11 years ago, the world saw the most serious
economic collapse since the Great Depression. The waves of this collapse went around the
world, touching every continent and every country. Then, when all was said and done, the finger
pointing began to see who was to blame and who should pay the price for this crash. In this video, weâll see how the insurance
company AIG largely avoided taking the blame, despite ultimately being the single largest
cause of the Great Recession. This video is brought to you by Audible. Get a 30-day free trial by registering with
the link in the description. To understand AIGâs role, we first have
to grasp what happened in 2008 and the events that led up to the crash. During the late 1990s, America was getting
a huge flow of foreign funds from Russia and many Asian countries which were beset by financial
crisis at the time. American banks naturally did not want that
money just lying around earning no interest, so they made it easier to get mortgages as
a way to lend out this cash. Americans who would normally not get home
loans found it very easy to get the mortgages they needed to buy houses. After all, this was the âAmerican Dreamâ. Banks made it easier and easier to get a loan,
creating adjustable rate mortgages with low early payments and accepting people with low
credit scores. These less-than-ideal loans were called subprime
mortgages. Now, what banks usually do as a way to make
more money, is to bundle thousands of mortgages together as a single bond, known as a CDO,
and then to sell these bonds to other parties, like pension funds, insurance companies or
other banks. However, since subprime mortgages were riskier,
many of the funds that would normally buy these CDOs could not afford the risk to buy
them ⌠unless the banks employed a little bit of financial trickery. You see, if you bought an insurance policy
protecting you from the CDO failing, then you could buy it much more freely and this
is where AIG comes in. AIG was at the time the largest insurance
company in America with branches and offices in over 80 different countries. Theyâve been in business since 1919 and
have been declared Americaâs largest underwriter for insurance across many industries. In 2008 they had hundreds of billions of dollars
in assets and were in fact well on their way to becoming the first company in the world
to achieve a trillion dollar market cap. Hereâs what this huge company did to transform
very risky CDOs into much safer products. In a little office in London, AIG was performing
financial alchemy. They were selling insurance on CDOs that had
a very poor credit rating, effectively swapping it with the rating of AIG itself, a very solid
and highly-rated company. This insurance policy was known as a Credit
Default Swap and it literally swapped the bad credit rating of the CDO with the great
credit rating of the big insurance company. You were still buying these horribly rated
CDO bonds from the banks, but since AIG was willing to pay you off if that bond failed,
well then what was the risk? AIG loved the credit default swap and so did
the fund companies. In the 5 short years after introducing it,
that little office in London, known as the Financial Products division, saw its revenues
quadruple to over $3 billion dollars per year. Every time AIG sold another credit default
swap, they were making free money in the premiums being paid to them. It was almost too easy. But AIG got greedy. Normally, if an insurance company insures
you for a million dollars, they should have a million in assets around to pay it, just
in case. Instead of having the capital, however, AIG
were relying on the statistical probability that the housing market would not fall. This strategy worked until it didnât, and
in 2007, the housing market crashed. All those subprime mortgages increased their
adjustable rates and thus millions of Americans that should never have had mortgages saw their
monthly repayments increase. When those mortgages werenât getting paid,
the bonds filled with these mortgages, the CDOs, also started collapsing. But the banks and funds werenât concerned
yet, and rightfully so because they had an insurance policy, these credit default swaps. The banks were relying on AIG to honor their
end of the bargain, but when the time came, AIG realized it had insured far too many CDOs
to possibly pay up. As soon as AIGâs coffers ran dry, all the
banks it had insured also started going down. The speed of the collapse was incredible:
AIG ran out of money on September 15th, 2008 and later that same day, one of Americaâs
oldest and largest banks, Lehman Brothers, was forced into bankruptcy. That day served as a wake up call for the
government. Up until then, the Federal Reserve was taking
a hardline stance against government buyouts, hoping to teach Wall Street a lesson. AIG, however, was no small insurance agency
and the Fed realized that if AIG failed, the entire world was in trouble. Virtually all banks and insurance companies
had stock and policies held with AIG. Everything was too connected. Thus, AIG was deemed âtoo big to failâ
and on September 16, 2008, just one day after the US Treasury said there would be no more
government bailouts, the government bailed them out. In return for a massive cash loan to pay out
these credit default swaps, the Federal Reserve took an 80% equity stake in AIG, allowing
the government to change the leadership of the company, which they did. They installed a new CEO, hired at a salary
of just $1, who would be in charge of undoing the complex financial maze AIG had created. AIG then used $165 million of the bailout
money to pay executive bonuses, not for good performance, but for incentives to help undo
years of bad financial practice. In total, AIG received a bailout of $182 billion
dollars and in March 2009, they reported the single greatest loss in corporate history. As a result of that announcement, the Dow
closed at the lowest level it had been since 1997, and at just 50% of itâs record high
in Oct 2007. AIG also settled a lawsuit brought against
them, paying off nearly a billion dollars to investors who were clearly misled. As a result, AIG reduced its staff to less
than half its 2008 numbers just to remain profitable. Interestingly enough, once the dust had settled
and AIGâs business had stabilized, the governmentâs stake in the business actually became a profitable
trade. In 2012, the Federal Reserve sold their shares
of AIG to make a $22 billion profit, a truly unprecedented result considering the size
of the bailout. It took another 5 years before the government
considered AIG safe enough to remove it from the âtoo big to failâ list and ever since,
itâs been back to the good old boring days of insurance. AIG never caught the same backlash as banks
like Lehman Brothers, who were arguably victims in all of this, since they relied on fraudulent
insurance. Thus, it is worth remembering just how close
AIG got to crashing the entire global economy and if you wanna read more about the inside
story of AIGâs collapse from the people in the meeting rooms, you should listen to
Fatal Risk on Audible. Using the personal notes of men like AIGâs
former CEO, youâll learn the full story from the perspective of its key players and
you can listen to it for free right now if you register for a free trial of Audible by
visiting audible.com/businesscasual or by texting âbusinesscasualâ to 500500. Not only will you get a free audiobook to
go along with your free trial, youâll also receive two Audible Originals that you canât
hear anywhere else. Now, I hope you enjoyed this video and Iâd
like to thank you for watching it. If you wanna see teasers for my future videos
you should follow me on Instagram. You can expect my next video in two weeks,
and until then: stay smart.
I don't think it's entirely accurate to say the banks were "arguably the victims" in this situation.