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...
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