How Did AIG Figure Into the Crisis of 2008? Essay

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AIG and the Impact of the "Insurance" Gambit

In the marketplace leading up to the 2008 economic crisis, lenders, ratings agencies and insurance companies were working together to create wealth from bad debts (loans given to homeowners unlikely to pay). These debts most likely to default were bundled and sold in tranches to investors, who believed or at least allowed themselves to think (or did not even care to question) that they were getting AAA-rated bonds (Lewis). When it turned out that banks (the biggest buyers of these "time-bomb" bundles) were over-exposed and that the demand for these bundles was suddenly drying up as investors realized that they were holding junk bonds rather than bonds likely to yield good fruit, the price of insurance on the bundles skyrocketed. Banks began dumping the bundles, and overnight, as in the case of Lehman Brothers and others, banks around the world saw themselves threatened with extinction as their investments in bad debt came back to bite them. Those who had insurance on the bad debts expected to be paid accordingly. When American International Group (AIG), which had sold insurance on the bad debt (never really expecting to have to pay because, after all, the bundles had been given good ratings by the ratings agencies), was now faced with the prospect of forking over billions that it did not have, the game was up. Someone from somewhere would have to intervene with a lot of cash, or else the entire scheme would collapse. Fortunately, AIG (and Goldman Sachs, the largest purchaser of insurance) had "friends" in high places. This paper will show what the circumstances of the AIG scandal were, how the scandal was discovered, why legislation was needed, who the players were, why the outcome has simply allowed the criminals to continue to exploit the market, what the red flags were, who was hurt by this unethical behavior and who prospered.

As Matt Taibbi shows, the recession was the direct cause of the irresponsible money lending and financial directives of banks such as Goldman Sachs and insurance agencies such as AIG. Goldman had been buying toxic mortgages and having them insured by AIG by the billions. The plan was simple: wait until the loans default and collect the insurance. AIG did not have the money to cover all its policies and was faced with the prospect of liquidating its assets, which were located in states all over the nation. Faced with the possibility of losing its entire fortune in an attempt to compensate the banks to which it owed billions (like Goldman, who knew their bonds would never be able to be covered, yet kept purchasing them), and creating a tidal wave of market economy relapse, the federal government (run by Goldman Sachs men like Paul Rubens and Henry Paulson) decided to spare both AIG and Goldman Sachs the hardship they had both brought upon themselves. The federal government spared them (and companies like them) by putting it all on the average American -- to the tune of $700 billion -- taxpayers' money. Their reward was not what should have happened in a legitimate contest of competition, where good actions are rewarded with the crown of success and bad, irresponsible actions are rewarded with the fires of failure. AIG was saved by taxpayers despite taxpayers' loud outcry. AIG, in turn, took the billions of dollars it was given and put it into the pockets of Goldman Sachs, while millions of men and women all over the country lost their homes and were put out of work (as was Goldman's competition, Lehman Brothers -- which received no bailout and was allowed to go under).

The scandal was discovered by several individual investors, market analysts, and hedge fund managers, who profited on the impending bust by shorting the market (the banks and insurance companies in particular). Among these savvy "shorts" were Steve Eisman, Dr. Michael Burry, and Charlie Ledley -- all of whom are profiled by Michael Lewis in his expose of the subject called The Big Short. Each uncovered the depth of the looming disaster in his own way, but essentially they saw the level of risk associated with credit default swaps and collateralized debt obligations. The risk was absurdly high and no one in the banking business, the ratings world, or at AIG seemed to be aware of it, as far as Eisman, Burry, Ledley and others could tell. They probed the marketplace and the men behind it and found that these shoddy bonds were being bundled and sold as sound investments when in reality they were built on the shoddy loans at the root of the housing bubble, which was about to burst.

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The major red flags that these men saw were the fact that ordinary Americans were being given irresponsible loans that they could not possibly repay. Eisman's babysitter for instance had essentially been loaned enough to buy multiple homes -- all on a babysitter's salary. This banking policy, which was nationwide in the early 2000s, was a giant red flag.

Another red flag, after the implosion of Lehman Brothers, and the subsequent bailout, was the fact that all of this had been foretold as the world of finance and the world of government began its merger in the 1980s. Anyone paying attention then would have noted that it was Reagan who ushered in the era of Wall Street de-regulation, which continued under Bush (I), Clinton, Bush (II), and Obama. During that time, the position of Treasury Secretary had been given to men who had maintained important spots in the world of finance, such as Donald Regan (Merrill Lynch), Robert Rubin (Goldman Sachs), Henry Paulson (Goldman Sachs), and Timothy Geithner (President of the Federal Reserve). Moreover, at AIG, Joe Cassano was "generating $300 million a year, or 15% of AIG's profits" by selling insurance on the junk bonds that were passing as AAA-rated bonds (Lewis 71) and Goldman Sachs was at the top of the list of buyers. It had no fear: its man Henry Paulson was U.S. Secretary of the Treasury. If Goldman, or more to the point AIG, ever got in trouble, Paulson was there to make sure Goldman never got burned. And that would mean bailing out AIG.

Public Law 110-343 created the Troubled Asset Relief Program (TARP) which bailed out AIG, which owed Goldman Sachs. TARP oversaw $700 billion worth of taxpayers' money go into the pockets of the criminal enterprises. As William Greider reported in The Nation, "The AIG rescue demonstrated that Treasury and the Federal Reserve would commit taxpayers to pay any price and bear any burden to prevent the collapse of America's largest financial institutions." When the ranks of the Treasury and the Fed are filled with company men from those very same "largest financial institutions" who face literally no opposition it is not surprising that such should become policy.

To make the illustration even clearer: Goldman played unfairly and was allowed to manipulate the rules of the game to save its own skin, while other banks like Lehman Brothers (who played just as irresponsibly but did not have their men in places of power like Goldman) were thrown under the bus. Taibbi states:

America's fourth-largest bank goes broke gambling on mortgages, then gets sold to Wells Fargo for $12.7 billion after the latter receives $50 billion in bailout cash and tax breaks from the government. The resulting postmerger bank is now the second-largest commercial bank in the country…Fattened by all this bailout cash, incidentally, postmerger Wells Fargo would end up paying out $977 million in bonuses for 2008. (Taibbi 243)

This fat bailout was supposed to "right" the economic crisis, but all it did was load the pockets of the banks whose friends, like Paulson, had come up with TARP. The legislation was designed to ensure that Goldman and others were rewarded for their behavior, while average Americans were left paying the price. Banks turned on borrowers overnight: rates went up, foreclosures abounded. The Fed began its policy of quantitative easing, aka printing off more and more money to prop up the market, which the government refused to let collapse.

The effect of TARP has been an increase in American debt. It has ensured that generations to come will be divided into two camps: the extremely wealthy and the poor. The middle class continues to dwindle as the only rise in employment opportunities is in the service sector. By selling insurance on junk to Goldman, AIG allowed Goldman to pull the strings (through Paulson) that made certain that AIG's reckless policy would be underwritten by the American taxpayer. For this reason, the legislation was nothing more than a burden on the average citizen, who saw his own wealth take a substantial hit as confidence in the market and in the banks that controlled it quickly evaporated. AIG essentially acted as the stooge for Goldman and other banks, who controlled the ability through the White House to lay the burden of funding the bailout….....

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