The Collapse of AIG and Its Impact on the Mortgage and Banking System

Most people have no real understanding of the impactdiscovered the soaring claims being paid out by AIG
of the American Insurance Group or AIG on thefor their credit default swaps insurance policies. AIG
mortgage market and the global banking system andwas able to raise capital $11billion only once from the
how close we came to Financial Armageddon. All of amarket to repair the damage, but the claims kept
sudden the dominoes started to fall and the Federalgrowing. The Largest Insurance Company in the world
Reserve Bank of America started to pick and choosewas effectively bankrupt.
who they would save. Lehman Brothers, theThe domino effect had started, the first to fall was
investment company posted losses of $3.9billionLehman Brothers they were reported to be the
before they filed for Chapter 11 bankruptcy protectionbiggest bankruptcy in history. Merrill Lynch was bought
and then collapsed. Merrill Lynch was bought by theby the Bank of America. The Federal Reserve Bank
Bank of America for $50billion.stepped into help AIG. AIG's problems could still cause
The Federal Reserve Bank of America stepped in andfurther turmoil in the market for the debt insurance
agreed to lend AIG $85 billion in order to facilitate thecontracts. That market was considered to be worth
sale of its global assets estimated at over $1 trillion in$58 trillion worldwide at the end of 2007. The biggest
exchange for essentially all the company's equity. Theproblem is that nobody really knows how much of the
Federal Reserve Bank is currently lending AIG the$58 trillion AIG is responsible for? Frightening!
money while they sell off their assets to pay theirThere is still more to emerge and this is possible only
liabilities for all the Credit Default Swaps that theythe tip of the iceberg. We have had Freddie Mac,
insured. AIG are paying the Federal Reserve BankFannie Mae, the American car manufacturers, I-Save
8.5% above the 3-month Libor rate, currently 11.5% andthe Icelandic bank, Royal Bank of Scotland, Lloyds
they currently own 79.9% of AIG.TSB, HBOS and others. These are the big and the
An AIG bankruptcy would have been the worstgreat, what about all the smaller banks and companies
financial collapse in history if it had been allowed. Soaround that are now trying to struggle on in the current
what had happened and why did the Federal Reservecircumstances
Bank stepped in? Most of us thought it was saved byThe consequences of AIG's
the Federal Reserve Bank because AIG was theThe mortgage bubble would never have grown so
largest Insurance Company in the world with 74 millionlarge had it not been for AIG's involvement. The banks
clients in over 130 countries and its demise would havewould never have made such huge profits and the
left us all uninsured if it had gone bust. Wrong! Few ofsupply of money would not have been so easy to
us actually understood the significance of this takeobtain by everyone and the growth in the mortgage
over by the Federal Reserve Bank and its impact ifmarket would have been controlled. Today the
the Federal Reserve Bank had not intervened.investment banks are now struggling as they have no
The Past Decadeway of borrowing money as no one will insure their
What had happened over the past decade was thatobligations any more since the collapse of Credit
the banks and investment banks had been bundling upDefault Swaps or debt insurance contracts.
risky sub-prime mortgages that they had sold and thenThe Impact of AIG
selling these to investors or banks in Europe. To makeThe collapse of AIG has had a major impact on the
these mortgage investments more saleable theymortgage market and the banking system worldwide.
would purchase an AIG Credit Default Swaps or alsoIt has added to the dire situation we all find ourselves in
known as debt insurance contracts. AIG's credittoday with:
default swaps were insurance contracts which wereA worldwide recession
not regulated. Typically these insurance policies wereUnemployment rising
for three to five years. AIG did not have the capitalHome repossessions rising
reserves required to back up these policies shouldHomeowners falling in to arrears with mortgage
they ever have to pay any claims out. This wouldpayments
prove to be their downfall or their nemesis when theirFalling house prices
day of reckoning arrived.Negative equity
AIG was not required to hold any capital in reserve asMortgages that are hard to obtain
collateral on its credit default swaps as long as theyLack of confidence between banks when lending
maintained a triple-A credit rating. AIG made hundredsmoney to each other
of millions of dollars in 'profit' each year, without anyFalling stock markets
collateral reserves. All the banks that purchased theseFalling interest rates
credit default swaps were able to assure their nationalGovernment intervention to prop up the banking
regulators that they were holding only triple-A creditssystems
mortgage products instead of the sub-primeDeflation on the horizon
mortgages that they were really holding which wereUncertainty in the financial markets.
high risk and toxic.The future for the next two to three years is gloomy
AIG's Day of Reckoning arrivedat present. We need to hope that a consequence of
On the 15th September AIG's day of reckoning arrivedall this spending by governments to ease this recession
when the major credit-rating agencies Standard &does not lead to high inflation in the future in order to
Poor's, Moody's and Fitch downgraded AIG's triple-Adown value the overall debt that all the governments
credit status. The credit rating agencies hadwill have in the future.