First of all—what is AIG?
AIG is American International Group , the largest insurance policy company in the macrocosm . It ’s not just an insurance company , however ; its clientele is divided into four air division : general indemnity , life policy and retirement service , financial services , and asset management . It was started in 1919 in Shanghai .
How did it (almost) collapse?
Like many other banks , AIG lost a slew on its mortgage , include $ 18.5 billion in the retiring three quarters — all part of the subprime crash . Its share damage has dropped 79 % this twelvemonth . But bad became worse this Monday when AIG received a downgrading of its reference rating . What ’s a credit military rating ? All securities are given a rating that narrate you how much risk is associated with your investment into that security system . reckon on the military rating , the company must have a certain pct of money on hand . The paygrade , afford by agencies like S&P and Moody ’s , are a lot like school grade " “ A ’s are dependable ( need less money on hand ) , B ’s are ok / bad ( need more money on hired hand ) , and C ’s are junk ( require even more money on deal ) . So S&P & Moody ’s downgrade AIG , which mean it needed to post $ 14.5 billion in collateral to digest its trading contract . AIG could n’t sell its plus off rapidly enough to get that money . Seeing its impending doomsday , AIG tried to summon the eternal sleep of the banks ( JPMorgan & Goldman ) to contribute them the money .
That did n’t ferment , so the Fed had to abuse for keep it from total flop . The Fed has promised to bestow up to $ 85 billion to AIG .
But I thought the Fed wasn’t going to bail anyone out anymore.
Well , yes , that ’s what they say . And they definitely stuck to their word when they let Lehman slide to its demise this weekend . However , AIG is more than just an investment firm . It ’s such a huge insurer ( the gravid in the world in terms of assets ) , and was such a Brobdingnagian player in the Credit Default Swaps ( CDS ) market place , selling off risk to other fiscal participant around the globe . If it collapsed , it would have shake the global financial domain .
What are Credit Default Swaps?
Okay , say I commit $ 10 M into a attachment for General Motors , but I ’m now afraid that GM may see financial trouble . Instead of just selling my bond certificate off , I can enter into a kind of insurance policy with a big camber , say AIG . I pay up AIG a low premium every after part . If GM remains okay , then AIG does nothing . If GM does see financial problem and I lose money on my bond certificate , AIG will give me what I lost on my bond paper . belike , this will be a bunch of money , proportional to the minuscule premium I pay . Once this pass , the contract of the " trade " terminates . This is all fine and great , except for the fact that the CDS market is n’t regulated — thus I could enter into a contract with a bank that does n’t have the resources to cover the loss of my GM bond . The CDS market totals $ 62 trillion , in which AIG plays a central role . Since just about every bank , insurer , and institutional money manager has some sort of exposure to CDS , they all have some sort of exposure to AIG . Hence , the necessary bailout .
How does the bailout work?
Well the Fed does n’t just pass on over the money when they do these bailouts . It has forebode a two - year loan for up to $ 85B. In return , it scram a 79.9 % equity post in the companionship in the form of warrants ( a warrant is basically a call option issued by the tummy — allowing the Fed the option of buying common stock in AIG at a specific price ) called fairness player note . Interest on their loan is at Libor ( the London Interbank offer pace — it ’s basically the London combining weight of the US Federal pecuniary resource stake pace , and is often used as a bench mark for short - term loaning ) + 8.5 portion points . That ’s about 12 % ( now ) , which is very mellow interest .
So AIG has to make good on the loan in the two - years either through general operation ( not likely ) or through sale of its various asset or branches of business organization . AIG has about $ 1.1 trillion Charles Frederick Worth of asset , and the Fed design to sell them off in an neat manner .
Why so much money?
Though AIG only postulate $ 14.5 billion after the credit downgrade this week , the $ 85B loan was plan so AIG would be leave with small debt and it could take on whatever the next few quarters has in entrepot .
Does this matter to me?
Yes — now you own part of AIG ! Well , kind of . That $ 85 billion is represent of your tax dollar . Yep , your revenue enhancement money is now going to protect bad investment . Investments that packaged up your debt into various surety , and sold it off to another company , who sold it off to another political party , who sell it off all over the earthly concern .
However , since the Fed is LENDING the $ 85B to the corporation ( unlike theFannie & Freddie deal ) the administration could make some serious money off the high-pitched interest pace . That is if , by some sort of divine intervention , the food market , and thus AIG , rebound . The Fed is make it clear that the taxpayer will only see positive effects of the bailout .
But will the taxpayer be affected?
Who recognise . It may be unfeigned " “ the Fed and the Treasury may make some money off AIG due to the gamy stake rate , but will I ever see that money ? . It ’s sure enough a good style to assuage the public ’s fear .
Will the bailout work?
It should . See , certain branches of AIG are doing just fine . Its aircraft leasing business , for deterrent example , is the second largest in the world and is estimated to bring in between $ 7 and $ 10 billion .
And who’s to blame?
That ’s for next meter .
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