US Financial Crisis: The Bailout of AIG


Code : ECC0018

Year :

Industry : Banking, Insurance and Financial Services

Region : Global

Teaching Note: Available

Structured Assignment : Available

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History of AIG The history of AIG dates back to 1919 when a US businessman, Cornelius Vander Starr established an insurance agency in Shanghai, China and named it as American Asiatic Underwriters (AAU). In 1926, he opened a New York office under the name ofAmerican International Underwriters (AIU), to serve as an insurance writer on US-owned risks outside North America. As US entered into World War II, its headquarters was shifted from Shanghai to New York, temporarily closing the Shanghai office. By 1940, AIU expanded its regional headquarters in Cuba and half-a-dozen more offices in South America....

Spread of Global Financial Virus The market for credit derivatives gained momentum with the growth of housing bubble in US. The market size of US corporate bonds in 2002 was more than 50% of the global market. The number of corporate bonds that reached markets in US was 2,928 followed by Europe's 1,518 and Asia's 1,052 (Exhibit II). This indicates how the CDS have helped the underwriters to utilise bond trading as highly leveraged and high-velocity business. No sooner, this highly toxic form of credit derivative spread like a wildfire throughout the system and acted as a closed loop.

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Role of AIG in Subprime Crisis The burst of housing bubble afterAugust 2005, resulted in the collapse of healthy financial institutions facing huge losses – shocking Americans as how many Wall Street firms had been gambling in a vast pyramid scheme with someone else's money. All the firms rested on the assumption that 'home price would always be rising' and profiting would always expand – even as the number of homebuyers that were able to buy overpriced properties was shrinking.

Collapse of Subprime Market: Its Effect on AIG For years, the interconnectedness betweenmajor financial institutionsmasked enormous underlying risks of credit derivatives. Merrill's ties to AIG give a vivid picture of how difficult it is to untangle the financial system. During the housing boom years,Merrill sold billions of dollars worth of dubiousCDOs, backed by pools of risky subprimemortgages. To avoid its own risk, Merrill bought swaps from AIG , which would pay off incase of credit market failure.

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