Due date: Friday November 20, 2015
Too Big to Fail
American International Group, INC (AIG) case
Introduction
AIG is the story of a company, and its network of financial partners, who took
unprecedented risk and fell because of it. To prevent global economic disaster, the U.S.
government came to its rescue. This has resulted in the biggest taxpayer bailout of a private
company in American history.
Background
American International Group, Inc. – also known as AIG – is an American
multinational insurance corporation with more than 88 million customers in 130 countries. AIG
companies employ over 64,000 people in 90 countries. The company operates through three core
businesses: AIG Property Casualty, AIG Life and Retirement and United Guaranty Corporation
(UGC). AIG Property Casualty provides insurance products for commercial, institutional and
individual customers. AIG Life and Retirement provides life insurance and retirement services in
the United States. And UGC focus on mortgage guaranty insurance and mortgage insurance. AIG
also focuses on global capital markets operations, direct investment and retained interests. AIG’s
corporate headquarters are in New York City, its British headquarters are in London, continental
Europe operations are based in La Défense, Paris, and its Asian headquarters are in Hong Kong.
The company serves 98% of the Fortune 500 companies, 96% of Fortune 1000, and 90% of
Fortune Global 500, and insures 40% of Forbes 400 Richest Americans. AIG was ranked 40th
largest company in the 2014 Fortune 500 list. According to the 2014 Forbes Global 2000 list,
AIG is the 42nd-largest public company in the world. As of June 1, 2014, it had a market
capitalization of $78.48 billion, per Google Finance.
Cornelius V. Starr started AIG as “American Asiatic Underwriters” in 1919 in Shanghai,
China. He moved from Shanghai to New York after the Communists came to power in 1949. In
1962, he gave management of the company’s lagging U.S. holdings to Maurice R. Greenberg,
who shifted its focus onto selling insurance through independent brokers rather than agents. In
1968, Starr named Greenberg his successor. Then AIG went public in 1969. Greenberg was fired
due to accounting scandal in February 2005 and was succeeded as CEO by Martin J. Sullivan.
On June 15, 2008, Sullivan resigned and was replaced by Robert B. Willumstad, Chairman of the
AIG board of Directors. Willumstad was forced by the U.S. government to step down and was
replaced by Edward M. Liddy on September, 18, 2008.
AIG faced the most difficult financial crisis in its history when a series of events unfolded
in late 2008. The insurer had sold credit protection through its London unit in the form of credit
default swaps (CDSs) on collateralized debt obligations (CDOs) but they had declined in
value. The AIG Financial Products division had entered into credit default swaps to insure $441
billion worth of securities originally rated AAA. Of those securities, $57.8 billion were
structured debt securities backed by subprime loans. As a result, AIG’s credit rating was
downgraded and it was required to post additional collateral with its trading counter-parties,
leading to a liquidity crisis that began on September 16, 2008 and essentially bankrupted all of
AIG.
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Due date: Friday November 20, 2015
The United States Federal Reserve Bank created an $85 billion credit facility to help AIG
meet increased collateral obligations, in exchange for stock warrants worth 79.9% of the
company’s equity. To date, the U.S government’s total loan package to AIG has topped $182.5
billion (Hamilton 2009). This has made AIG the largest government bailout of a private company
in U.S. history.
Since September 2008, AIG has marketed its assets to pay off its government loans. A
decline in the valuation of insurance businesses, and the weakening financial state of potential
bidders, has hindered its efforts (Barr 2009). On March 2, 2009 AIG reported a fourth quarter
2008 loss of $61.7 billion. The announcement of the loss had an impact on morning trading
Europe and Asia, with the FTSE100, DAX and Nikkei all suffering steep losses. In the U.S., the
Dow Jones Industrial Average fell to below 7000 points, a twelve-year low. On top of these
losses, in March 2009 AIG was attacked by the public and media for its retention payment of
$165 million. As a result of public anger over these employee bonuses, AIG has rebranded a
majority of its business under AIU holdings, Inc (Kaiser & Daly 2009). Liddy announced on
May 21, 2009 that he is resigning, but will stay until a new CEO is hired. He receives a salary of
$1 and equity grants, though he may be “eligible for a special bonus for extraordinary
performance payable in 2010” (Barnes 2009).
