AIG's Failure Is So Much Bigger Than Enron

Enron -- reviled, fraudulent Enron -- destroyed more than $60 billion of shareholder value.

AIG (NYSE: AIG  ) , which the government just took over, has destroyed $180 billion already -- and it almost brought down our entire financial system.

We don't know money
Which is ironic, given AIG's old television commercials, in which the giant letters "A I G" displayed on the screen while text flashed underneath that culminated in the following phrase -- all in capital letters:

WE KNOW MONEY

There were no smiling couples, young children at play, or lounging retirees. No, AIG was above that -- it was better than that.

But here's a news flash, AIG: You don't know money.

If you did, you'd have realized a few things. Insurance is terribly simple, as long as you follow the Three Rules:

  1. Price your risk correctly.
  2. Invest conservatively so you can pay out claims when they come due.
  3. Don't do anything else.

Sit back and collect the spread. That's it, folks.

Seriously, that is it. Ask Warren Buffett, and he'll probably tell you that if you follow those three rules, you'll be fine. You won't be the biggest or fastest grower, but you'll be absolutely fine.

The problems come when you get greedy and aren't satisfied with the spread. And your greed can lead to certain actions that aren't stated anywhere in the rules, including:

  1. Diversifying into fast-money proprietary trading.
  2. Leveraging your company 11-to-1.

Neither of these is a goal of a well-run insurance company, yet AIG embraced both with open arms.

Diworsifying
But AIG self-destructed not because it screwed up in its insurance business. It didn't fall into the trap of mispricing risk, as so many other insurers over the years have done. It also invested premiums fairly conservatively. So it followed Rules 1 and 2.

Where it slipped up was in Rule 3. See, the folks at AIG thought they were so smart at insurance that they could start other capital-markets businesses ... including proprietary asset management in things such as commodities, currencies, energy, interest rates, and the selling of default swaps on collateralized debt obligations (CDOs).

This strategy worked beautifully -- for a while. AIG created a separate business segment called Financial Services to trade in the aforementioned assets. This business had $204 billion in assets at year-end 2007, up from $60 billion in 1998.

Operating income surged from $900 million in 1998 to $4.4 billion in 2005. Some of the moves it made were brilliant, such as the purchase of ILFC, an aircraft-leasing business. But the other trading businesses were the Medusa that turned the whole company to stone.

Let me make one thing clear: Proprietary trading isn't bad, in and of itself. Warren Buffett engages in it. But just like atomic weapons in the wrong hands, proprietary trading can do a lot of damage. The problem is when you start to get aggressive and don't heed proper risk -- when you start to speculate instead of invest. 

And there's one other critical ingredient for disaster.

The "L" word
As in "leverage," the sharp knife in corporate seppuku dramas. Leverage is, by my estimation, the No. 1 reason why companies fail.

And compared with its peers, AIG had one of the sharpest knives around. Here's how its leverage (assets to equity) stacked up against other insurance operations as of December 2007:

  • AIG: 11 to 1.
  • Markel (NYSE: MKL  ) : 4 to 1.
  • Berkshire Hathaway (NYSE: BRK-B  ) : 2 to 1.
  • Montpelier Re (NYSE: MRH  ) : 2 to 1.
  • Travelers (NYSE: TRV  ) : 4 to 1.
  • White Mountains Insurance (NYSE: WTM  ) : 4 to 1.
  • Chubb (NYSE: CB  ) : 4 to 1.

I would love it if someone gave me a rational, believable explanation of why leveraging your equity 11-to-1 is a good thing for an insurer. The sole job of an insurance CEO is to ensure that his or her company stays in business; the CEO's job has nothing -- absolutely nothing -- to do with growing profits every year in a steady, smooth line.

Surprises in insurance are almost always negative, so simply staying solvent is the overriding priority. A company can do just that by following the Three Rules.

Two years ago, a few of my Fool colleagues had an interesting conversation with Chris Harris, the chief investment officer at reinsurer Montpelier Re. Harris noted that Montpelier invested its float primarily in U.S. Treasuries, Fannie and Freddie bonds (back when they were considered safe), and the like.

