Should the Government Continue to Bailout AIG?
It would be nice to say “No, the government should not continue to bailout AIG”; however, the US government has no choice but to bail out AIG. This is because if AIG collapses, it will be a nightmare and would seriously damage the already fragile U.S. economy, and even the world economy. Most experts feel a collapse of General Motors would be a thunderstorm, while a collapse of AIG would be a category 5 hurricane to the U.S. economy.
AIG currently has more than 375 million policies with a face value of $19 trillion. If the 375 million policyholders lost faith in AIG and rushed to cash in their policies at once, the entire insurance industry would tank. Simply put, AIG is too big to fail. There is also the fear that if AIG collapses, many people would be unable to obtain the same insurance from a competitor for the same price, which would cause many people to be shut out.
Unfortunately, no one knows when AIG will turn around and how much more money the U.S. government will have to pump into the company to keep it afloat. The government has rescued AIG four times in the last six months.
Last Monday AIG reported a $61.7 billion quarterly loss, the worst ever for a U.S. company. The US Treasury then announced the same day that it would provide A.I.G another $30 billion loan from the $700 billion financial bailout program, although the company already received more than $170 billion in taxpayer money.
Video: AIG Receives Billions More
How did AIG get into this mess? Contributing factors were as follows: the company used its triple-A rating from the insurance part of its business to run a risky hedge fund, which wrote hundreds of billions of dollars of credit default swaps without hedging itself, or buying protection against the prospect that it would be forced to pay up.
What’s a credit default swap? Credit default swaps are insurance contracts sold by banks, hedge funds and others that promise to cover losses on various securities in the event of a default. They are usually purchased for mortgage securities (we all know what happened here), corporate debt, and municipal bonds. Buyers of credit default swap insurance policies pay premiums over a period of time in return for peace of mind, knowing that losses will be covered if a default happens. Credit default swaps work similarly to someone taking out home insurance to protect against losses from fire and theft.
When AIG’s credit ratings were downgraded last September, the insurer’s trading partners demanded more collateral, but AIG didn’t have the cash. The US government, worried by the bankruptcy of brokerage firm Lehman Brothers a day earlier, gave $85 billion to keep AIG afloat which went to satisfy the trading partners’ demands for more cash.
Video: Credit Default Swaps Explained
Who is AIG? American International Group, Inc., (AIG) via its subsidiaries, provides insurance and financial services in the United States and internationally and has 116,000 employees. It operates in four segments:
- General Insurance – underwrites various business insurance products, including large commercial or industrial property insurance, excess liability, inland marine, environmental, workers compensation, specialized forms of insurance and excess and umbrella coverages.
- Life Insurance and Retirement Services – offers individual and group life, payout annuities, endowment, and accident and health policies, as well as retirement savings products consisting of fixed and variable annuities.
- Financial Services – provides aircraft and equipment leasing, capital market transactions, consumer finance, and insurance premium financing.
- Asset Management – investment-related services and investment products, including institutional and retail asset management, broker-dealer services, and spread-based investment products.
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