Financial Analysis
The financials for 2008 were not good, as AIG posted a $99 billion loss for the year.
However, the first quarter of 2009 looks promising with revenue in the first quarter of 2009
outperforming all of 2008. Earnings-per-share is poor, but the first quarter 2009 loss was
considerably lower than fourth quarter 2008. It is the hope of the markets that AIG has started to
rebound from the low points of their 2008 crisis.
Financial Highlights for AIG (July 20, 2009) from MSN Money
Sales
17.53 Billion
Income
-97.25 Billion
Net Profit Margin
-557.83%
Return on Equity
-155.05%
Debt/Equity Ratio
4.09
Revenue per Share
130.87
EPS(Earnings per share)
-720.86
Book Value per Share
340.12
Dividend Rate
0.00
Payout Ratio
N/A
Revenue-Quarterly for AIG (In Millions, 2009)
1ST Quarter
2nd Quarter
3rd Quarter
4th Quarter
Total
FY(2009)
20,458
N/A
N/A
N/A
20,458.0
FY(2008)
14,031
19,933.0
898.0
-23,758.0
11,104.0
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FY(2007)
30,645.0
31,150.0
29,836.0
18,433.0
110,064.0
Due date: Friday November 20, 2015
Earnings per Share for AIG (In Millions, 2009)
1ST Quarter
2nd Quarter
3rd Quarter
4th Quarter
Total
FY(2009)
-$39.67
N/A
N/A
N/A
-$39.67
FY(2008)
-$61.75
-$41.13
-$181.04
-$459.02
-$742.94
FY(2007)
$31.62
$32.87
$23.95
-$41.51
$46.93
Quarter over Quarter ESP Growth Rate AIG (In Millions, 2009)
1ST Quarter
2nd Quarter
3rd Quarter
4th Quarter
FY(2009)
91%
N/A
N/A
N/A
FY(2008)
-49%
33%
-340%
-154%
FY(2007)
–4%
-27%
N/A
Year over Year Growth Rate AIG (In Millions, 2009)
1ST Quarter
2nd Quarter
3rd Quarter
4th Quarter
FY(2009)
36%
N/A
N/A
N/A
FY(2008)
N/A
N/A
N/A
N/A
FY(2007)
N/A
N/A
N/A
-1,006%
Causes of Failure
By 2007, the CDS market had grown into a $70 trillion annual business. In selling CDS, AIG
was receiving huge payments. AIG’s FP unit was an endless money machine, adding $6 billion
of riches to AIG’s reserves from 1988 until 2005. Ironically, AIG’s trouble began when its
Financial Products (FP) unit started selling default swaps. AIG FP developed a portfolio of $2.7
trillion in credit derivatives. AIG became liable for much more money than it could pay out if the
portfolios were to default. In 2008, AIG FP piled up $40 billion in losses related to its dealings in
complex mortgage bond derivatives. When it was initially writing all that CDS protection, AIG
thought it wasn’t possible to take ant losses because its contracts were supporting such highly
rated, highly protected slices, according to a former AIG FP employee. AIG FP lost more than
$10 billion in 2007 and $14.7 billion in the first six months of 2008.
As long as AIG FP was producing a profit, senior management didn’t ask or care how it was
being achieved. Martin Sullivan, who was fired from being Chief Executive of AIG in June
2008, had even eliminated a twice-a-month meeting to assess the work of the unit. “He wasn’t
really interested in the business”, this person said.
Howard Sosin founded AIG FP in 1987, and remained there until 1993. When he was first
hired at AIG, Howard Sosin was offered a 20 percent stake in the FP unit and 20 percent of its
profits (Browning 2008). While many hedge fund managers receive this type of incentive
program, this is a conflict of interest. This causes a manager to throw caution to the wind in order
to make a profit. Understanding that the higher the risk, the higher the expected return, Sosin was
given almost free reign.
