Aig Bailout Essay
Xilin Yang (Celine)
The article introduces credit default swaps and explores the problems of the credit derivatives. By analyzing the AIG’s bailout, the article describes the regulation gap in the CDS market and states the regulation reform after the crisis. Part I is background, generally introduces the Wall Street crisis. How it happened? What consequence it has? Part II is mainly about AIG’s CDS business: how AIG got involved in the crisis and why the biggest world insurance company suddenly collapsed. Part III is about credit default swaps: definition, construction, and problems. Part IV is concerned on the regulation reform after AIG’s failure.
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AIG’s CDS Business * How AIG involved in financial crisis?
There is no problem with AIG’s insurance business. What pull AIG into the abyss is its subsidiary—AIG Financial Products Corporation (AIGFP). AIGFP issue a large number of credit default swaps (CDSs) on super senior tranches of multi-sector collateralized debt obligations (CDOs.)
For investors who own CDOs, credit default swaps work like an insurance policy. An investor who purchased a credit default swap pays AIG a quarterly premium. If no credit event occurs the protection seller retains the premium payment, while when the CDOs goes bad, AIG promises to pay the investor for their losses.
Selling CDS became a significant and profitable business for AIG. AIG’s Financial Products division in London issued $533 billion worth of credit default swaps at the year-end 2007, many of them for CDOs backed by subprime mortgages. Investors welcome CDS, since they didn’t need to worry about counterparty credit risk any more.