Analyzing the Impact of AIG's 2008 Financial Crisis on Global Markets

The assignment delves into the American International Group (AIG) credit crisis during 2008, highlighting its more severe impact compared to other institutions. It explores governmental interventions like the $182 billion US bailout and AIG's subsequent recovery through asset sales. The analysis extends to global repercussions such as market volatility, regulatory shifts prompted by entities like the Security and Exchange Commission, and systemic risk in the insurance sector. By examining these facets, the assignment provides a comprehensive understanding of how AIG’s crisis reshaped financial policies and practices worldwide.

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Abstract
American international group (AIG) is a financial institution that offers insurance services to
both distributors and consumers. AIGfaced a financial crisis in 2008 due to debt and reckless
management. The institution was unable to insure claims made by its clients. AIG credit
crisis placed pressure on mortgage securities and economic growth. This was beneficial to
AIG`s competitors but a great fear in most international investors. It caused an economic
disturbance due to fluctuations in interest rates and security exchange rate (Ericson, & Starc,
2015).US government decided to bailout the institution from the financial crisis. US
government paid an amount of $182 in order to recover AIG.
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Introduction
American Institution Group was founded in 1919, Shanghai China. AIG is a multinational
insurance company that has branches in over 80 countries. Example Pakistan, Kenya,
Indonesia (Patrick, 2017).AIG has its main headquarters in United States of America. AIG
offers insurance products to both consumers and commercial clients. Commercial products
include mortgage, property casualty and institutional. Consumers insurance involves pension,
medical (maternity, optical and dental) and life assurance. Most of AIG`s profit come from
consumer product insurance. In 2001-2004, AIG was able to make a net profit of 9.9 million.
Despite all AIG sunk into a credit crisis in 2008. It had a total debt of $182 (Cummins, &
Weiss, 2014). The US government decided to bailout AIG through credit by Federal Reserve.
The reasons as to why AIG went into crisis include:
1. AIG lacked the knowledge to hedge its investments from risk. According to general
reinsurance corporation, insurance companies have to reinsure themselves against
losses or risk.
2. Poor decision making was also an impact of credit crisis. Maurice Greenberg was
hired by C.V Starr. Greenberg was to renovate its services, turnover international
crisis and boom health business. However, Greenberg decided to sell most of its
insurance products to brokersinstead of agencies. This is encouraged bids rigging
from AIG to its competitors. Most competitors lowered their premium and improved
their benefits. Encouraging people to swift from AIG products to its competitor’s
products.
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3. Carl Icahn, a financial analyst and activist. He is a major investor in AIG holding $40
million shares. Carl Icahn who is a representative was able to protect (hedge himself
from losses). He states that AIG was caused by heavy capital requirements which
would be used to finance their pool fund.
4. Formation of cartel in AIG. Maurice Greenberg and Mr Spitzer agreed to have taking
money from the company. When the company hit $9.9 million profit, there was
evidence that it was a cause of financial crisis.
5. Poor management practice. Due many multinational branches it has lead to no
collateral and minimum supervision.
LITERATURE AND REVIEW
Introduction
Credit crisisoccurs due to high claims from client (creditors).This is when a large number of
insured clients claim for insurance whereas the pool is insufficient. Adverse selection is lack
of symmetric information between insurer and insured. The insured tends to hold back
information from the insurer.
Moral hazard is the action or behaviour that happens when the insured has a
cover(insurance). Example when person insures herself against burglary. Before she got the
cover would hire a guard at her apartment. After she got the cover, she no longer needs the
guard Insurance tends to initiatives like screening and signalling. Signalling is where the
insurance requires warranties from durable goods in order to be insured.℮⃰ (θᴸ) ≠℮ (θ)
screening is when advantages are looked over before underwriting.
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AIG credit crisis affected some institutions like: Security and exchange commission which is
head of exchange rates and pricing of stocks. In the event of 2008, stocks dropped which lead
to a loss. Reinsurance General Corporation is a regulator to all insurance companies in the
US. Wall Street suffered a major reputation since Mr Spitzer was involved in fraud
allegations (Patrick, 2017). This requires insurance companies to observe its guidelines.
Theories related to the topic
Monetary policy attempts to regulate money supply and interest rate in the economy.Federal
Reserve ensures that the economy maintains a fixed exchange rate. This is by controlling
money demand and supply to be equal. If interest rate is low demand for credit will increase
while supply will decrease high. If interest rate is high demand for money will be low and
supply will be high and it causes the point of intersection shows equilibrium (Grubel, 2014).
This shows stability in the economy. Equilibrium helps to eliminating national debt, global
financial crisis and interest rates.
