William Byrnes' Tax, Wealth, and Risk Intelligence

William Byrnes (Texas A&M) tax & compliance articles

AIG Marked as Central Player in the Financial Crisis Blame Game

Posted by William Byrnes on March 15, 2011

According the FCIC report, in the late 90s, AIG leveraged its superior credit rating—its “most valuable asset”—to branch out beyond standard insurance products and become a major over-the-counter derivatives dealer. Through its subsidiary AIG Financial Products, AIG eventually amassed a derivatives portfolio with $2.7 trillion in notional value.

A significant portion of AIG’s derivatives business was devoted to credit default swaps (CDS’s) that “insured” debt held by financial firms and institutional investors. A CDS is a contract under which the party writing the CDS agrees to reimburse the party purchasing protection if there is a default on the underlying debt. In exchange, the party purchasing protection makes a series of payments to the issuer of the CDS—essentially premium payments.

AIG’s credit protection business grew rapidly, swelling from $20 billion in 2002 to $211 billion in 2005 and $533 billion in 2007.

Although insurance policies and CDS’s are similar, crucial differences between the two played a critical role in the crisis. An insurance company is obligated to set aside reserves to balance against potential losses; but a credit default swap, not being an insurance policy, is not subject to a reserve requirement. As a result, AIG was not required to put up collateral when it issued hundreds of billions in CDS’s. What the company did do, however, was promise to post collateral if its credit rating was downgraded.

Read the entire analysis by linking to AdvisorFX !  Sing up for the no obligation free trial – with full access to Advanced Underwriting Service, the Presentation Aids, Soft Skill Tools, Calculators, and Daily Journal.


Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out /  Change )

Google photo

You are commenting using your Google account. Log Out /  Change )

Twitter picture

You are commenting using your Twitter account. Log Out /  Change )

Facebook photo

You are commenting using your Facebook account. Log Out /  Change )

Connecting to %s

%d bloggers like this: