INTRODUCTION
The collapse and bailout of American International Group (AIG) that happened in 2007-2008 was one of the controversial crises in U.S. financial history. AIG is basically an insurance provider and sometimes reinsures firms that have taken too much risk. The cause of the downfall began after AIG’s financial products unit (AIGFP) ventured into the sale of Credit default swap. A credit default swap mimicked insurance policies but covered securities. The buyer makes regular payments to seller and the seller pays the face value of the loan in a case of default. Investors could hedge mortgages with CDS and that increased demand for sub-prime mortgages. Other causes of AIG downfall includes reliance on rating that built faulty trust in the market, housing bubble hurt subprime mortgages, lax insurance regulators and absence of oversight structure for non-insurance activities. The debt securities consisting of credit swap pool range from residential mortgages to automobile loans and ratings from professional rating agencies will make easier to sell credit swaps to investors (Vasudev 760). Credit raters such as Moody’s and Standard and Poor’s were quick give to assign triple AAA rating to all sorts of financial derivatives without understanding the risk involved (Serwer and Sloan). Credit defaults swaps are not considered insurance and insurance regulators forbid the writing of credit swaps (Harrington 790). OTS was a federal regulation unit charged to supervise companies like AIG from taking too much risk. Federal Office of Thrift Supervision acknowledged their inability to regulate a complex unit like AIGFP. The crises that ensued AIG began under the leadership of Hank Maurice Greenberg as the CEO.
AIGFP was created in 1987...
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...with investors could calculate the risk involved in credit default swaps and cancel their deals with AIG. CDS were insurance against defaults on financial instruments and times of non-payment by issuers AIG was supposed to pay collateral to the holders of these instruments and since AIG did not have such liquidity available to meet such requirement it relied on a bailout from the federal government. Cassano once again lied to investors about AIGFP not losing even a dollar in its CDS transactions. He was right. AIG didn’t lose a dollar but several billions of dollars.
CONSEQUENCES TO IMPORTANT STAKEHOLDERS
The insurance giant, AIG suffered tremendously from the credit swap business of it financial product unit. AIG shift from its core insurance business to a new line of business of business without a clear understanding of the financial derivatives and its risks.
After the time of financial crisis, JP Morgan was not the only national bank in US which got involved in trade of toxic loans related to mortgage. Before JP Morgan, it was Goldman Sachs-another large US Bank that faced the allegation of manipulating the trades in its own self interes, ended up in favor of SEC while GoldMan Sachs were asked to pay $500 Million during late 2011 in a deal called Abascus 2007-AC1 where the bank were alleged to mislead its investors on a deal related to Collateral Debt Obligation(CDO). (Eaglesham, 2011) The ab...
...o turn their securities back into AIG and demand billions of dollars. AIG was faced with a problem and they had to start asking subsidiary insurance companies to liquidate their pension and insurance holdings so they could cover their losses. If this happened those customers would have received a fraction of the money due to them and would ensure a global crisis. Of all the people complaining about AIG, Goldman-Sachs was doing it the most frequently and the loudest. An audit of AIG showed that they had no liquidity to pay off the bulk of what they owed so the Federal government issued a bail out of $80 billion which later elevated to $200 billion. Goldman-Sachs received the largest percentage of that $200 billion and would have torched the entire country in order to get that money that felt they deserved; and the housing-market bubble was just at the beginning of it.
But this time would be different. Henry Paulson stepped in to let Lehman Brothers know there would be no bailout for them. Someone had to fail to set an example for the rest of the banking industry and Lehman Brothers would be that someone. In Paulson’s view Lehman Brothers was guilty of moral hazardous decisions and would not be paid for mistakes made. I find it interesting that Richard Fuld the CEO at Lehman Brothers at this time was Paulson’s chief competitor before becoming Treasury Secretary. Why was Lehman Brothers by the way of Paulson’s moral hazard decision making? They were a large bank and posed greater systemic risk to the overall industry than Bear Stearns. Paulson told Fold to make a deal with another bank or risk bankruptcy. When no deal could be made Paulson told the Wall Street banks to solve the problem collectively since they created the problems collectively. With no end in sight Paulson eventually shelved his moral hazard standing and was forced to make loans to the largest banks in America. Two of the largest companies in the world were United States banks and had lost almost 60 percent of their value. United States banks held nearly 5 trillion in mortgages. AIG alone held billions in credit default swaps and would eventually need nearly 185 billion in government loans to remain in business. AIG famously was deemed too big to fail. The government now controlled the largest insurance company along with Fannie Mae and Freddie Mac the largest mortgage banks on
Many people today would consider the 2008, United States financial crisis a simple “malfunction” or “mistake”, but it was nothing close to that. Contrary to what many believe, renowned economists and financial advisors regarded the financial crisis of 2007 and 2008 to be the most devastating crisis since the Great Depression of the 1930’s. To make matters worse, the decline in the economy expanded nationwide, resulting in the recession of 2007 to 2009 (Brue). David Einhorn, CEO of GreenHorn Capital, even goes as far as to say "What strikes me the most about the recent credit market crisis is how fast the world is trying to go back to business as usual. In my view, the crisis wasn't an accident. We didn't get unlucky. The crisis came because there have been a lot of bad practices and a lot of bad ideas". The 2007 financial crisis was composed of the fall of many major financial institutions, an unknown increase in mortgage loan defaults, and the derived freezing up of credit availability (Brue). It was the result from risky mortgage loans and falling estate values (Brue) . Additionally, the financial crisis of 2007 was the result of underestimation of risk by faulty insurance securities made to protect holders of mortgage-back securities from risk of default and holders of mortgage-backed securities (Brue). Even to present day, America stills suffers from the aftermaths of the financial crisis.
