Mairin O’Connor, Jordana Blankman, Manuela Carello, María Villagómez

Overview of Company● American International Group, Inc. (AIG) is one of the world’s largest

international insurance organizations, with a presence in over 100 countries.

● In 1919, Cornelius Vander Starr founded a general insurance agency, American Asiatic Underwriters, in Shanghai, China.

● AIG has over 65,000 employees, with corporate headquarters in New York and London.

● Company Revenue in 2014: $64.4 billion.● AIG serves 99.6% of Fortune 500 companies.

AIG Before the Crisis● It was considered a “Financial Fortress”:

✓High Stock Valuation✓AAA Credit Rating ✓Able to deal with long maturities (30 years)

● 2006: AIG is accused of fraud● Offered a way around Basel 2 Regulations● Credit Default Swaps (CDS)

○ Banks were able to maximize their profits.○ CDS written by AIG cover more than $440 billion in bonds.

● Securities Lending○ Usually the collateral cash is invested in short term and relatively safe

assets.○ AIG invested heavily in high-yield and high-risk assets (i.e. real estate).

Stock Prices Before the Crisis

Stock Price Average (2000-2008):

$71.37

Sto

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rice

(dol

lars

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Year

*Source: Stock prices taken from Yahoo Finance

AIG During the Crisis● Epicenter of the near collapse: AIG Financial Products.

● Real estate prices were plummeting.○ Many of the CDOs insured by AIG’s CDS included bundled mortgages.

● Problems arose with the CDS and securities lending:○ CDS: consisted of over $440 billion in bonds.

○ Securities lending: AIG lost $21 billion.

● Credit rating was lowered to AA-.

● Stock price dropped dramatically.○ Feb 2, 2009: Stock price plummeted to $0.42

● AIG lost $99.2 billion in 2008.

Timeline● Mid-2007: Housing slump leads to mortgage bonds decreasing in value.● 3rd Quarter, 2007: AIG had securities lendings payable of $88.4 billion.● End of 2007: UBS AG, Barclays, Credit Agricole & Royal Bank of Scotland

request money for collateral from AIG.● 4th Quarter, 2007: AIG suffered a $5.3 billion loss.● May 2008: AIG experienced a quarterly loss of $7.8 billion.● July 2008: AIG issued over $16.5 billion in collateral.● August 6, 2008: AIG announced a large second quarter loss.● September 15, 2008: AIG’s credit ratings were slashed.

Stock Prices During the Crisis

Stock Price Average (2008-2009):

$19.35

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rice

(dol

lars

)

Year

*Source: Stock prices taken from Yahoo Finance

Bailout ● “Idiosyncratic illiquidity”● “TOO BIG TO FAIL” -- Paralyzed Economy

○ A lot of mutual funds, pension funds and hedge funds invested and were insured by AIG (i.e. Goldman Sachs had $20 million in AIG’s business).

○ The failure of AIG could have caused the failure of too many major banks.○ Domino effect.○ On September 16, 2008 the federal government gave AIG a bailout of $85

billion, receiving nearly 80% of the firm’s equity.● AIG’s bailout came with controversy

○ Was it appropriate for the government to use taxpayers’ money? ■ Dodd-Frank Act.

● Nov 10, 2008: Fed Reserve Bank of NY created two special purpose vehicles for the rescue: ○ Maiden Lane II: purchased the remaining securities lending invested

collateral from AIG. ○ Maiden Lane III: acquired the CDO’s (Collateralized debt obligation)

associated with the CDS.● March 2, 2009: Bailout raised to $182.3 billion.● Aug 7, 2009: First profit after 7 quarters.● Jan 14, 2011: AIG started repaying the Fed credit line.● May 24, 2011: The U.S. and AIG started selling stocks at $29, their first offering

since the bailout -- Raised $8.7 B -- cut the government’s stake to 77%. ● Aug 23, 2012: The NY Fed ended its portion of the rescue with 16% of AIG’s equity.

