stated interest income for the government.
FAQs on The AIG Bailout: Lessons Learned
1. What is AIG and what was its primary business before the 2008 crisis?
American International Group (AIG) is a multinational finance and insurance corporation. Before the 2008 financial crisis, its primary business was traditional insurance, including general life, property, casualty, and retirement products. However, its Financial Products division expanded aggressively into selling complex financial instruments, most notably Credit Default Swaps (CDS), which led to its near-collapse.
2. Why did AIG, an insurance company, require a massive government bailout in 2008?
AIG required a bailout not because of its traditional insurance operations, but because its Financial Products division had sold enormous quantities of Credit Default Swaps (CDS). These were essentially insurance policies on mortgage-backed securities. When the US housing market collapsed, the value of these securities plummeted, and AIG faced billions of dollars in claims it did not have the capital to pay. Its failure would have triggered a chain reaction of losses across major global banks, leading to a systemic collapse.
3. What exactly did AIG do wrong to cause its near-collapse?
AIG's critical error was insuring highly risky assets without setting aside enough capital to cover potential losses. The company made several key mistakes:
It massively underestimated the risk of a widespread housing market downturn.
It sold trillions of dollars' worth of Credit Default Swaps without adequate collateral or capital reserves.
Its risky operations were concentrated in a London-based unit that operated with less regulatory oversight than its US insurance counterparts.
4. What are Credit Default Swaps (CDS) and how did they lead to AIG's problems?
A Credit Default Swap (CDS) is a financial derivative or contract that allows an investor to 'swap' or offset their credit risk with that of another investor. Essentially, it's an insurance policy on a loan or bond. AIG sold these CDSs to banks, promising to pay them if the mortgage-backed securities they held went into default. AIG collected premiums and believed a widespread default was impossible. When the defaults happened, AIG was liable for catastrophic losses it couldn't cover, making it insolvent.
5. What does the term 'too big to fail' mean in the context of the AIG bailout?
The term 'too big to fail' describes a financial institution that is so large and interconnected with the economy that its bankruptcy would cause a disastrous ripple effect, known as systemic risk. AIG was considered 'too big to fail' because it had insured the assets of countless major banks and financial institutions worldwide. If AIG had defaulted on its obligations, it would have likely bankrupted these counterparties, leading to a complete freeze of the global financial system.
6. How did AIG's actions create 'systemic risk' for the entire global financial system?
AIG created systemic risk by becoming the central counterparty for a vast web of financial transactions. Major banks across the globe bought CDS from AIG to insure their investments. This interconnectedness meant that AIG's failure would not be an isolated event. It would trigger a domino effect, where its inability to pay would cause massive losses at other major institutions, leading to their potential failure and a cascading collapse of the entire financial structure.
7. What were the main conditions of the $182 billion government bailout package for AIG?
The U.S. government bailout was not a simple cash gift but a loan designed for an orderly unwinding of AIG's risky positions. The main conditions included:
The government received a loan with high interest rates and an initial 79.9% equity stake in AIG, effectively taking control of the company.
The Federal Reserve provided a massive credit facility to give AIG the liquidity to meet its obligations and avoid bankruptcy.
AIG was required to sell off many of its assets and divisions to repay the government loan over time, which it eventually did with a profit to the U.S. Treasury.
8. What were the key lessons learned by the financial industry from the AIG bailout scandal?
The AIG bailout provided several crucial lessons for regulators and the financial industry. Key takeaways include the importance of regulating non-bank financial institutions (or 'shadow banks'), the dangers of unregulated over-the-counter derivatives like CDS, and the need for firms to maintain sufficient capital to absorb unexpected losses. It also highlighted the problem of 'moral hazard', where institutions might take on excessive risk believing they will be bailed out if they fail.
