The AIG Debacle

The Washington Post is running a three-part series on the collapse of AIG. A few takeaways:

• AIG was long considered one of the safest companies in the world, as reflected in its AAA rating from the major credit rating agencies.
• The demise of AIG was caused by its subsidiary, AIG Financial Products. AIGFP was formed in 1987 as a joint venture between AIG and three defectors of the junk bond firm of Drexel, Burnham, Lambert (Howard Sosin, Randy Rackson, and Barry Goldman). The deal was structured such that AIG would 62% and AIGFP 38% of the profits.
• AIGFP specialized in derivatives, "financial jargon for a contract settling in the future that is based on something trading now."
• "Under the joint-venture agreement, Financial Products received its profits upfront, even if the transactions took 30 years to play out. AIG would be on the hook if something went wrong down the road, not Sosin and his team, who took their pay immediately."
• In 1993, Howard Sosin and Hank Greenberg, AIG's chairman, had a falling out, apparently precipitated by a deal that lost $100 million, and Sosin left (getting $150 million in the process), taking Rackson with him.
• AIGFP became a subsidiary of AIG, with the parent company taking 70% of the profits.
• In 1998, AIGFP got into "credit default swaps," a contract in which "the firm essentially would insure a company's corporate debt in case of default." AIGFP's computer model calculated that there was a 99.85% probability that the firm would never have to pay out on these contracts; that the "U.S. economy would have to disintegrate into a full-blown depression to trigger the succession of events that would require Financial Products to cover defaults."
• "When the housing market tanked, a statistically improbable chain of events began to unfold. Provisions in the contracts kicked in, spurring collateral calls on swaps linked to $80 billion in questionable assets, requiring the firm and AIG to come up with billions of dollars in cash. They scrambled for almost a year to stave off the calls, but there were too many deals with too many counterparties.

  In September, the Bush administration concluded that AIG's position at the nexus of the deals meant that it could not be allowed to fail, triggering the most expensive rescue of a private company in U.S. history. So far, the government has invested $152 billion in its efforts to save AIG. Federal investigators are sifting the carnage."