When asked why he didn't invest more aggressively, Harris said the company believed that it got all the risk it could handle on the other side of the fence, insuring against megacatastrophes.

Even if you disagree, as an investor you have to recognize the judiciousness in this way of managing one's business. An insurer that has to pay big claims from hurricanes Ike and Gustav and Typhoon Sinlaku -- and additionally worry about the rapid decline in its investment portfolio as a result of the higher level of risks it has taken on -- has a big problem.

That insurer, folks, is AIG. And that big problem is now yours and mine.

This really is bigger than Enron
The edifice Hank Greenberg built has all come crashing down. Apparently, AIG didn't realize that almost 40 years of 15% growth multiplied by a big fat zero equals just that: zero. It didn't consider that its leverage left it exposed to a liquidity crisis, and it didn't consider that its non-insurance businesses could bring down the whole company.

In all fairness, management did not realize how much exposure it had to CDOs backed by subprime loans. This may or may not be true, but Buffett has famously stated that each one of these prospectuses has something like 15,000 pages, so it's unlikely they were gone through in any great detail.

But investing in things you don't know is a huge risk, right? And that risk was compounded by having so much leverage. The fact is, the more leverage you have, the more careful you must be with the investments you hold, because your own capital structure is that much riskier.

AIG did nothing of the sort. And so even though it has a rock-solid, wonderful insurance franchise, its greed and lack of care in its investing decisions took down one of the world's great companies.

What a shame. What a shame for all of the investors who lost billions thinking that this company was conservative. What a shame for taxpayers like you and me. What a shame for the United States' reputation as a beacon of financial stability and conservatism.

For Fool.com's continuing coverage of this week's events, check out "The Biggest Financial Story of the Past 50 Years."

Andrew Sullivan has no financial interest in any of the companies mentioned. Montpelier Re is a Motley Fool Hidden Gems selection. Markel and Berkshire Hathaway are Motley Fool Inside Value recommendations. Montpelier Re and Berkshire Hathaway are Motley Fool Stock Advisor picks. The Motley Fool owns shares of Berkshire Hathaway and has a disclosure policy.


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  • Report this Comment On September 17, 2008, at 5:41 PM, RHaganC wrote:

    This is right on the money. It's a sad shame for all the people at AIG whod did do the right things and preformed their jobs impeccably. I can't wait to see if the toll over time from US bailing them out. Whenever the gov't runs something, it's always scary and they never seem to get out of it.

  • Report this Comment On September 17, 2008, at 5:42 PM, econdon35 wrote:

    You guys are tiddlers in foolishness, compared to how the wall street guys have been revealed in the last couple of weeks, they are REAL fools.

  • Report this Comment On September 17, 2008, at 6:19 PM, WileyCyote wrote:

    Whenever ANY sort of major event happens we are all supposed to "learn valuable lessons" How come we don't?

    For starters (Fanny and Freddy) why isn't Raines in jail ?

    Does anyone out there think that ANYBODY is going to jail for ANYTHING relative to this massive failure ? Of course not. If you listened to the pundits, experts and all other sorts of lowlife comment on the subject, AIG is "too big to fail" "it would be a national catastrophe if AIG were allowed to go under" Where have we heard that before?

    There will be some who will make real money out of this and it won't be us!

  • Report this Comment On September 17, 2008, at 6:35 PM, gfouras wrote:

    Thank you for dissecting the situation so completely. It is just amazing how people need to relearn the same lessons over and over .... and over.......

    What is really sad is how a few people who make horrible decisions can ruin it for so many others.

  • Report this Comment On September 17, 2008, at 6:37 PM, 2scooper wrote:

    I foresee a pretty strong inflationary swing from the unbridled printing of money to bail out these companies. How is our federal government going to pay for this? We as investors and taxpayers lose big time. The value of our investments fall, the cost of goods and services rise faster than our incomes and the economy stagnates. Middle class Americans are going to get screwed here..as usual. And to think, the Republicans want to give over our Social Security fund to these clowns for private investments.

