Aig and the Financial Crisis

Topics: Subprime mortgage crisis, Credit default swap, Collateralized debt obligation Pages: 5 (1985 words) Published: October 15, 2012
AIG and the Financial Crisis
In 2008 United States of America suffered a massive financial crisis. The entire economy was affected, and a lot companies were forced into bankruptcy. AIG was on the verge of being bankrupt until the government decided to bailout the company. Now the AIG is being controlled by the government to restructure and recover assets. According to Kathy Gill about 80 percent of the AIG is controlled by the government (Gill). There are many reasons that lead to the fall of one of the largest insurance company in America, but the four that stand out the most are leverage provided by the government, the creation of Collateral Debt Obligations (CDO), the use of Credit Default Swaps (CDS), the arrogance to believe nothing would go wrong with the Credit Default Swaps, and last but not the least is how the United States government allowed these instruments to cause damage to the economy. The Creator of the Financial Crisis

The starting point for the fall of AIG was with leverage. According to investopedia leverage is “The amount of debt used to finance a firm's assets. A firm with significantly more debt than equity is considered to be highly leveraged” (Leverage). The man responsible for creating leverage in the United States of America is Alan Greenspan. Alan Greenspan was the chairman of the Federal Reserve Bank to. Alan Greenspan created leverage by allowing the Federal Reserve to hand out loans for only one percent of interest (Davidson). The reasoning behind his decision was due to the attack of September 11 in 2001, and the internet bust. Greenspan thought by lowering the interest he might be able to boost up the economy in those difficult times. Companies on Wall Street saw the cheap credit and borrowed tons of money to make deals so they can have a huge profit. The entire country was given the illusion that our economy was rising due to the temporary profit everyone was earning. Little did Alan Greenspan unknowingly had given an idea to companies on the Wall Street to connect investors with the housing market. “Furthermore, the combination of low interest rates and easier leverage in a loose lending environment led investors to look for a new asset class through housing market and securitization process”(Jo Hoje). That securitization process became Collateral Debt Obligation (CDO). How did Collateralized Debt Obligations Work?

“Collateral Debt Obligation (CDO) is an investment – grade security backed by a pool of bonds, loans, and other assets. CDO’s do not specialize in one type of debt but are often non-mortgage loans or bonds.”(Collateralized) The first CDO was created in 1987 by the bankers in the company called Drexel Burnham Lambert Inc (Salas). It is ironic how the company that created the CDO’s does not exist anymore because of their involvement in junk bonds. This was done under the supervision of Drexel Burnham lamberts CEO Michael Milken, who was charged with committing securities fraud (Salas). As shown earlier CDO’s were connected to the Wall Street through mortgages and homeowners, what companies did was buy a massive amount of mortgages from a mortgage company and earn monthly payments from home owners. While they were earning profits through their CDO’s, they were also earning profit from the investors who were investing in their companies. The way these companies set up their Credit Debt Obligations is that divided into three sections Safe, Okay, and Risky. The safe and the okay CDO’s earn companies majority of the money since the safe payments comes in first. The risky CDO’s are most likely to default and because of that their interest rates are higher, but they still earn a good amount of money because of the huge interest on them. There were many companies that took advantage of this security and earned millions in profit. Some of those companies were Goldman Sachs, Merrill Lynch, AIG, and Bear Stearns. CDO’s helped investors and the economy to boost up. CDO’s were one of...
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