The AIG Bailout

Table of ContentsI. Introduction 944II. AIG's Operations 945A. Overview 945B. Credit Default Swap Primer 947C. AIG's Credit Default Swap Business 952III. AIG's Collapse 959A. Credit Default Swaps on Multi-Sector Collateralized Debt Obligations 959B. Securities Lending Program 961C. Inability to Access Capital Markets and Credit Downgrade 962IV. The Bailout 963A. Initial Bailout 964B. Additional Lifelines 968C. Bailout Restructuring I 969D. Bailout Restructuring II 972E. Grand Total 974F. Legal Issues 976G. Why the Bailout? 977V. The (Lack of) Regulation of Credit Default Swaps 983A. Regulatory Gap 983B. Regulatory Reform 989VI. Conclusion 990I. IntroductionOn February 28, 2008, American International Group, Inc. (AIG), then the largest insurance company in the United States,1 announced 2007 earnings of $6.20 billion or $2.39 per share.2 Its stock closed that day at $50.15 per share.3 Less than seven months later, however, AIG was on the verge of bankruptcy and had to be rescued by the United States government through an $85 billion loan.4 Government aid has since grown to $182.5 billion,5 and as recently as June 2009 AIG's stock traded at less than $1.00 per share.6AIG's collapse was caused largely by its $526 billion portfolio of credit default swaps (CDSs), a type of credit derivative widely used by financial institutions but, up until recently, largely unknown by the general public.7 AIG's troubles have been covered extensively by the media but are difficult to comprehend fully because of the esoteric financial instruments involved. Thus, this Article weaves explanations of CDSs, asset-backed securities, securitization, tranching, and collateralized debt obligations into a detailed and systematic account and analysis of what went wrong at AIG and why the government bailed it out. A thorough understanding of these events is important because of the unprecedented size of the bailout and attendant calls for increased regulation of CDSs.Part II provides a brief overview of AIG' s operations, a primer on CDSs, and analysis of AIG's CDS activities. Part III explains how AIG's CDS business pushed it to the brink of bankruptcy by draining it of cash. Part IV details the terms of the government bailout (including its two restructurings), explores why it was undertaken, and questions its necessity. Part V describes the regulatory gap exploited by AIG and offers some thoughts on regulatory reform. …