  • Report this Comment On September 17, 2008, at 6:40 PM, kyddfool wrote:

    so what now, does this mean the US taxpayer is a shareholder and will draw a dividend check twice a year!!

  • Report this Comment On September 17, 2008, at 6:51 PM, Tinka82 wrote:

    "For starters (Fanny and Freddy) why isn't Raines in jail ?"

    I ask the same question, Wiley. Raines, Jamie Gorelick and Johnson were fined, but no one did anything else.

    All three were former Clinton Administration staffers. Two of them are now Obama staffers. Economic advisors, no less. We can basically lay a good chunk of the blame for our financial crisis on their behavior and policies, and they are awarded with Obama staff positions. Where is the media outcry?

  • Report this Comment On September 17, 2008, at 6:56 PM, Tinka82 wrote:

    "And to think, the Republicans want to give over our Social Security fund to these clowns for private investments."

    2scooper, I believe you may misunderstand. The clowns in congress have our Social Security funds. They misappropriate, overspend, and have no accountability all day long.

    The republicans want to give control of a small portion of your social security funds back to YOU for investment as YOU see fit. Not to Wall Street runamucks.

    Right now, 100% of your social security money is going straight to fund the Federal Budget. As it stands, your social security money is bailing out AIG and Fannie/Freddie.

  • Report this Comment On September 17, 2008, at 7:14 PM, titanicdwn wrote:

    And the reason financial experts did not see this coming is...

  • Report this Comment On September 17, 2008, at 7:25 PM, caro2008 wrote:

    Yes and had the Rep been able to get the social security back into all the people's hands and they had invested it in whatever they chose where would they be today?? Most people do not have a clue what to invest in and even those that read what they can and follow the market could not tell you today where to put your money. If Gore had gotten in social security would be in that lockbox not bailing out poorly run companies. The market might have been more strongly regulated and we might not have given loans to dead people or those with no credit to buy houses they did not need much less afford. The Bush years have allowed anything as long as the wealthy and I mean the really wealthy made more money. Several people should be in jail for treason. We are watching the slow demise of our once great country.

  • Report this Comment On September 17, 2008, at 7:41 PM, titanicdwn wrote:

    "... and it almost brought down our entire financial system." Are you assuming the worst has passed? Next year will be so much more worse than this people. AIG going down is like nothing. Wait till next year folks. Now we're talkin fun times. One of our fine presidential candidates is thinking of no less than two major wars which will make America even greater-in debt, caving this country's walls in be exausting what is left of the military. This other fine candidate will collaps the country from the inside out-oh ya. Better check out his economic policies people, they ARE really amazing. You should play chess. The is a final move known as CHECKMATE. Guess what country on the chess board has lost almost everything but its king. We do not even have pawns to trade in.

  • Report this Comment On September 17, 2008, at 7:46 PM, titanicdwn wrote:

    Sorry for extremely poor editing. It happens when I lose control of my temper or extremely depressed.

  • Report this Comment On September 17, 2008, at 7:48 PM, fifo100 wrote:

    The last few comments seem to be why nothing ever seems to be done about social security. You do realise that the people pushing us into social security (i.e. Congress) don't even have to contribute to SS - they have something called SWIFT that gives the contributors different investment options. Presumably the general public is too stupid to be able to decide what they should put the money in. If this was Al Gore's plan, then I'm all for it, but I don't think it was. Bush tried to create an option like this as far as I can see, but people seemed to rather have the ponzi scheme that we have today. The failure of SS and Medicare are going to make AIG and the two FM's seem like the corner store going out of business...

  • Report this Comment On September 17, 2008, at 7:51 PM, charliemccabe wrote:

    So do we buy AIG now??

  • Report this Comment On September 17, 2008, at 8:08 PM, BmattIII wrote:

    Have the "Independent" Accountants issued "Clean" opinions recently or have they been qualified because there is a cloudy future? Don't even begin to answer that because we'll easily see that the profession does not uphold their dogma to be Certified "- Public" Accountants - they are also beholding to their greed .

