Nationalization Of The American International Group Finance Essay

Introduction

This essay will describe about the American International Group ( AIG ) and why it had to come to a 80 % nationalisation of the company. The company originally had been founded 90 old ages ago by C.V. Starr. It started as a little insurance concern in 1919 in China ( Gilani 2008 ) . 81 old ages subsequently after the new millenary the former little insurance company became one of the biggest in the World. It operated in around 130 states and served about 74 million clients. Furthermore before the crisis AIG owned a value of assets of estimated US $ 1 trillion with one-year grosss of circa US $ 110 billion p.a. ( AIG 2003 ) . This success narrative ended surprisingly in 2008 when the company which had up to this twelvemonth singular figures to show found itself non able to cover its obligatory payments on certain contracts that it had signed earlier. The job was so terrible that the FED and the federal authorities of the USA had to step in and provide the company with adequate financess to protect it from denoting it ‘s officially bankruptcy ( AIG 2011 ) .

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1 AIG the company

AIG as already mentioned has started as a little insurance company in China. There it was one of the first Western companies located in Shanghai ( AIG 2003 ) . An extra office followed in 1926 in New York which had later besides been transformed into the new companies headquarter. At that clip AIG was runing under the name of American International Underwriters besides at that clip known as AIU. In the late 40s AIU expanded even more by opening farther offices in South America ( ebenda ) . One of the first 1s which had been opened was located in Cuba ( Ehrbar, Shelp 2006. p.52 ) . This transmutation of the company went on and on. Particularly after CEO Maurice Greenberg started to diversify the insurance company which resulted into an amazing US $ 1 trillion balance sheet ( AIG 2003 ) . But the good looking Numberss were subsequently overshadowed when AIG ‘s Financial Products subsidy AIGFP started to come in into the concern of barter portfolio default underwritings which subsequently chiefly contributed to the demolishment of the whole company.

1.1 AIGFP

The fiscal Product division of AIG was founded in 1987 when H. Greenberg had been convinced to make a new subdivision that focused on derived functions trades. The advantage was that the AIGFP section was able to work under the so called three-base hit A evaluation of its female parent company AIG. The first trade undertaken by the company was a US $ 1 billion involvement rate barter with the Italian authorities ( Buchwalter, Roth, 2009 ) . Within 6 month the company was able to derive US $ 60 million. In entire 38 % of the sum stayed in the company and the remainder went to the chief company AIG itself. After the concern managed to execute quiet well it expanded its ain offices to Tokyo and London. In 1998 the company had one-year grosss of US $ 500 million which had been achieve up to this phase without doing a individual recognition barter. This changed when JP Morgan on of the biggest investing Bankss in the USA convinced AIGFP to see its debts in instance of default. In exchange for subventioning this insurance, AIGFP would have an indirect dividend in a signifier of a fee or premium ( ebenda ) . The fiscal merchandise division of AIG accepted the trade because chance theoretical accounts tested by Gary Gordon resulted that the wage out of this insurance would ne’er go on. The trials seemed to be trusty because of a per centum rate of 99.85. It was besides said that in the worst instance scenario which would hold been a “ fiscal crisis ” JP Morgan would be wiped out, so that they would non be able to demand the hard currency out from AIGFP ( ebenda ) .

1.2 AIGFP starts to fall in

Four old ages subsequently in 2002 the company got accused by the US Justice Department for illicitly assisting a house called Financial Services Group ( PNC ) to hide bad assets from its balance sheets ( Bloomberg Businessweek, 2004 ) . This error cost the company a mulct of US $ 80 million and an extra US $ 46 million fee for all the involvement that AIGFP earned through the trade ( SEC, 2004 ) . The following job was that AIG ‘s chief section besides had been accused of pull stringsing its militias to increase them to around US $ 1.7 billion ( Taub 2005 ) . The usage of accounting methods which were to a great extent against the accounting jurisprudence had the consequence that the company got more and more under probe by the Securities and Exchange Commission “ SEC ” . After probes started which resulted that the long term CEO Greenberg stepped back, the company was re-evaluated by the evaluation bureaus. The consequence of this procedure was that AIG had to be downgraded. This meant that the company moved from an AAA evaluation to AA evaluation ( Bloomberg Businessweek, 2004 ) . However this downgrading besides had a important consequence on its subsidy AIGFP in London because now it had to supply more securities and collateral for its trades.

