American International Group - Financial Product Division - Essay Example

American International Group (AIG) Financial product division The financial division activities in AIG are consideredto be the principal cause that brought the company down. The AIG crisis did not result from state regulated insurance companies, but principally the crisis arose from the company’s financial products, which comprised written credit default swaps, derivatives and futures with a national amount of about $2.7 trillion, encompassing around $ 440 billion outstanding of credit non-payment swaps. The financial products unleashed methods that other vital organization rushed to emulate, resulting to wide that bound financial institutions mysterious ways that were hardly comprehended. The losses incurred in some of the credit default, swaps as well as the collateral calls, by global banks, broker dealers and hedge funds, who were counterparties to this credit, significantly contributing to the AIG crisis. These resulted when AIG was encountered with ratings downgrades. The company underwent demands of tens of billions of dollars for cash collateral on the credit default swops that were written by financial products and assured by the investing company. Some of the world’s biggest financial institutions managed to hedge their contribution in the risky credit default swap business living AIG struggling on its own (Roth and Buchwalter, 1). AIG selected the federal office of Thrift supervision (OTS) after purchasing a saving’s loan in 1999, which was an agency charged with supervision of savings, loan banks and economy associations. OTS became the primary regulator of the company. Notably AIG financial products are not a licensed insurance agency; therefore, it was not synchronized by the states. The financial product is primarily an investment that is based in London. It managed to evade control, as provided by the British financial services authority, principally because OTS, which was an equivalent regulator of the British regulatory body, had registered the AIG holding company. Nonetheless, even though OTS accepted its part as the holding company regulator, it should be understood that credit swaps were exempted from regulation by British policies thus preventing the states from regulating these instruments (Dinallo, 4). Collateralized Death Obligations Most people buy life insurance for the profit off their family members or those that rely on their on their earnings. Banks would buy a large number of life settlements to create the collateral pool which they would expect to begin making payment as earlier as probable. However, risks arise when the insurer fails to meet the death gain claim. This policy entails that investors will persist in paying out premiums on insurance and will eventually get the payout once a person dies. If the policyholder encounters his death earlier, this will entail that the returns will be immense. However, if there is a greater increase in life expectancy for a certain segment of the populace. Companies such as AIG lose money in downturns when claims mount which at times may result in bankruptcy (Lewitt, 183). Recently AIG has sought to garner support among investors and credit ratings companies for a deal that is highly viewed as controversial. This is the sale of securities supported by insurance guidelines of the aging people. However, this has gained few customers as critics refer to these deals as death bonds because they principally pay once the insured person has demised. The giant insurer’s life-settlements portfolio overall sum is $18 billion in anticipated death benefits. This is in regard to the company’s financial filings which has witnessed an approximation of over $45 billion traded since the market started over a decade ago. The AIG activity in a way depicts the company’s entrepreneurial culture as well as exhibiting hoe the company has fallen in last few years as it strived to raise funds to repay the government bailout, thus resulting on it making little profits (Sullivan, 1). Credit Default Swaps (CDS) Congress is in viewing legislative suggestions that will fundamentally change the manner market contributors’ access and utilize over?the?counter (OTC) offshoots. These governmental proposals ought to strike poise amid defending the veracity and reliability of the financial structure while endorsing beneficial economic action. Congress ought to support these verdicts on a comprehension of the way OTC offshoots function and their factual position in the fiscal crisis. Up to now, this deliberation has been perceived mainly via the framework of AIG's collapse centered on the imprecise finale that such collapse was the outcome of its CDS portfolio. The general insight concerning the near?fall of AIG is that the firm's financial difficulties are mainly, if not exclusively owing to its employment of CDS. Moreover, the fall could have been evaded if only its offshoots actions had been supervised in an improved perspective (International Swaps and Derivatives Association, 3). In reality, AIG's financial