  • Report this Comment On September 17, 2008, at 8:14 PM, titanicdwn wrote:

    Perhaps I should sate it more plainly. "On date-and-so, the United States government officially closed its doors so to speak. Most officials had already resigned and left the capital when they found out they had squeezed all they could and no one wanted to be seen leaving in haste. The doors to both the White House and the Capital were mostly left wide open. People were seen roaming through both buildings looking for usable items. One person who was seen carrying the original Constitution of the United States said he thought it would make a nice keepsake. Fires throughout most of the former US capital were left to burn out of control. Money for civil service employees having dried up shortly before last year...The reporter for this article is not paid for writing it. I just thought I would do it because, well, I really do not know why. Just because."

  • Report this Comment On September 17, 2008, at 8:58 PM, titanicdwn wrote:

    I actually do believe my last comment will become historical fact once politicians feel they no longer feel the desire or need to be politicians. I further believe no one else will want it either by that time. What little government will be left in the country once known as the USA, will be mostly small pockets of people trying to survive. Larger groups will be like man-eating beasts looking for weaker prey. People living alone without such protection will not have a chance in blazes.

  • Report this Comment On September 17, 2008, at 9:57 PM, nevertoomuch wrote:

    Government taking over business...hmmmm. Have we gotten to the point where the two overlap so much that we're a strange reflection of Venezuela? I don't know what's worse: Greed for money or greed for power.

    With greedy MBA'a running amok the system loses it's integrity nevermind what being an American is all about. Don't talk to me of "freedom to choose". Choose what? The next color of my underwear that all comes from China? Where has our culture gone? America is dead and we have killed it.

  • Report this Comment On September 17, 2008, at 10:12 PM, burneb43 wrote:

    And yet we will continue to hear how the Great God PRIVATE INDUSTRY is the ultimate answer to all our needs, always preferable to having any GOVERMNENT interference or regulation.

    This is often true to a great extent, but what is mostly true much of the time (reality) is not always true all the time (dogma).

    Within 2-3 years of every big push for DEREGULATION, or major relaxation of enforcement (trucking, airlines, savings & loan, mortage lending, etc), you see a corresponding meltdown in that economic segment as greed and corner-cutting takes over.

    There is NO excuse for making no-doc "liars loans" or leveraging insurance revenue 11-1. But in this regulation-adverse Administration, anything goes.

  • Report this Comment On September 17, 2008, at 10:27 PM, bkruse59 wrote:

    This was a good article but it would be even better if it was dated a year ago. It would be ever so much more impressive if the consequences of these strategic errors had been predicted in advance. On a related subject, I have a question. Now that the entire universe knows that AIG is teetering on the brink of insolvency, why does S&P still give it an A- rating? How bad would it have to be to dip down into the Bs or the Cs?

  • Report this Comment On September 17, 2008, at 11:25 PM, titanicdwn wrote:

    Well, actually I wrote numorous blogs and pages about what is happening right now for more than ten years. Did you read what I said would happen regarding the presidential election? Today's date is 9/17/08. Less than two months before that election. Feel free to ask me 3/1/10 how I was so bang on target. Actually, if a certain candidate wins I am thinking about right now, you ask me 9/9/09. The dates are not drawn from a hat. One case involves the time required for war prep and troop movements based on when the pressure cooker reaches maximum capacity. The other case is a candidate who thinks we are all victims, and it is ok for victims to victimize all...Where I live is a good example. I used to walk the streets at night in an old neighborhood enjoying the quiet and the night air. That is all inner city now and the haves are a lot more concientious about living in 'good' neighborhoods away from a rapidly growing inner city. When I wrote about 'CHECKMATE' in another comment, I really did mean 'CHECKMATE'. GAME OVER

  • Report this Comment On September 17, 2008, at 11:46 PM, titanicdwn wrote:

    ...And what does all this have to do with stock values? La-de-da-la-de-da...Come on people. Its not THAT hard to figure it out. Someone please come up with the right answer to that question. If no one comes up with it by when I get up tomorrow, then I will give it to you. Clue:The CURRENT reality of buying, AND paying off home that will be safe to live in 50+ years as most simply want a HOME, period. That clue is only one part of a total picture, do not assume it is the picture.

