AIG and Credit Default Swaps Research Paper

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The Ethics of AIG’s Commission Sales

1

American International Group (AIG) had been a big player in the financial crisis of 2007-2009. The company had been selling credit default swaps and making a commission on the sales (Brooks & Dunn, 2018). AIG had not expected the market to turn south in subprime lending as quickly and devastatingly as it did. The result was disastrous for the global economy as many were left holding toxic debt.

The credit default swaps (CDSs) were like insurance on the bundles of home loans sold to investors. Investors would buy the mortgages for the fixed return and then savvy investors would buy insurance on the investments (the CDSs) in case the mortgages were not repaid. The bundles of loans were supposedly mortgages of home owners who were unlikely to default, according to their AAA-rating. However, many of the bundles consisted of tranches that were full of sub-prime loans with a high default risk. Investors who saw this immediately starting buying up CDSs anticipating a huge default blow-up.

AIG was mostly oblivious to this and did not mind collecting the commission sales on the CDSs. As far as it was concerned, it was selling insurance on something that would never be needed. Then the bottom fell out and suddenly a flood of defaults came in, starting right with the sub-prime mortgages that filled up all the bundles of loans that were being sold. Those with insurance now wanted to sell back the CDSs but just at a higher price. This in essence was their “big short” play, which Lewis (2010) describes in detail in his book by the same name.

The biggest buyer of AIG’s CDSs was none other than Goldman Sachs—and Goldman wanted to make sure it got paid, so that is why AIG got a bail-out from the government: Goldman always has friends in high places—like Henry Paulson who was former CEO of Goldman and served as U.S. Treasury Secretary at the time of the economic crisis—so he made sure to see to it that AIG could make good on its CDSs sold to Goldman (Taibbi, 2010).

AIG’s sales agents didn’t mind one way or another—they got to collect their commissions on the sales of the CDSs that ultimately blew up in their faces—and then they got a bail-out from taxpayers so they were never really held accountable.

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In their eyes, all’s well that end’s well. AIG lived to see another day, and they still made a lot of money.

2

The top two who were affected by AIG were Goldman Sachs and the taxpayers who had to foot the bill for TARP—the Troubled Asset Relief Program—a “$700 billion stimulus package” (Brooks & Dunn, 2018, p. 89). Banks all over the world were affected by the subprime mortgage debacle, but in the U.S. the two most affected were Goldman and the people on Main Street. TARP would eventually be repaid—but the banks were never really penalized for their practices. The worst part of it was not even the bailout but the Fed’s role in all of it. The Federal Reserve began buying the mortgage-backed securities that no one wanted and the treasury bills the U.S. needed to sell in order to pay for TARP, etc. The Fed’s money helped inflate asset bubbles all over the place, pushing the stock market to all-time highs and then some (Houston & Spencer, 2018). As Milton Friedman has pointed out, the Fed was creating an inflationary bubble (StatelessLiberty, 2013). Thus, the common worker saw the value of his dollar drop substantially over the past decade as hedges like gold soared. And while Goldman and all the other banks of the world were affected, like Deutsch and Swiss Bank and other central banks, the Fed was the one that really got the ball rolling on saving the world from the bankers’ and lenders’ and credit rating agencies’ blunders.

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The moral and ethical problem here was that a) lenders were handing out loans hand over fist just to collect commissions on loans originated. They did not care that they were handing out bad loans that would have repercussions all around the world. The requirements for handing out loans had been loosened considerably by the government because the government wanted more people to have the….....

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