The AIG bailout of 2008: insurance, swaps and a crisis rescue

What was AIG Financial Products before the AIG bailout of 2008?

AIG Financial Products, the derivatives unit of AIG, was founded by Howard Sosin in 1987. It specialised in interest rate and currency swaps and dealt in over-the-counter derivatives, acting mostly as principal in its transactions (Wikipedia). The page reports that the unit contributed over $5 billion to AIG’s pre-tax income from 1987 to 2004.

The unit held major operations in London, and Joseph Cassano led it in the years that matter here. Profits from the unit made a trading business look like a steady source of income for an insurer. Investors saw a strong parent and gave little attention to a small unit that carried large contracts.

How did credit default swaps put AIG at the centre of the 2008 crisis?

A credit default swap pays the buyer if a bond or a loan defaults, so it works like insurance on credit. AIG Financial Products sold such swaps that insured $441 billion of securities originally rated AAA, and $57.8 billion of them were structured debt backed by subprime loans (Wikipedia). The seller of a swap must pay out when losses arrive.

A swap seller owes payments when losses arrive, and the amount can exceed the cash it holds on the day. For AIG, the contracts also tied the cash it had to post to its own credit rating. The rating of the parent decided how much cash the swaps required, so a downgrade could create a payment demand at once, in a month when markets offered no easy way to raise funds.

What triggered the AIG liquidity crisis in September 2008?

Starting on 16 September 2008 AIG faced a liquidity crisis after its credit rating was downgraded and it had to post more collateral to trading counterparties (Wikipedia). Collateral is cash or assets pledged to cover possible losses. A lower rating raised the amount that counterparties could demand, and AIG had to find cash within days.

The Lehman filing on 15 September had just frozen funding markets, which made it hard to borrow or to sell assets. A company with plenty of long-term value can still fail when it faces short-term demands for cash. The AIG case shows how a rating change can turn a paper loss into an urgent payment.

How did the AIG bailout of 2008 work on 16 September?

The New York Fed created a secured credit facility worth up to $85 billion for AIG, secured by warrants for a 79.9% equity stake and the right to suspend dividends (Wikipedia). The AIG board accepted the terms the same day. The article calls it the largest government bailout of a private company in US history.

Authorities acted partly to protect trading partners, among them Goldman Sachs, Morgan Stanley, Bank of America, Merrill Lynch, and several European banks (Wikipedia). A failure of AIG would have forced those firms to take losses on their contracts. The rescue therefore served as a guard for the wider network of counterparties, and the Fed took equity in return.

How much did the AIG bailout of 2008 cost in total?

Total support grew beyond the first facility. Wikipedia gives $182.3 billion in combined support from the Treasury and the New York Fed. Within that total, the Treasury bought $67.8 billion of AIG preferred shares under the Troubled Asset Relief Program (Wikipedia). The first $85 billion marked only the opening step of a larger package.

Different sources count the amounts in different ways, because loans, share purchases, and special vehicles each have their own figures. The New York Fed also created Maiden Lane entities in 2008 as part of the support. Readers should check the definition behind each number before comparing totals, and they should note the date of each figure.

Did the AIG bailout of 2008 return money to the government?

AIG repaid $205 billion, and the government realised a combined positive return of $22.7 billion (Wikipedia). The Treasury sold its last AIG common stock on 14 December 2012 for about $7.6 billion. The outcome shows that a rescue with equity and strict terms can end with a gain, even though the risks during the crisis were large.

A return for the state does not remove the question of fairness. Shareholders of AIG saw their stakes diluted by the 79.9% warrants, and the market learned that a large firm can receive support. The debate on moral hazard, the idea that rescue encourages risk-taking, continued long after the repayment.

What did the court decide about the AIG bailout of 2008?

Starr International, a major AIG shareholder, brought a $40 billion lawsuit against the bailout, and the trial began on 29 September 2014 (Wikipedia). On 15 June 2015 the court ruled that the government’s acquisition of an equity share in AIG was an illegal exaction. The ruling started a debate on the limits of emergency powers.

For an investor in Singapore or Hong Kong, the case shows that rescue terms can face legal review years later. Treat emergency support as a possible event rather than a guarantee. The EQOS Asia method page explains how a score measures counterparty fragility, and the 30-minute pre-diagnostic applies it to your own exposure to insurers and banks.

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About the author

Stéphane Jambu

President, EQOS Forecast Asia

Stéphane Jambu leads EQOS Forecast Asia and works as a consultant in e-commerce, search visibility, and AI. LinkedIn profile