The AIG Blowup American International Group, better known as AIG,
was a trillion dollar insurance giant and before 2008 was one of the 20 largest companies in the world. A small separate unit, AIG’s Financial Products division, went into the credit default swap business in a big way, insuring over $400 billion of securities, of which $57 billion was debt securities backed by subprime mortgages. Lehman Brother’s troubles and eventual bankruptcy on September 15, 2008, revealed that subprime securities were worth much less than they were being valued on the books, and investors came to the realization that AIG’s losses, which had already been substantial in the first half of the year, could bankrupt the company. Lenders to AIG then pulled back with a vengeance, and AIG could not raise enough capital to stay afloat. On September 16, the Federal Reserve and the U.S. Treasury decided to rescue AIG because its failure was deemed as potentially catastrophic for the financial system. Not only were banks and mutual funds large holders of AIG’s debt, but the bankruptcy of AIG would have rendered all the credit default swaps it had sold worthless, thereby imposing huge losses on financial institutions which had bought them. The Federal Reserve set up an $85 billion credit facility (later raised to $182 billion) to provide liquidity to AIG. The rescue did not come cheap however. AIG was charged a very high interest rate on the loans from the Fed, and the government was given the rights to an 80% stake in the company if it survived. Maurice Greenberg, the former CEO of the company, described the government’s actions as a “nationalization” of AIG. Insurance companies have never been viewed as posing a risk to the financial system as a whole and this is why their regulation has been left to insurance commissions in each state. Since the problems at AIG nearly brought down the U.S. financial system, this view is no longer tenable. The insurance industry will never be the same.