AIG: The One-Way Bet Behind the 2008 Financial Crisis?

Table of Contents

AIG logo

Prior to the 2008 financial crisis, American International Group, Inc. (AIG) ruled the insurance sector all over the globe. However, due to several derivative transactions unrelated to its core business, AIG experienced a historic collapse in September 2008. 

Many believe the corporation brought on its own destruction and nearly ruined the economy. All to face relatively minor consequences while the public endured irreparable financial and emotional damage that remains to this day. In this article, the first half of two, the Zero Theft Movement will explore how AIG potentially contributed to causing the 2008 financial crisis. We ultimately wish to ask you to ponder (and even eventually answer) the question: did any of AIG’s actions create significant damages to the U.S. economy and monetarily and/or emotionally harm American citizens?

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What is AIG?

AIG is a global finance and insurance corporation operating in over 80 countries and jurisdictions. The company ranked 66th on the 2020 Fortune 500 list and claims to serve more than 87% of the Fortune Global 500 and 83% of the Forbes 2000. During the 2008 mortgage crisis, the Treasury Department and Federal Reserve committed $180 billion to bail out/stabilizing AIG. The government, in short, became the majority shareholder of AIG’s common stocks, owning up to 92% (1.655 billion shares) at the start of 2011.
AIG Architecture
AIG HQ in New York City by Marc Bryan-Brown
The Financial Crisis Inquiry Commission published a report, stating: “AIG’s failure was possible because of the sweeping deregulation of over-the-counter derivatives, including credit default swaps, which effectively eliminated federal and state regulation of these products…AIG engaged in regulatory arbitrage by setting up a major business in this unregulated product, locating much of the business in London, and selecting a weak federal regulator, the Office of Thrift Supervision (OTS).” By December 2012, the government had sold off all of their AIG stocks, recouping $194.7 billion

AIG Revenue

AIG Revenue
YearAmount (in billions)
1995$23,360,000,000
1996$25,300,000,000
1997$28,870,000,000
1998$31,910,000,000
1999$43,190,000,000
2000$56,340,000,000
2001$61,770,000,000
2002$66,170,000,000
2003$79,420,000,000
2004$97,670,000,000
2005$108,780,000,000
2006$113,390,000,000
2007$103,360,000,000
2008-$6,840,000,000
2009$75,447,000,000
2010$72,830,000,000
2011$65,110,000,000
2012$71,210,000,000
2013$68,870,000,000
2014$64,410,000,000
2015$58,330,000,000
2016$52,370,000,000
2017$49,520,000,000
2018$47,390,000,000
2019$49,750,000,000

A Predictable Outcome? 

What goes up must come down, as they say. That truism definitely applies to all financial markets, including housing and mortgage. Experts in financial and insurance products should have seen that the housing bubble of the 2000s, a temporary but sustained period of over-valued homes and prolific speculation, would not last, no? 

That what was rising would have to come down. 

collateralized debt obligations

Setting the Stage

In 2002, a new financial product called collateralized debt obligations (CDO) became available to the mortgage market. The shiny and new product rapidly grew into the popular vehicle for those looking to refinance mortgage-backed securities (MBS). Furthermore, the Federal Reserve slashed interest rates. Buyers could more easily finance an expensive purchase like a car or even a house. For little or no money down, a homebuyer could get an adjustable rate mortgage that might require only payment of interest for two years. Sharply rising payments followed. But as the flood of new homeowners drove prices up steadily, the home buyer could borrow more on it, or even sell for a profit. 

Banks, mortgage broker agencies, and Wall Street investment firms holding MBSs hopped on the trend, creating and selling CDOs. Many companies’ offerings included tranches filled with subprime loans. MBSs were offered to people who were not financially equipped to repay them, leading to the bubble’s expansion towards its inevitable bursting point. 

Do you know that high-frequency trading firms could be accessing dark pools to make millions of financial transactions in a millisecond? 

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AIG & Credit Default Swaps

According to an Investopedia article, the AIG Financial Products (a subsidiary of AIG) “decided to cash in on the trend. It would insure CDOs against default through a financial product known as a credit default swap (CDS). The chances of having to pay out on this insurance seemed highly unlikely. The CDO insurance plan was a big success, for a while. In about five years, the division’s revenues rose from $737 million to more than $3 billion, about 17.5% of the company’s total. A big chunk of the insured CDOs came in the form of bundled mortgages, with the lowest-rated tranches comprised of subprime loans. AIG believed that defaults on these loans would be insignificant.”

And so, the bubble grew bigger and bigger until it burst in 2007-2008, in a way that experts could have reasonably predicted and, perhaps, prevented. In 2004, the Securities Exchange Commission (SEC), the regulator and overseer of Wall Street, reportedly exempted big investment banks from a debt limit regulation, enabling them to potentially invest billions of dollars in reserve into MBSs. 

Subprime Loans Explosion

The Wall Street Journal reported “…AIG didn’t anticipate how market forces and contract terms not weighed by the [advanced risk-assessment] models would turn the swaps, over the short term, into huge financial liabilities. AIG didn’t assign Mr. Gorton [the Yale Professor responsible for creating those computer models] to assess those threats, and knew that his models didn’t consider them. Those risks have cost AIG tens of billions of dollars and pushed the federal government to rescue the company in September.”

