AIG Blame for the Bailout Marketing Case Assignment (Case Study Sample)

AIG – blame for the Bailout
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Abstract
This paper intends to serve as a discussion on the downfall of the one of the leading insurance companies in the US, namely, the American Investment Group (AIG), which happened in 2007.
Keywords: AIG, CDS, CDO
AIG – blame for the bailout
AIG, one of the premier financial services company in the world, having its presence in 130 countries and specializing in the insurance sector, crumbled in 2007 and was offered a whopping $85 billion as the bailout money, by the federal government, in exchange for nearly 80% of the firm’s equity. The downfall of the giant company is attributed to various internal and external factors. The most important factors can be listed as follows,
* AIG financial products (AIGFP)’s decision to insure Collateralized Debt Obligation (CDO’s) against the default through Credit Default Swap (CDS).
* Internal accounting problems that affected the rating system hugely and subsequently deteriorated the AAA rating of AIG to AA. The internal controls, before this sham happened, were loosely coordinated and there were no strict rules that needed to be adhered to.
* Got itself mired in multiple scandals which were under investigation by the SEC, New York’s Attorney General, Mr. Eliot Spitzer and the other authorities.
The root cause of the whole scandal was lack of transparency and over-dependency and lack of farsightedness. Had the weekly meetings with the employees, to review the current financial situation of the company along with the critical review of the financial reports been done, then the original position would have clearly known, preventing the unnecessary chaos and the ultimate downfall. The workings of the company should have elevated the rating by itself. Conversely, here the workings were chosen in such a manner that it would facilitate the rating. Due to lack of transparency, the higher echelons were unaware of the actual happenings of the company and the outside world and hence this resulted in ‘Cooking the account books’, internal audit problems and so on.
In my view, the problem could have been prevented in the initial stage itself, had the steps of the company been measured by the factors of transparency, regular weekly and monthly meetings with the employees of all the strata, continuous review of the weekly, monthly and annual financial reports to undermine the hurdles, which degrades the efficiency of the company, constantly thriving in a genuine manner to lift the rating up.
Let us now investigate the factors in detail.
The problem first began with the over dependency of AIG on the rating system. The rating system should be used only as a measure of performance, as an opinion of credit risk, not as an overall measure of the default probability. This rating problem has its roots here and is intertwined with the CDS problem, becoming the major one. This perspective of mine is supplemented by the following reasons.
* AIG’s main strategy was to look for those prospects which enhanced and benefitted from its AAA rating, which was initially backed up by strong capital base and risk management skills.
* An investment of around $70 million as Asset Backed Securities (ABS) with subprime mortgages, which were considered as extra income and converted as AAA ratings, had a huge blow when the credit markets got seized and the ABS were sold at a loss, reiterating the fact that the rating system should only have been treated as a measure and not the sole scale of determining the range of a company.
* Standard and Poor’s rating cut measure in September 15, 2007, which triggered the downscale of additional collateral requirements in the CDS portfolio, amounting to $14.5 Billion, was the final straw.
* The majority of the contribution to the downfall stemmed from the activities adhering to the Credit Default Swaps (CDS) that the organization had done on various investments. Simply put, Credit Default Swap is an insurance against the default or the non-payment of debts. In this process, the buyer of the swap mitigates the risk by reallocating a portion of the concerned risk onto another insurance company or any other CDS seller in exchange for a periodic fee. With this method in tow, AIG staked all the CDO’s against the default. CDO’s accumulate all types of debt, right from lower to higher risk debts into a single bundle. The various types of debts which get accumulated in this way are known as Tranches. Thus, various mortgage-backed securities that AIG possessed were converted into CDO’s filled with subprime loans. During this conversion, AIG forgot the fact that this concept lacked the initial funding requirement. Hence, more influence was needed to purchase actual debts. Negligence of this fact, led to the miscalculation of the CDS, by using the historical data and not by the risk-adjusted present value of the debts. Also, AIG misconstrued that the chances of the insurance payout are highly unlikely in this method as for a brie...