2 The Financial Crisis

A few old ages before the large fiscal crisis in 2007 an extra, this clip internal probe in AIGFP revealed that the companies swap portfolios had been loaded with tonss of collateralized debt duties “ CDOs ” . These duties contained a high sum of sub-prime mortgages. The job with CDOs is that they are constructed with borrowers that are non able to acquire high recognition evaluations ( Investopedia, 2010 ) . In other words mortgages were lent to costumiers under rates, which would increase over clip so called “ teaser rates ” . Normally this is non a terrible job if the debitors have sufficient financess or income. For this ground sub-prime loans are besides known as “ Ninja Loans ” . They fundamentally contain people that do non hold a proper income, assets or occupation to pay back the mortgage rates. Still during that clip a batch of Bankss handed out loans to these clients ( Long 2008 ) . This leak of look intoing consequences is the job that sub-prime mortgages have a manner higher possibility of default than conventional mortgages ( Investopedia, 2010 ) . Harmonizing to Fudda ( 2008, p.1 ) the sum of sub-primes in general increased from 2003 to 2005 by 14 % points from 8 % to 22 % which was related to the higher outputs that they provided in comparing to safer exchequer bonds. In pecuniary footings this addition of 14 points within the old ages of 2003 and 2005 had been an addition from US $ 240 billion to US $ 912 billion. The job was that AIG on its ain owned US $ 441 billion of the entire sum through its default barter portfolios ( Fudda 2008, p.2 ) .

These new findings meant that because of the downgrading of AIG as mentioned before, AIGFP had to come up now with more collateral. Even though the company in 2005 stopped acquiring new barters incorporating sub-prime mortgages the company was non able to undo the already accounted US $ 80 billion deserving debt duties ( Buchwalter, Roth, 2009 ) . However AIGFP still believed that they would ne’er hold to anticipate any extremely losingss on their stakes and classified them as minor issues. This position ended merely a few months after the lodging market began to prostration and the first client started to demand its payout. This company was Goldman Sachs which demanded US $ 1.5 billion of collateral from AIG to cover the mortgage securities for which AIG had insured them ( ebenda ) . AIG experienced now that the underwriting of sub-prime mortgages at low rates and merely having low premiums were non able to make adequate liquidness militias to cover the outstanding claims.

The company ‘s subsidy in London had to set up US $ 2billion to guarantee its AAA evaluation because more and more people started demanding collateral from them. The state of affairs worsened when the stock value of AIG dropped. First by 25 cent per portion which was about a loss of US $ 352 million and subsequently the figure had to be corrected to US $ 1.1 billion ( ebenda ) . The company got more and more under onslaught for inaccurate accounting particularly AIGFP. However, AIG still said that the state of affairs would be under control and their portfolios would hold been good evaluated and could non do terrible losingss. This proclamation was non truly converting because the company had to acknowledge in early 2008 that the losingss were at around US $ 11 billion dollars. After Greenberg ‘s replacing, CEO Cassano resigned from his place and left the sinking company merely earlier AIG was about to be downgraded once more ( Buchwalter, Roth, 2009 ) . The mentality of another re-downgrading was about to complete the company because it meant that more people would get down to demand collateral from AIG which it evidently non had. The state of affairs was so unstable that AIG tried to negociate about acquiring a loan from investing Bankss such as Goldman Sachs and JP Morgan which were major swap-credit default contract parties of AIG.

3 Nationalization of AIG

September 2008 had changed many things in New York and on the stock market. It was non merely AIG that was about to make a about position of being insolvents besides other large companies or Bankss for illustration Lehman Brothers had to denote that they were non liquid any longer. Merely two yearss after AIG would hold to confront the same job the company ‘s portions as displayed in graph 1, dropped on September 16 from US $ 80 to US $ 1.25. Besides harmonizing to Fudda ( 2008, p.1 ) the market capitalisation of AIG ‘s stock dropped from US $ 185 billion to simply US $ 5.5 billion.