Interest rate
2.25
2.3
2.35
2.4
2.45
2.5
2.55
Series 1
Series 2
\Money supply and demand (dd/ ss)
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Series 1 is money supply curve
Series 2 is money demand curve
According to capitalist, quick liquidity encourages high risk in most financial institution
(Frieden, 2015).Initial public offer traded little sharesunder low divideds returns once the
crisis happened.
There is a direct relationship between credit crisis and lack of liquidity in the debt market.
AIG went was unable to pay it's debt by converting assets into cash(liquidity). These caused
AIG's operations frozen until it gained stability in 2012
Discussion and analysis
Credit default swap is a contract between a buyer and seller in case of a credit event. The
institution is covered before the maturity date.
They are many types of credit events such as restructuring and bankruptcy. Debt contract
involves two parties: debtor and creditor. In case credit event does not happen before
maturity date of the loan. Security of the seller will not make payments to the buyer
(Kroszner, & Strahan, 2014).
Credit default swap is structured by the event principal value or shortfall of its interest.Ways
to calculate the size of the payment by seller to buyer:
*No cap. In the event of the seller compensates his/her shortfall interest without limits.
*Variable cap. the seller compensates buyer from any shortfall interest but under limited set.
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* Fixed cap. Maximum amount is paid to protect seller under fixed rates. Most institutions
prefer this form of protection.
Method of Credit default swap value=expected present value –expected present value of fixed
interest.
Disadvantage of credit default swap includes default correlation and default probability.
Opinion
If American International Group would have been allowed to fail? No. This is because AIG
has shown drastic improvement. February 9, 2016 the company decided to cut on its fund
portfolio. This was also followed up by hedging their investments due to high volatility and
decreased liquidity (Andolfatto, 2017).
Federal reserve, US government and insurance regulators should limit stakeholders from
making decisions on their own. For example AIG has $50billion as assets and little liquidity.
There is no way stakeholders can decide to sell its shares over the counter. This encourages
more regulations, restrictions and high supervision. This was not only decided for AIG but
also other non banking and banking institutions (Zeng, 2013).
American International Group (AIG) should reduce consumer`s insurance products. This
enables them to manage and supervise their pool fund. When AIG carefully underwrites its
insurance contracts minimum losses will be assured. Some risks are too high for the insured
to claim. Example medical cover for cancer stage 4. The insured will use all AIG`s funds in
the pool reducing profitability. AIG sunk into a credit crisis in 2008. It had a total debt of
$182. The US government decided to bailout AIG through credit by Federal Reserve. AIG
was able to repay the organisation fully by selling its assets (Patrick, 2017).
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Most institutions that suffered from AIG crisis have recovered from the major. Security and
exchange commission which is head of exchange rates and pricing of stock. In the event of
2008, stocks dropped which lead to a loss. Reinsurance General Corporation is a regulator to
all insurance companies in the US. Wall Street suffered a major reputation since Mr Spitzer
was involved in fraud allegations. This requires insurance companies to observe its
guidelines.
AIG had cracks in their organisation example pest draining cartel. Mr Spitzer, attorney
general investigated and found out that money was stolen from the company. When the
company hit $9.9 million profit, there was evidence that fraud caused financial crisis in 2008.
This would be resolved by the court. Allowing more room for AIG to recover and grow.
Conclusion
AIGis a global company that grew fast under leadership. AIG went into great credit crisis
which was worse than its competitors. In different countries the government is to bailout
potential companies that collapse into debt. The company received $182 from the US
government. This was to help AIG recover back to its normal operations (insuring AIG`s
claims made by insured clients). In 2009 AIG was able to sell some of its assets and business.
AIG was able to repay the government back its money. Last year, AIG made a quarterly loss
which frustrated investors. It will take time for AIG to improve on its performance with
proper management and leadership.
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References
Andolfatto, D. (2017). A Theory of Money and Banking. Evolution, 5, 17.
Cummins, J. D., & Weiss, M. A. (2014). Systemic risk and the US insurance sector. Journal
of Risk and Insurance, 81(3), 489-528.
Ericson, K. M. M., & Starc, A. (2015). Pricing regulation and imperfect competition on the
massachusetts health insurance exchange. Review of Economics and Statistics,
97(3), 667-682.
Grubel, H. G. (2014). A theory of multinational banking. PSL Quarterly Review, 30(123).
Frieden, J. (2015). Banking on the world: the politics of American international finance.
Routledge.
Kroszner, R. S., & Strahan, P. E. (2014). Regulation and deregulation of the US banking
industry: causes, consequences, and implications for the future. In Economic
Regulation and Its Reform: What Have We Learned? (pp. 485-543). University of
Chicago Press.
Patrick, S. C. (2017). Reform of the Federal Reserve System in the early 1930s: the politics of
money and banking (Vol. 12). Routledge.
Zeng, Z. (2013). A theory of the non-neutrality of money with banking frictions and bank
recapitalization. Economic Theory, 1-26.
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