complexities can be outlined to extensive losses from numerous, diverse businesses and can be trailed to grave inadequacies in firm?extensive risk management. To be positive, AIG did undergo noteworthy mark?to?market fatalities on its CDS portfolio. However, the corporation as well suffered noteworthy losses in numerous of its extra activities. The initial Federal administration bailout of AIG in the year 2009 was compelled not simply by the requirement to finance collateral calls linked to AIG's CDS portfolio, but as well losses stalking from its securities loaning processes (Jacque, 277). The fall of AIG's monetary condition can be drawn back to the year 2005, when the firm's ancient AAA credit score was decreased to AA+ subsequent to the quitting of Hank Greenberg, who was the firm’s a long time CEO. In line with noteworthy sources, the reduction effected in part from the firm's participation in a number of dubious financial deals. AIG Bailout In 2008, AIG Corporation, the current foremost insurance business in the U.S., proclaimed 2007 proceeds of 6.20 billion dollars which amounted to 2.39 dollars for every share. Its stock finished that day at 50 dollars for every share. Under seven months afterwards, though, AIG was almost becoming broke and had to be saved by the federal administration via a loan of 85 billion dollars. Administration aid has since developed to182.5 billion dollars, and the Corporation’s stock lately traded at below one dollar for every share. This Article depicts why AIG, a Corporation with 1 trillion dollars in resources and 95.8 billion dollars in investors' impartiality, unexpectedly collapsed. It then expounds the tenures of the federal administration bailout, discovers why it was implemented, and queries its inevitability. Lastly, this section has expounded on the authoritarian gap developed by AIG and provides some considerations on authoritarian reform (Ritholtz and Aaron, 209). AIG's fall was instigated mainly by its 526 billion dollar collection of credit default swaps (CDSs) a credit offshoot extensively employed by financial businesses but, up until lately, mostly unidentified by the common public. AIG's dilemmas have been enclosed lengthily by the media other than they are tricky to understand fully since the impenetrable financial devices involved. Therefore, this section weaves clarifications of CDSs, resource-backed defenses, securitization, as well as collateralized liability duties into a thorough and systematic report and scrutiny of what failed at AIG and the reason behind the federal administration bailed it out. A methodical perception of these occasions is significant since the unparalleled magnitude of the rescue and attendant requires increased guideline of CDSs. A COP report depicted that the AIG salvage displayed that Treasury along with the Federal Reserve could consign taxpayers to compensate any cost and abide any load to stop the fall of America’s leading financial institutes. This would have been evaded, the report debated that if the Fed had paid notice to disinterested counselors with a fewer narrow-minded comprehension of the communal interest. Federal administration and Treasury bureaucrats discharge this assessment as second-conjectures of hard-hitting resolutions they had to craft in the plunge of 2008, in the midst of the speedy-moving international crisis. However, twenty four months later, those contentious decisions stay extremely relevant. Public irritation has not subsided. It compelled the election confusion that the election year menaced to topple sittings in both parties that elected the bank bailouts. Even though, the AIG rescue was implemented in the declining periods of George W. Bush’s administration, the trendy sense of prejudice has profoundly scarred the current Barrack Obama, given that he too approved a forgiving advancement toward blameworthy financial interests (Engel and Patricia, 106). Obama emerged into office with the reason of restoring civic faith in the administration. His lenience of the mammoth-banks guided to the differing result. Moreover, the AIG tale raises actual doubts and thoughts concerning how the administration will react in the next instance. There is as well doubt whether the latest financial restructuring legislation truly corrects administration’s esteem to the acmes of clandestine financial power. Enormous federal involvement was unquestionably compulsory, the Warren board concurs, including rapid action to preclude AIG’s economic failure. However, government rebuffed to stipulate anything in return. The report established that the AIG bail was implemented in manners that had “venomous consequences” on the fiscal marketplace and civic opinion. Cynical anticipations were verified, both for residents and financial participants. It materializes that some fiscal business are merely “too large to fail,” and that Washington will never allow them fall and will overlook what the president states. Effects of Bailout After the federal bailout of the AIG Company, various effects were experienced. The instant impact of