Environmental Factors that cause AIG Scandal

This report discusses the environmental factors that led to the AIG scandal, including auditors, risky credit default swaps, political environment, credit rating, Hank Greenberg, and bid rigging.

Business Environment

Table of Contents
Introduction...............................................................................................................................2
Environmental Factors that cause AIG Scandal.........................................................................2
Conclusion..................................................................................................................................4
References..................................................................................................................................5
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Introduction
American International Group Incorporation (AIG) is the world’s largest international
insurance organisation. The business of the company is divided in three main corporations
which include United Guaranty Corporation (UGC), AIG Property Casualty and AIG Life and
Retirement. Mainly, the organisation focuses on factors such as mortgage insurance and
mortgage guaranty insurance. The corporation has over 88 million customers situated in
more than 130 countries. In the AIG scandal of 2005, the company was found guilty of $17
billion and the CEO and employees and the government has to bailout the company for
$182 billion. In this report, various environmental factors will be given to understand how
AIG scandal happened.
Environmental Factors that cause AIG Scandal
 Auditors
The auditor of the company was the biggest reason for its scandal.
PricewaterhouseCoopers was the auditors of the company for the previous two years
before the scandal. The auditor reported that the internal control of the corporation was
excellent, and they have no knowledge of the fraud until then. In reality, the internal and
management control of AIG was relatively weak (McDonald & Paulson, 2015). The auditors
rejected various red flags such as AIG previously conducted dubious transactions, faulty
paperwork and noncompliance with accounting standards.
 Risky credit default swaps
The company was mainly focusing on credit default swaps which include various
financial instruments such as insurance contracts on bonds. Since the insurance
corporations face the same risk regarding the property as its owners, they wanted to insure
their investment as well. AIG’s credit swaps did not require parties to put up any collateral
to be paid in case the market changes which increases the risk. Due to high credit rating of
AIG, the company was able to sell high number of credit swaps (Gethard, 2012017).
However, as their ratings lowered, the collateral provision kicked due to which the company
owed a great deal of money to its counterparties.
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 Too big to fail
One of the key issues with AIG was that people think it was too big to fail. The company
had incredible amount of mutual funds, hedge funds, pension funds and institutional
investors which were both invested in the company, and they were insured. People
investing in the company thought that their money is highly secured since the operations of
the company are so big and diverse which would protect them from adverse market impact.
 Political environment
During the time of the scandal, the political regulations were relatively weak, and the
Securities Exchange Commission was not monitoring the actions of larger enterprises
effective. Factors such as lack of political stability, flexible regulations and lack of strict
reporting policies contributed to AIG scandal (Greider, 2010).
 Credit rating
People and investors believe that investing in the real estate market is safer option for
them since all the credit agencies were giving it AAA ratings which were the highest ratings.
Public though that their money cannot lose if they invest in the real estate market, whereas,
in reality, the analysis showed that the assets which backup up the real estate securities
resulted in losing money in the long term. The credit rating agencies were not thoroughly
checking the operations of AIG based on which they were giving them AAA rating which
influenced the decisions of the investors (Amadeo, 2018). Due to high credit rating, the
company was able to attract more investors which resulted in increasing the negative
impact of the scandal. As soon as the credit ratings changed and lowered by the credit rating
agencies, investors started demanding money from AIG which it did not have, and it leads to
the AIG scandal.
 Hank Greenberg (CEO)
The CEO of the company, Hank Greenberg, was misusing his position and power to
conduct illegal activities in the corporation by non-complying with legal regulation. The CEO
was the main contributor due to which the scandal took place. He used his power and illegal
tactics to book loan for the company as revenue which resulted in increasing its net worth
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which attracted more and more investors towards the company (Reich, 2011). Furthermore,
the CEO also sends clients to other insurance corporations who he had previous deals with.
The CEO has payoff deals with these companies which he completed by sending customers
to them. Based on these deals, the CEO was earning more and more money without facing
any legal consequences.
 Bid rigging
Another reason for causing of AIG scandal was big rigging in which two or more parties
agreed to call for bids in which one or more of them would not submit a big or withdraw
their bid based on a previous agreement. Generally, bid rigging is used by competitors to
artificially increase the price of their goods and services which adversely affect the
customers. Hank Greenberg was the mastermind behind this scandal. He used payoff
agreements and influenced traders to inflate their stock prices which resulted in big rigging
and stock price manipulation (Foley, 2009). Due to such big rigging, the share prices of AIG
were artificially increased which attracted more investors towards the company. Greenberg
showed off to the public that the company has lots of reserves and money whereas, in
reality, it did not have any.
Conclusion
From the above observations, it can be concluded that there are various
environmental factors which resulted in causing the AIG scandal. The mastermind of this
scandal was the CEO of the company, Hank Greenberg, who used factors such as bid rigging
and stock price manipulation to increase the stock price of the company which leads to the
scandal. He also showed loans as revenue for the company to show that the company has
large reserves. Furthermore, fake credit ratings, risky credit default swaps, failure of
auditors and political environment are some of the factors which resulted in contributing to
the AIG scandal.
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References
Amadeo, K. (2018). AIG Bailout, cost, timeline, bonuses, causes, effects. Retrieved from
https://www.th0. ebalance.com/aig-bailout-cost-timeline-bonuses-causes-effects-
3305693
Foley, J. (2009). The Ultimate Cause Of AIG's Problems. Retrieved from
https://www.forbes.com/2009/03/19/aig-failure-sullivan-leadership-governance-
soul.html#96dd94fc0596
Gethard, G. (2017). Falling Giant: a Case Study of AIG. Retrieved from
https://www.investopedia.com/articles/economics/09/american-investment-group-
aig-bailout.asp
Greider, W. (2010). The AIG Bailout Scandal. Retrieved from
https://www.thenation.com/article/aig-bailout-scandal/
McDonald, R. & Paulson, A. (2015). What Went Wrong at AIG?. Retrieved from
https://insight.kellogg.northwestern.edu/article/what-went-wrong-at-aig
Reich, R. (2011). The Real Scandal of AIG. Retrieved from
https://www.huffingtonpost.com/robert-reich/the-real-scandal-of-
aig_b_175105.html
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