eFinancialCareers

What is it?

American International Group (AIG) is/was an insurance company of truly epic proportions. With $1.06 trillion in assets, 2007 revenues of $110bn and a profit of $6.2bn, it is/was involved in everything from selling life assurance to insuring office buildings and insuring against default on structured derivative products like credit default swaps (CDS). It was the latter that proved its undoing.

What’s it got to do with the financial crisis?

AIG’s existence as an independent entity came to a sticky end in September 2008. On 17 September, the US Government agreed to lend it up to $85bn to save it from collapse. The Government demanded a 79.9% stake in the company in return.

What led to this point? As with most other troubled financial institutions, plummeting profits and spiralling writedowns were to blame. AIG lost $13.16bn in the first two quarters of 2008, and made a loss of $5.3bn in the final quarter of 2007. The losses were partly thanks to a huge $41bn in writedowns.

In turn, those writedowns were the result of AIG’s heavy involvement in the market for derivative products. It sold investors a huge $587bn of protection in the form of CDS in case companies defaulted on bond repayments. It also insured investors against default on the least risky, triple A-rated CDOs. And when these CDOs defaulted, it had to pay up.

In the end, however, AIG’s demise was precipitated by the ratings agencies. On 16 September, both Standard & Poor's and Moody’s cut their ratings on AIG over fears that it would be unable to compensate the investors who were victims of default. The downgrades meant that AIG was obliged to post as much as $14bn of additional collateral against its outstanding CDS trades with banks – collateral that it didn’t have.

As AIG’s stock price went into free fall, the US Government stepped in with its rescue plan – unlike Lehman, but like Fannie Mae and Freddie Mac, AIG got bailed out.

The reason for this bailout was simple: if AIG had gone under, the $62 trillion market for credit default swaps would have seized up, jeopardising the entire financial system. Analysts at RBC said in September that the demise of AIG could result in more than $180bn of losses for financial institutions globally. AIG itself argued that failure to bail it out would money market funds.

By late October 2008, it started to look like the nationalisation of AIG was going to be a lot (lot) more expensive than first anticipated. The company said it had already used up special purpose entity and buy the ailing institution's toxic assets directly.

This wasn't the end of the saga, however. AIG needed more money in March 2009. By the end of March, the US government had pledged $160bn to help AIG meet its obligations. In the fourth quarter of 2008 AIG lost $465,421 every single minute.

Useful links:

Pdf of Michael Lewis' article on AIG's demise Return to A-Z home page