the bailout was obvious on investor confidence. With the rising level of household income and consumer expenditure and in the start of 2009, the AIG scandal surpassed the markets. Taking into consideration that many Americans own shares and securities with worldwide capital markets, they responded assertively to AIG public releases and regime bailout packages. The US economy and, as a result, the worldwide economy, were affected by the governmental measures to aid a business enemy recover. Most of the financial institutions that had insured their plants and property with this insurance company did not have to re value their property. The bailout helped rescue investments that would otherwise be at risk (Stockton, 1). Employees of the company who were the verge of losing their employment opportunities were saved. Bailing of AIG led to bailing of jobs too. AIG being a large company had employed a large number of employees hence its bailout was essential to protect the workers source of livelihood. Creditors were paid almost 90% of the money given as bailout. This helped in recovering the amount that stood to lose in the event of a collapse. The bailout also became the liabilities bailout. The insurance market became competitive again because a major company had a rebirth and was now ready to battle it out with its rivals. The competitiveness made the shares prices of the rivals decline as some shareholders regained some confidence in AIG (Egginton, et al, 7). Any investor that had been involved and had dealt in business with AIG, came to terms with the reality of their own investment going under, hence after the bailout, and some of them withdrew their investments for fear of future collapse of the company. The bailout led to the government owning 79.9% equity of the company in exchange. They therefore continued to provide loans to the company that continued to experience losses for some time. This made the government a major shareholder in the company and hence had powers to make decisions on behalf of the company.AIG after the bailout was the target of widespread anger as an outcome of the 165 million dollars rewarded in a windfall to AIG superior administration and traders that essentially caused the crumple. Investors and taxpayers in general were dismayed at the thought of those who caused AIG's failure and financial distress to be rewarded (Egginton, et al, 16). The AIG bailout led to reengineering of management that investors thought was corrupt. Since the cash used in the bailout was the taxpayers’ money; they became vigilant on the company’s affairs after the bailout. This scrutiny led to improved management of the company. This bailout led to a lot of government revolt by taxpayers who thought the government had not explored all options before making the decision. This bailout has since become a government failure. The bailout occurred when the economy was experiencing depression. It therefore led to overcoming the depression. However, past experiences have shown that recessions are resolved only when inflated prices stabilize, and the company is yet to achieve this. The government gave the company a way out of their crisis, but taxpayers are needed to make this bailout a success. AIG posed instability in the financial market hence its bailout enabled the government restore the investors’ confidence though not fully (Egginton, et al, 20). Works cited Dinallo, Eric. Hearing on “American international group: examining what went wrong, government intervention and implications for future regulations. New York state insurance department. 2009. Pp 1-8. Egginton, Jared, Liebenberg, Andre and Liebenberg, Ivonne. What effect did AIG’s bailout, and the preceding events, have on its competitors? 2009. Pp 1-29. Engel, Kathleen C, and Patricia A. McCoy. The Subprime Virus: Reckless Credit, Regulatory Failure, and Next Steps. New York: Oxford University Press, 2010. Print. International Swaps and Derivatives Association. AIG and Credit Default Swaps. Web. Jun 16, 2012. Available at: < http://www.isda.org/c_and_a/pdf/ISDA-AIGandCDS.pdf> Jacque, Laurent L. Global Derivative Debacles: From Theory to Malpractice. Singapore: World Scientific, 2010. Print. Lewitt, Michael E. The Death of Capital: How Creative Policy Can Restore Stability. Hoboken, N.J: John Wiley & Sons, 2010. Internet resource. Ritholtz, Barry, and Aaron Task. Bailout Nation: How Greed and Easy Money Corrupted Wall Street and Shook the World Economy. Hoboken, N.J: John Wiley & Sons, 2009. Print. Roth, Zachary and Buchwalter, Ben. The Rise and Fall of AIG’s Financial Products Unit. TPM. March 20, 2009. Accessed at, Stockton, Gilbert. The Effects of Bailouts on the Stock Market. Ezine articles. 2008. Accessed at, < http://ezinearticles.com/?The-Effects-of-Bailouts-on-the-Stock-Market&id=1629628> Sullivan, John. AIG Tries to Sell ‘Collateralized Death Obligations: Securitization of life settlements raises ethics, fraud concerns among critics. Advisorone. Accessed at, < http://www.advisorone.com/2011/04/22/aig-tries-to-sell-collateralized-death-obligations> Read More