AIG

We have heard the phrase, “too big to fail” and a perfect example is AIG, the large insurance company that insured all of the bad mortgage loans that banks had provided. Recall these were loans given to people who did not have the where with all to repay unless the housing market continued its climb. The market did not cooperate and the buyers lost their homes. As the value of homes declined the mortgages that backed these loans lost value and the banks called on AIG to cover their losses, since that was the purpose of buying the insurance. As an aside, AIG did not call these products insurance because that would have meant oversight by the state insurance department so they called them credit default swaps. Now it was AIG’s time to step up to the plate but everyone knows that insurance is based on the concept that not everything will go wrong at once but that is just what happened. AIG’s stock went from $70 to one dollar and they were facing bankruptcy. Keep in mind that filing bankruptcy generally means your liabilities exceed your assets. AIG was a conglomerate that owned many different businesses and many not associated with the mortgage scene still had value but the losses suffered with the mortgage crisis exceeded the total value of the company. Now comes the fun part. The government stepped in and anted up 180 billion so that AIG could meet its commitment to the banks. Then AIG sold off some of its assets and the value of these toxic mortgages begin to rise. Keep in mind we are not talking about the actual value but the perceived value, that is, what a willing buyer will pay a willing seller. This increase was accelerated as the home market bottomed out. The end result is that AIG stock price begin to rise and when it hit $30 the government sold off its shares and made a profit. These shares became so in demand that the government sold them at auction and many bidders participated. The same banks that got hurt the first time around buying these mortgage bundles are now outbidding one another for the same bundles. They are betting that the recession is over and that housing prices will continue to rise. They are also assuming that if the bottoms drop out that the US government would once again come to the rescue. This is what is meant by the term, “moral hazard”. They are willing to take a greater risk knowing that the government will cover any downside loss. This is also what is meant by too big to fail.