On September 16, 2008, the United States Federal Reserve gave insurance giant American International Group (AIG) an emergency loan for $85 billion. There’s been a lot of talk before and since about whether that was the right thing to do; especially since the total bailout for AIG has reached $180 billion. The result of this is the government now owns 80 percent of AIG.
When the first bailout money was loaned to AIG, it was stated that the whole U.S. economy may have faltered if the bailout hadn’t been done. There are a number of experts who disagree with that assessment including AIG’s former head Hank Greenberg, who ran the company for almost 40 years. He believes the countries taxpayers would be better off if the company had been allowed to file chapter 11 bankruptcy. How did they get into that mess in the first place?
Like many large corporations, AIG has various divisions, most of which have continued to do well financially. The problem at AIG was due to the huge losses by one of its divisions named AIGFP (AIG Financial Products). AIGFP’s selling of credit derivatives is what caused AIG to fail. Buying credit derivatives is similar to buying insurance. In this case, the “insurance” company AIGFP, sold a common type of credit derivative called “credit default swaps,” which essentially insured the mortgage company against non-payment of the loans they gave out. When the economy faltered and people quit paying back their loans, AIGFP was forced to honor the credit derivatives they sold and paid the mortgage companies for their loss of income.
Under normal economic conditions, like the years up through 2004, selling credit derivatives was a very profitable source of income for AIG. Not realizing that many of the loans were given to people who were very unlikely to be able to make the payments if the economy faltered, lead to AIG’s demise.
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