...n Sachs gained from bailout of AIG. [online] Available at: http://www.theguardian.com/business/2011/jan/27/goldman-sachs-received-aig-bailout-cash [Accessed 28 Apr. 2014].
The presence of systemic risk in the current United States financial system is undeniable. Systemic risks exist when the failure of one firm may topple others and destabilize the entire financial system. The firm is then "too big to fail," or perhaps more precisely, "too interconnected to fail.” The Federal Stability Oversight Council is charged with identifying systemic risks and gaps in regulation, making recommendations to regulators to address threats to financial stability, and promoting market discipline by eliminating the expectation that the US federal government will come to the assistance of firms in financial distress. Systemic risks can come through multiple forms, including counterparty risk on other financial ...
In December 2007, the U.S. entered the third longest recession in its history. According to Britannica, the crisis in the American housing market eventually caused the entire economy to collapse. Mortgage dealers issued mortgages to unqualified families with unfavorable terms (Havermann, n.d.). Companies like Moody’s came into the picture when it was time to rate these mortgage-backed securities. If housing prices continued to rise,
Investment banks, Rating agencies and Insurance companies are key components of the financial market. In this presentation, I’m going to explain how these three key roles worked together to create the 2008 financial crisis.
...t up to par. The mortgage brokers allowed many high risk borrowers to obtain loans that they could not afford. When the price of houses fell, the values of these homes were well below what was owed for the mortgages. This caused many borrowers to default on their loans. Before we knew it, the balance sheets of banks deteriorated, the stock market crashed, and large investment banks began to fail. This was all started with financial innovation that had gone out of control.
Although not as big as the 1929 crash, the crash of 2008 still had a huge impact on Americans. Unlike the crash of 1929, the crash of 2008 was caused by activities outside of Wall Street, namely, the failure of congress to pass the bank bailout bill. The bank bailout bill was made to bailout companies like HSBC and Lehman Brothers, who went bankrupt as a result of poor and illegal business practices. Some of these business practices included money laundering. Money laundering is when someone makes illegally obtained money look like it was legally obtained, or in other words, making dirty money look like clean money. The rejection of the bank bailout bill by congress sent the Dow into a nosedive, dropping almost 800 points in one day, the largest point drop in any single day in history. Another cause of this crash was the subprime mortgage crisis. This crisis occurred when companies hired rating companies like Standard and Poor’s to give good ratings to the mortgages that these banks were giving out to people. These mortgages were sold to other places, such as investment banks and government agencies, as mortgage-backed securities. Mortgage-backed securities are paid like regular mortgages, except that interest and principle payments don’t go to the company that lent you the money. For example, if you get a mortgage from Chase bank, Chase can sell your mortgage to the Federal Home Loan Mortgage Corporation (Freddie Mac). Freddie Mac then
Cited as one of the most influential and paramount financial regulation since 1930’s, Dodd-Frank act and Consumer Protection Act was passed by the Obama Administration in 2010 as a response to the financial crisis of 2008. It is not a hidden fact that after the repealing of Gramm-Leach-Bliley Act in 1999, commercial banks again started investing in unregulated derivatives, and this unregulated and least supervised investment channels of banks led to formation of cowboy financing, eventually leading to massive carnage in the US economy in the form of financial crisis of 2007-08. Learning from the mistake of past government, and to endow a supervisory eye on investments and risk channels of the bank, the Obama Administration passed the law in order to have a sweeping impact on the delivery of financial services in the United States. Therefore, Dodd-Frank Act is a legislative proposal to reform the entire financial service industry in the United States, in order to prevent financial crisis.
The "subprime crises" was one of the most significant financial events since the Great Depression and definitely left a mark upon the country as we remain upon a steady path towards recovering fully. The financial crisis of 2008, became a defining moment within the infrastructure of the US financial system and its need for restructuring. One of the main moments that alerted the global economy of our declining state was the bankruptcy of Lehman Brothers on Sunday, September 14, 2008 and after this the economy began spreading as companies and individuals were struggling to find a way around this crisis. (Murphy, 2008) The US banking sector was first hit with a crisis amongst liquidity and declining world stock markets as well. The subprime mortgage crisis was characterized by a decrease within the housing market due to excessive individuals and corporate debt along with risky lending and borrowing practices. Over time, the market apparently began displaying more weaknesses as the global financial system was being affected. With this being said, this brings into question about who is actually to assume blame for this financial fiasco. It is extremely hard to just assign blame to one individual party as there were many different factors at work here. This paper will analyze how the stakeholders created a financial disaster and did nothing to prevent it as the credit rating agencies created an amount of turmoil due to their unethical decisions and costly mistakes.
In previous years the big financial institutions that are “too big to fail” have come to realize that they can “cheat” the system and make big money on it by making poor decisions and knowing that they will be bailed out without having any responsibly for their actions. And when they do it they also escape jail time for such action because of the fear that if a criminal case was filed against any one of the so called “too big to fail” financial institutions it...
Unlike most other bonds, the mortgaged backed securities were made up of a bunch of bonds pooled together. Because of that, the rate at which the failure of these bonds were not suspected to be high as a couple failing would not likely result in the failures of the rest. It was believed that a mass failure would not happen. This is where Credit Default Swaps (CDS) come in. Similar to insurance policies, CDSs are bought to insure CDOs in case of failure. Up until the failure occurs, the buyer of these swaps are required to pay a premium. In turn, one of the causes of the financial crisis is the lack of regulation and lack of risk-detection that occurred in these subprime, or below good quality, loans. The banks lost in the end; however, they were bailed out by the
Kim, J. (2008). From Vanilla Swaps to Exotic Credit Derivatives: How to Approach the Interpretation of Credit Events. Fordham Journal of Corporate & Financial Law, 13(5), 705+.