Graph cubic decimeter: AIG Stock Value Decline

( CNBC 2009 )

After all the occurrences Tim Geithner the caput of the Federal Reserve Bank in New York tried to see if there would be a solution for AIG. Even though it was clear that AIG was an insurance company and non a bank it became clear that the job with AIG was more debatable and closer related to the US, European and Asian markets than really expected ( Greider, 2010 ) . After recognizing this, Geithner called in a meeting with the caputs of JP Morgan and Goldman Sachs to convert them that they should supply a span loan to give AIG more clip to derive liquidness. The program was that JP Morgan would step up as a chief loaner and Goldman Sachs as a kind of helper or advisor to sell certain assets so that AIG would be able to increase its capital. The Fed besides thought that by including the two Bankss to assist AIG, other Bankss would possibly besides follow. This program did non work because the Bankss merely declined the Feds program and it seemed that the Fed would hold to bail out AIG itself ( ebenda ) .

At the same clip some of the bigger stockholders of AIG tried to roll up necessary liquidness in the private markets to get away from a endangering nationalisation of the company. AIG shortly had to accept that it had non many other options from get awaying the proclamation of its bankruptcy. After they realized that the FED was one of the lone options they had, an understanding was signed. The contract that they signed contained the judicial admissions that the FED would bail out AIG by supplying the company US $ 85 billion dollars but under the status that it would acquire 79.9 % of the company ‘s portions which equalled about 80 % of voting power. The offered continuance of the loan was two old ages and in add-on besides 80 % of all dividends the company gained would hold to flux from now on to the FED ( Holm, Sun, 2008 ) . Even though it was clear that at the terminal the US $ 85 billion would hold to be bared by the revenue enhancement remunerators of the US, the FED at this point had no other pick than to bailout the company. Even the former Chairman and CEO Greenberg ( CNBC 2009 ) said that the linkages and the connexions to other economical countries universe broad would be so strong and relevant that allowing the company file in bankruptcy would do a black consequence on the planetary economic system and its participants ( CNBC News 2009 ) .

However the deliberate sum of money was non plenty so the Fed had to shoot twice an extra sum of US $ 12 billion right after the first US $ 85 billion. At the terminal the sum of money which had been handed to AIG reached around US $ 150 billion ( CNBC News 2008 ) .

4 Available Options

Before we come to the decision this subdivision will look at what options where really available for AIG? As we heard one of the other options would hold been a span loan. This would hold merely worked if the before asked Banks would hold agreed to it. The contention is that the FED of New York would hold really been able to coerce the Bankss but did non make it. Furthermore through non actions like this the bank got under crisp critic why they decided to bail out AIG but non other large Bankss or companies that filed in the same proposal. In add-on other voices criticized that the chief creditors really received dual payments ( Geider2010 ) . For illustration JP Morgen and Goldman Sachs who received money before from the FED now received extra bond out money because the money transferred to AIG at the terminal was fluxing directly to their histories.

This would hold been another ground why they should hold really agreed to the span loan so that the revenue enhancement remunerators at the terminal would hold non bared double the costs ( ebenda ) .

An about rather similar option would hold been a in-between manner of bond out from FED and those Bankss to minder the taxpayers ‘ load.

The FED in general has far more than adequate power to endanger or coerce Bankss to make as they had been asked. The last option would hold been to merely non to assist AIG. The effects here are now hard to foretell. It could hold resulted into a deterioration of the whole state of affairs or the linked opposite numbers would hold managed to get by with the effects?

5 Decision

To sum up the occurrences we can see that, foremost there were loopholes and mistakes in the accounting system. This contributed to the job because otherwise it would hold been more hard for AIG to pull strings its histories. Besides the governments in charge for fiscal ordinances should hold tried to happen ways to cut down the attractive force for investors to theorize or make concern with CDOs. AIG ‘s nationalisation at the terminal was necessary because excessively many other large companies or Bankss for illustration JP Morgan in the USA or even Alianz from Germany would hold been affected by non assisting AIG. This means the planetary impact by allowing this insurance company default might hold been really drastic and could hold caused many other negative effects because many other subdivisions were attached to it. One thing that is clear is that Goldman Sachs and JP Morgan should hold reacted in a different manner and possibly should hold agreed to the span loan option. Particularly the sum of money which had to flux into the system was truly high and the ensuing load for the revenue enhancement remunerators excessively. However it was at the terminal necessary to happen a solution to incorporate the possibility to decline the already bing economic sciences crisis.

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