By selling a large volume of CDS, AIG was taking a bigger lopsided position on a single
one-sided bet. AIG lacked the financial resources to make good on those contracts in the event
that the housing downturn became as severe as it has now proved to be. AIG underwrote
systemic risk. “One thing about the insurance model: it relies on diversification as its means to
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Due date: Friday November 20, 2015
exist,” said a top executive at an AIG competitor. “If an insurance company plays in a field
where it underwrites systemic risk, that is a totally different experience”. Insurance companies
can handle catastrophic risk but not systemic risk.
AIG was able to engage in risky business for so long because Washington looked the other
way. The company befriended politicians with campaign contributions, escaping regulation that
might have prevented the current crisis. Regulators never imagined the extent of the looming
defaults. AIG’s uncollateralized insurance business was regulated by Washington’s Office of
Thrift Supervision, whose task is to watch over savings-and-loan companies, not global insurers
(Saporito 2009). Evidently it wasn’t watching AIG. Joseph Cassano built up AIG FP on what’s
been described as regulatory arbitrage. As Federal Reserve Chairman Ben Bernanke explained,
“AIG exploited a huge gap in the regulatory system. There was no oversight of the Financial
Products division. This was a hedge fund basically that was attached to a large and stable
insurance company”.
On March 17, 2009, AIG announced that they were paying $165 million in executive
bonuses, according to news reports. Total bonuses for the financial unit could reach $450 million
and bonuses for the entire company could reach $1.2 billion. President Barack Obama, who
voted for the AIG bailout as a Senator responded to the planned payments by saying "[I]t’s hard
to understand how derivative traders at AIG warranted any bonuses, much less $165 million in
extra pay. How do they justify this outrage to the taxpayers who are keeping the company
afloat?" and "In the last six months, AIG has received substantial sums from the U.S. Treasury.
I’ve asked Secretary Timothy Geithner to use that leverage and pursue every legal avenue to
block these bonuses and make the American taxpayers whole." Politicians on both sides of the
Congressional aisle reacted with outrage to the planned bonuses. Political commentators and
journalists expressed an equally bipartisan outrage.
Too big to fail
Simply put, AIG was considered too big to fail. An incredible amount of institutional
investors – mutual funds, pension funds and hedge funds – both invested in and also were insured
by the company. In particular, many investment banks that had CDOs insured by AIG were at
risk of losing billions of dollars. For example, media reports indicated that Goldman Sachs
(NYSE:GS) had $20 billion tied into various aspects of AIG’s business, although the firm denied
that figure. Money market funds – generally seen as very conservative instruments without much
risk attached – were also jeopardized by AIG’s struggles, since many had invested in the
company, particularly via bonds. If AIG was to become insolvent, this would send shockwaves
through already shaky money markets as millions of investors – both individuals and institutions
– would lose cash in what were perceived to be incredibly safe holdings.
However, policyholders of AIG were not at too much risk. While the financial-products
section of the company was facing extreme difficulty, the vastly smaller retail-insurance
components were still very much in business. In addition, each state has a regulatory agency that
oversees insurance operations, and state governments have a guarantee clause that will reimburse
policyholders in case of insolvency. While policyholders were not in harm’s way, others were.
And those investors – from individuals looking to tuck some money away in a safe investment to
hedge and pension funds with billions at stake – needed someone to intervene.
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Due date: Friday November 20, 2015
American International Group, INC (AIG) case
Case Study
INSTRUCTIONS: After reading the attached case study regarding American International
Group, INC (AIG), answer the following questions in paragraph form using complete sentences.
Be sure to check for spelling, punctuation, and grammar before uploading your responses.
– Requirement
o 2-3 pages long
o Font size 11
o Font: times New Roman
1. List ethical dilemmas AIG faced before 2008 financial crisis
2. Who are the stakeholders of American International Group? Explain how each
stakeholder is tied to the company
3. Elaborate the causes, and consequences of Too Big to Fail in the AIG case.
4. What could be possible solutions for resolving the ethical dilemmas above?
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