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AIG: The Center of a Financial Apocalypse

This is 2 of 3 in our AIG Series. Check out "AIG on the Brink: Was a Bailout Necessary to Save the Financial System?" for the first article and "The Government Bails Out AIG: Was It Worth It?" for the third article.

In September 2008, AIG was on the brink of failing as an institution and running out of liquidity. The company, particularly its financial products division, was on the wrong end of a number of derivative contracts that required collateral to be posted to its counterparties. As panic spread throughout the financial system, not only were its counterparties demanding collateral and payments on credit default swaps and other contracts but its investors were recognizing the impending doom the company was facing as well. As a result, the equity and debt of the company was being sold in droves, causing its stock price and bond prices to plummet. Thus, raising funds in order to meet its obligations became virtually impossible.

AIG's collapse could have brought down the global economy.

AIG became an idiosyncratic risk to the greater financial system due to its one-sided bets on derivative products and the extent to which it was the sole counterparty to a number of investment banks, hedge funds, and other investors. AIG’s traditional business such as providing life as well as property and casualty insurance were also under threat as the company moved further down the abyss. Because AIG represented such a grave risk to the U.S. and worldwide financial system, a rescue either by private investors and/or the government was necessary in order to avoid total financial collapse and the adverse implications that would come from it. If AIG failed, investors big and small would be hurt with the continuity of insurance policies put in doubt and the soundness of derivative contracts put in question. Chaos would ensue and everyone’s financial stability – from the restaurant owner’s to the Fortune 500 CEO’s – would be in doubt.

The U.S. government eventually stepped in to save AIG in September 2008 in order to preserve the U.S. and global financial system. The Treasury and the Federal Reserve ended up providing a total of $182 billion to AIG, with $70 billion coming from the Treasury through the Troubled Asset Relief Program (TARP) and $112 billion from the Federal Reserve Bank of New York. Both the Treasury and Fed ended up turning a nominal profit on their investments in AIG to the tune of $5 billion and $17.7 billion, respectively, totaling $22.7 billion. In sharp contrast, the bailout of the U.S. auto industry cost the government around $10 billion. The Treasury and Fed recouped their investments through a series of equity sales, divestitures, redemptions, and interest from 2010 through 2013. As a result of the bailout and subsequent repayments to the Treasury and Fed, AIG is now close to 50% smaller in terms of assets, and the notional size of its derivatives portfolio through its financial products division is less than 10% of what it was before the crisis.

> Part 1: "AIG on the Brink: Was a Bailout Necessary to Save the Financial System?"
> Part 2: "AIG: The Center of a Financial Apocalypse"
> Part 3: "The Government Bails Out AIG: Was It Worth It?"

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