Myths of the AIG Collapse

Happy Anniversary, AIG !

It was exactly one year ago today that AIG went belly up, a collapse caused by the massive risk taking of their Financial Products (FP) division.

AIG FP remains somewhat unknown to most people. Numerous issues associated with the collapse seem to be still misunderstood by many professionals, analysts and pundits.

Consider these factoids:

Hedge Fund: AIG FP was essentially a derivative writing quasi-hedge fund within AIG. They were essentially a writer of highly leveraged, naked options. Indeed, their $3 trillion is leveraged bets was simply unconscionable.

Lehman Did Not Kill AIG: Even if Lehman Brothers was saved, AIG would still have had enormous exposure — over $3 trillion dollars! — and carried tremendous risk. They had huge, leveraged exposure to mortgages, especially credit default swaps written against sub-prime mortgages. The housing collapse was going to do in AIG, regardless of whether Lehman was rescued or not.

Exempt: Thanks to the CFMA, these derivatives were exempt from ALL regulation and ALL supervision — There was no oversight from an exchange, no listing of derivative trades, no disclosures of risk, no transparency, no counter-party information. Most damaging of all, these derivatives required zero reserves in case of a claim. No other traded financial instruments receive this special treatment;

No Reserves Required: If AIG was forced to maintain reserves, they would not have been able to write $3 trillion dollars in derivatives, while maintaining the assumption/delusion that they would never ever have to pay on any of them.  The “Free lunch” fees on this was $3 billion. Even a 5% reserve requirement would have meant having to pony up $150 billion dollars;

No Supervision: FP benefited from being part of a highly regulated, triple AAA rated Insurance business. However, the derivative exemption prevented any of the usual state insurance supervisors from requiring normal disclosures, reserves, etc.;

Only a Few Employees Did In AIG: The firm had over 86,000 employees, but the FP division was a mere 400 people.

Chalk another win up for the Free Lunch crowd!

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