Question

What caused the AIG scandal and what happen ?

Answer 1

Cause of AIG scandal:

A new financial product known as a collateralized debt obligation (CDO) became the darling of investment banks and other large institutions. CDOs lump various types of debt from the very safe to the very risky into one bundle for sale to investors. The various types of debt are known as tranches. Many large institutions holding mortgage-backed securities created CDOs. These included tranches filled with subprime loans. That is, they were mortgages issued during the housing bubble to people who were ill-qualified to repay them.

The CDO insurance plan was a big success, for a while. In about five years, the division's revenues rose from $737 million to more than $3 billion, about 17.5% of the company's total.

A big chunk of the insured CDOs came in the form of bundled mortgages, with the lowest-rated tranches comprised of subprime loans. AIG believed that defaults on these loans would be insignificant.

And then foreclosures on home loans rose to high levels. AIG had to pay out on what it had promised to cover. The AIGFP division ended up incurring about $25 billion in losses. Accounting issues within the division worsened the losses. This, in turn, lowered AIG's credit rating, forcing the firm to post collateral for its bondholders. That made the company's financial situation even worse.

What Happened

The collapse and near-failure of insurance giant American International Group (AIG) was a major moment in the recent financial crisis. AIG, a global company with about $1 trillion in assets prior to the crisis, lost $99.2 billion in 2008. On September 16 of that year, the Federal Reserve Bank of New York stepped in with an $85 billion loan to keep the failing company from going under.

During the financial crisis of 2008, the Federal Reserve bailed the company out for $180 billion and assumed control, with the Financial Crisis Inquiry Commission correlating AIG's failure with the mass sales of unhedged insurance. In 2011 the nationalization of AIG was ruled illegal, and after regaining autonomy, AIG repaid $205 billion to the United States government in 2012.