AIG After the Crisis

Stock Prices After the Crisis

Stock Price Average (2009-2015):

$32.23

Stock Price on November 2, 2015:

$59.31

Sto

ck P

rice

Year

*Source: Stock prices taken from Yahoo Finance

What went wrong?● AIG ignored the risk of CDS:

○ Bond issuers almost never go bankrupt; the risk is small.

○ Selling CDS was seen as a way to make a fortune: AIG was keeping the premium and almost never paying anything out.

○ Then a bond-default happened: AIG was no longer taking in free cash, but it had to pay out big money.

● AIG ignored the risk of securities lending:○ AIG invested the cash inflow from securities lending in long-term assets: they couldn’t

return cash collateral in the short term.○ AIG invested particularly in real estate and assets backed by subprime mortgage loans.

A Correlation Problem● AIG did not take into account the positive correlation of bonds:

○ With insurance on one’s car, house or life, the correlation is not positive: i.e., one person’s death is usually not linked to another person’s death

○ With insurance on bonds, the correlation is positive: once some bonds start to default, other bonds are more likely to default.

● Mismeasurement of known risks.

References1. "AIG to Pay $800 Million to Settle Securities Fraud Charges by SEC." ; Press Release No. 2006-19; February 9, 2006. U.S.

Securities and Exchange Commission, 2006. Web. 20 Nov. 2015. <https://www.sec.gov/news/press/2006-19.htm>. "Falling Giant: A Case Study Of AIG." Investopedia. N.p., 27 Oct. 2008. Web. 17 Nov. 2015. <http://www.investopedia.com/articles/economics/09/american-investment-group-aig-bailout.asp>.

2. Holm, Erik. "Chart of the Decade: AIG and the Lesson of the Long View." MoneyBeat RSS. The Wall Street Journal, 14 Sept. 2014. Web. 17 Nov. 2015. <http://blogs.wsj.com/moneybeat/2014/09/14/chart-of-the-decade-aig-and-the-lesson-of-the-long-view/>.

3. McDonald, Robert, and Anna Paulson. "AIG In Hindsight." Federal Reserve Bank of Chicago, Oct. 2014. Web. 20 Oct. 2015. <https://www.google.it/url?sa=t&rct=j&q=&esrc=s&source=web&cd=5&ved=0CEUQFjAEahUKEwitqP3xhZjJAhWFkx4KHeN4BB0&url=https%3A%2F%2Fwww.chicagofed.org%2F~%2Fmedia%2Fpublications%2Fworking-papers%2F2014%2Fwp2014-07-pdf.pdf&usg=AFQjCNFeJ9f_6qEhicUxytJ0lmW4c9yYdA&sig2=W8VA-Uosx7S526DVP5-A_A&cad=rja>.

4. Mollenkamp, Carrick, Serena Ng, Liam Pleven, and Randall Smith. "Behind AIG's Fall, Risk Models Failed to Pass Real-World Test." WSJ. The Wall Street Journal, 31 Oct. 2008. Web. 20 Nov. 2015. <http://www.wsj.com/articles/SB122538449722784635>.

5. Nayberg, Yevgenia. "What Went Wrong at AIG?" Kellogg Insight. N.p., n.d. Web. 17 Nov. 2015. <http://insight.kellogg.northwestern.edu/article/what-went-wrong-at-aig>.

6. "Overdue Examination." The Economist. The Economist Newspaper, 09 Jan. 2013. Web. 17 Nov. 2015. <http://www.economist.com/blogs/schumpeter/2013/01/aig-and-financial-crisis>.

7. "S&P Downgrades AIG, Citing ‘Reduced Flexibility’." Crisis on Wall Street RSS. The Wall Street Journal, 15 Sept. 2008. Web. 17 Nov. 2015. <http://blogs.wsj.com/wallstreetcrisis/2008/09/15/sp-downgrades-aig-citing-reduced-flexibility/>.

8. Tracer, Zachary. "AIG Bailout Ends Four Years After Two-Year Plan: Timeline." Bloomberg.com. Bloomberg, 11 Dec. 2012. Web. 20 Nov. 2015. <http://www.bloomberg.com/news/articles/2012-12-11/aig-bailout-ends-four-years-after-two-year-plan-timeline>.