Alleged billions of extra revenue, a genuine gold rush. And a belief that the repercussions would be inconsequential. It appears the executives at AIG ignored or did not ask themselves an important question: were they selling more CDS insurance on mortgages (directly or indirectly) than it could pay off, if the entire U.S. housing market imploded?

CDS = “Risk-Free Money?”

Joe Nocera of the New York Times wrote a scathing article on AIG’s CDS (“risk-free money”) selling spree, making grave claims about the insurance giant:

“In effect, AIG was saying if, by some remote chance (ha!) those mortgage-backed securities suffered losses, the company would be on the hook for the losses.” 

“Why would Wall Street and the banks go for this? Because it shifted the risk of default from themselves to AIG, and the AAA rating made the securities much easier to market…[believing it] surely would never have to actually pay up. Like everyone else on Wall Street, AIG operated on the belief that the underlying assets—housing—could only go up in price.”

“AIG didn’t have to set aside anything. It didn’t. Credit-default swaps were not regulated.”

“[AIG] agreed to something called “collateral triggers,” meaning that if certain events took place, like a ratings downgrade for either AIG or the securities it was insuring, it would have to put up collateral against those securities. Again, the reasons it agreed to the collateral triggers was pure greed: it could get higher fees by including them. And again, it assumed that the triggers would never actually kick in and the provisions were therefore meaningless. Those collateral triggers have since cost AIG many, many billions of dollars. Or, rather, they’ve cost American taxpayers billions.”

From 2006-2008, housing manufacturing and prices faltered. The white picket dream and shiny AAA credit ratings were belied by the growing number of red foreclosure signs.

According to a Congressional Budget Office report on the savings and loan crisis, “the cumulative loss in GNP in 1990 dollars for the years 1981 through 1990 could be as large as a whopping $200 billion. An additional loss approaching $300 billion of forgone GNP is likely to occur during the years 1991 through 2000 as a consequence of the S&L breakdown.” Was there economic foul play involved in the case? See what your fellow citizens have uncovered in their investigations…

The Fall of an Insurance Giant

Suddenly, the cash cow stopped producing, and AIG began accruing debt. Nevertheless, it had built in some protections. As long as the credit rating remained high, it would not have to pay the collateral. The organization made sure to include that provision in many of their CDS agreements. But alas, the credit rating fell.

From a report from the Kellogg School of Management at Northwestern University: 

“On September 15, 2008, the day all three major agencies downgraded AIG to a credit rating below AA-, calls for collateral on its credit default swaps rose to $32 billion and its shortfall hit $12.4 billion—a huge change from $8.6 billion in collateral calls and $4.5 billion in shortfall just three days earlier. While this debt kicked in automatically because of the provisions in AIG’s agreements, rather than the willful terminations of its securities lending agreements. AIG had written credit default swaps on over $500 billion in assets. But it was the $78 billion in credit default swaps on multi-sector collateralized debt obligations—a security backed by debt payments from residential and commercial mortgages, home equity loans, and more—that proved most troublesome. AIG’s problems were exacerbated by the fact that these were one-way bets. AIG didn’t have any offsetting positions that would make money if its swaps in this sector lost money.”

Prices Plummet

According to the Washington & Lee Law Review, AIG “announced 2007 earnings of $6.20 billion or $2.39 per share. Its stock closed that day at $50.15 per share. Less than seven months later, however, AIG was on the verge of bankruptcy…a company with $1 trillion in assets and $95.8 billion in shareholders’ equity [had] suddenly collapsed.”

Follow the Money Trail

What we have present here is only one half of our full exploration of AIG’s role in the 2008 financial crisis. In the second part, we will detail how the government saved AIG, potentially at the tremendous expense of the public. The rest of the story awaits you…

Eradicate the Rigged Layer of the Economy

The rigged layer on top of our otherwise ethical economy continues to allow crony capitalists and corrupt officials to rip us off of trillions of dollars. That’s what has caused the fifty years of wage stagnation and fixed prices, seemingly disproving the Kuznets curve

By exposing the bad actors and eliminating the rigged layer, we, the public, will leave the profitable, ethical layer of the economy intact. Only then can we benefit from higher wages across the board, markets that involve genuine competition for our business, and a government that legislates based on our interests. We can achieve this, but we need you to join our movement for an ethical economy. 

We must end the corporatocracy and restore our democracy. 

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Standard Disclaimer

The Zero Theft Movement does not have any interest in partisan politics/competition or attacking/defending one side. We seek to eradicate theft from the U.S economy. In other words, how the wealthy and powerful rig the system to steal money from us, the everyday citizen. We need to collectively fight against crony capitalism in order for us to all profit from an ethical economy.   

Terms like ‘steal,’ ‘theft,’ and ‘crime’ will frequently appear throughout the article. ZeroTheft will NOT adhere strictly to the legal definitions of these terms (since congress sells out). We have broadly and openly defined terms like ‘steal’ and ‘theft’ to refer to the rigged economy and other debated unethical acts that can cause citizens to lose out on money they deserve to keep.