AIG Bailout: Cost, Timeline, Bonuses, Causes, Effects

Why It Made Bernanke "Angrier Than Anything Else in the Recession"

Former Federal Reserve Chairman Ben Bernanke reported that the bailout of AIG made him more angry than anything else in the recession. Bernanke said that AIG took risks with unregulated products, like a hedge fund, while using cash from people's insurance policies. He said that the government had no choice but to bail it out to avoid the same kind of economic collapse that occurred when Lehman Brothers went bankrupt in September 2008. (Source: Bernanke Says Insurer AIG Operated Like a Hedge Fund, March 3, 2009)

What Caused the Bailout?

Bernanke Angry Over AIG Bailout
Photo: Chip Somodevilla/Getty Images

How did a boring, ultra-safe insurance company become one of the largest bailouts in the 2008 financial crisis?  To boost its profit margin, AIG had become a major seller of "credit default swaps" (CDS).These swaps insured the assets that supported corporate debt and mortgages. If AIG went bankrupt, it would trigger the bankruptcy of many of the financial institutions bought these swaps.

AIG was so large that its demise would impact the entire global economy. For example, the $3.6 trillion money-market fund industry invested in AIG debt and securities. Most mutual funds owned AIG stock. Financial institutions around the world are also major holders of AIG's debt.

AIG's CDS against subprime mortgages pushed the otherwise profitable company to the brink of bankruptcy. As the mortgages tied to the swaps defaulted, AIG was forced to raise millions in capital. As stockholders got wind of the situation, they sold their shares, making it even more difficult for AIG to cover the swaps.

Even though AIG had more than enough assets to cover the swaps, it couldn't sell them before the swaps came due. This left it without the cash pay the swap insurance. (Source: WSJ, U.S. to Take Over AIG, September 17, 2008)

2008: Details of Bailout

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Photo: Chip Somodevilla/Getty Images

On September 16, 2008, the Federal Reserve provided an $85 billion, two-year loan to AIG to prevent its bankruptcy and further stress on the global economy. 

In return, the Fed owned 79.9% of AIG's equity, the right to replace management, and veto power over all important decisions, including asset sales and payment of dividends. It replaced management and has veto power over all important decisions, including asset sales and payment of dividends.

The bailout occurred exactly one day after U.S. Treasury Secretary Henry Paulson said no to further Wall Street bailouts, allowing Lehman Brothers to go bankrupt. It came one week after the government took over Fannie Mae and Freddie Mac and six months after the Fed bailed out Bear Stearns. Later than week, Paulson and Bernanke headed to the Capitol to ask for a $700 billion bank bailout to rescue all other banks.

In October 2008, the Fed hired Edward Liddy as CEO and Chairman to break up AIG and sell off the pieces to repay the loan. However, the stock market plunge in October made that impossible, as potential buyers needed any excess cash for their own balance sheets. Meanwhile, Liddy had to safely unwind billions in credit default swaps. (Source: AP, Government Provides Record Aid Package to AIG, November 11, 2008)

On November 8, 2008, the Federal Reserve's $85 billion bail-out of insurance giant AIG was revised. The Treasury Department purchased $40 billion in AIG preferred shares from its Capital Repurchase Plan. The Fed purchased $52.5 billion in mortgage-backed securities. The funds allowed AIG to retire its credit default swaps rationally, stave off bankruptcy and protect the government's original investment.

March 3, 2009: AIG Reported Biggest Corporate Loss in History

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AIG's loss caused the Dow to plummet.. Photo by Chris Hondros/Getty Images

AIG reported the largest loss in corporate history, a record $61.7 billion for Q4 2008 alone. As a result of AIG's loss, the Dow fell nearly 300 points to close at 6,763.29, the lowest close since April 25, 1997 when it closed at 6,738.27. It was also lower than in the previous recession, which was 7,197 on October 9, 2002. The Dow dropped over 50% from its all-time high of 14,164, reached on October 9, 2007.

In addition to AIG's loss, investors were spooked that Obama's economic stimulus package was not large enough. Citigroup requested a third installment of government aid and Warren Buffet's Berkshire Hathaway posted its worst book loss in its history. (Source: Bloomberg, Stocks Drop Worldwide, March 2, 2009)

The Bonus Scandal

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AIG bankers received bonuses. That made people really mad.. Photo: Silvestre Machado/Getty Images

After reporting this loss, and taking the bailout, AIG had the nerve to pay $165 million in bonuses. People were outraged, even issuing death threats against AIG CEO Edward Liddy.

However, these were not merit bonuses, based on performance. They were retention bonuses. The AIG employees were asked to stay and safely unwind the credit default swaps, whose markets have disappeared. These derivatives are so complicated that no one else really understands them. They are also time sensitive. Unfortunately, it will take the same level of sophistication to get out of this mess safely that it took to get into it. Letting these swaps fall apart could cost the U.S. government, which now owns 79% of AIG, much more than $165 million.

AIG CEO and Chair Edward Liddy was hired by the Federal Reserve for a $1 salary last October. He successfully supervised a difficult strategy that safely reduced many of the outstanding credit default swaps. This protected your ownership in the company as a taxpayer. It also protected your retirement portfolio, since many mutual funds and even money market funds had invested in AIG's swaps.

2012: U.S. Treasury Sold Last of AIG Stock, Making a Profits

In December 2012, the Treasury Department sold off the last of its remaining shares of AIG. In total, the government and taxpayers made a $23 billion profit from the AIG bailout. That's because AIG was worth a lot more in 2012 than it was in 2008. (Source: CNBC, Does the U.S. Treasury Own Capital Gains on AIG Profits?, December 11, 2012)

2015: AIG to Pay Nearly $1 Billion to Settle Shareholder Suit

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AIG paid hundreds of millions to shareholders.. Photo: Getty Images

 AIG investors, led by the State of Michigan pension, accused the company of misleading shareholders about how risky the credit default swaps were that it issued. AIG agreed to pay $970.5 million to investors who bought AIG share between March 16, 2006, to September 16, 2008. This was one of the largest class-action settlements from the 2008 financial crisis. (Source: " AIG to Pay Nearly $1 Billion to Settle Class-Action Suite Brought by Shareholders," New York Times, March 22, 2015)

What Is AIG Insurance?

AIG (American International Group), with 116,000 employees, is one of the world's largest insurers. Most of its business is general life, auto, home, business and travel insurance, as well as retirement products like fixed and variable annuities.

It got into trouble when it moved beyond its traditional insurance business. The Financial Services division also got into aircraft and equipment leasing, capital markets, consumer finance and insurance premium finance. The Asset Management operations provided institutional and retail asset management, broker-dealer services and institutional spread-based investment business. 

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