  • Report this Comment On September 18, 2008, at 12:13 AM, TEL71 wrote:

    It amazes me that virtually everyone seems to think that the Federal Reserve is a government institution. It is not!! It is a group of private bankers and financiers who hijacked America. The government owns nothing nor do you. Look at who is lining up to bail out these companies. Its a who's who of the Federal Reserve. Look up the history of the Reserve Act and who started it and who runs it and it becomes all to clear who is in control. The government is at the mercy of the Fed not the other way around. Good ole' Woodrow Wilson saw to that. Thanks Woody buddy!! There is a reason American schools do not teach about the creation of the Fed. Its as close to the Mafia as you can get.

  • Report this Comment On September 18, 2008, at 1:26 AM, masthaas wrote:

    What is the total bailout today from the US Federal Reserve & Treasury in comparison to the total number of people below the poverty line or persons without health insurance.

    I am interested to see how much in entitlement programs and services would have been created per capita for people who are the poorest (total federal $$ in rescue bailout funds/persons in poverty or uninsured persons). It appears that while the CEOs of major investment banks, mortgage houses and brokerage firms have made huge salaries over the past 5 years, we are now watching as our tax dollars go (freely or without clear conditions I might add) to bailout what was a free market capitalist economy.

    Are we really opening up the Treasury because we realize our economic fundamentals were flawed and rampant with greed where now risk is reaping taxpayer rewards? Republican socialism?

    Oh, yeah if as a parent you have a drug addicted child (large corporations such as AIG) vs the one willing to stand on the sidelines (American public), you enable the drug addicted child until either there are not drugs available (taxpayers money) or the drug addicted child seeks help. But we are talking about the economy, right?

    Matthew Haas

    Los Angeles, CA

  • Report this Comment On September 18, 2008, at 4:57 AM, daehee wrote:

    could someone clearly explain how these bankruptcies and falls of these companies will affect the hedge funding companies in the next 10 years? i am guessing that there will be a more heavy regulations put on by the government on risky investment techniques and such on hedge funds and investment groups..

  • Report this Comment On September 18, 2008, at 6:33 AM, jdlech wrote:

    AIG should have known that such risky schemes nearly always fail. It's not a matter of how or why, it's a matter of when. But that does not neccessarily mean one should avoid them altogether. The best way to manage such risk is to treat it like a cash cow. When it makes you money, pull that extra money out and leave just enough for it to try doing it again. By doing this, you gain some benefits while isolating yourself so when it does fail, it does not take everything else with it. You should give risky ventures only what your company can afford to lose. In the case of leverage, they should have taken legal measures to isolate the rest of the company from any financial fallout when each venture fails.

    This strategy works unless the risky scheme fails immediately - leaving you without the capital to try it again.

    Even an average schlep like myself knows this. So why do professional managers and executives who are supposed to know so much better than I get into such situations where one failure cascades into total corporate meltdown? Such profound incompetence does not deserve any more salary than that of an average working stiff.

  • Report this Comment On September 18, 2008, at 10:42 AM, DeadmanLiving wrote:

    You have to ask yourself, how far does the rabbit hole go?

  • Report this Comment On September 18, 2008, at 1:36 PM, DetailDevil wrote:

    What everyone seems to miss is the view from the CEO's chair. You can keep up with your competitor's profits, earn millions in salary and bonuses, or be replaced by someone else who will. And if everything goes pear shaped, you loose your job but keep enough money to last you the rest of your life. Why would any rational manager behave any other way?

  • Report this Comment On September 18, 2008, at 2:20 PM, John53705 wrote:

    Is it true that an insurance company CEO's job is only to stay in business? That seems simplistic to me. I would have thought they faced all kinds of pressure to increase profitability, hence the decision to take risk. I'm not excusing it, not at all, just curious if the market for insurance co CEOs is really just about who can stay in business.

  • Report this Comment On September 18, 2008, at 3:05 PM, mjs08 wrote:

    So what does it mean for policy holders?

  • Report this Comment On September 18, 2008, at 5:34 PM, buffalojohn1955 wrote:

    AIG is a travesty my broker told me it was a blue chip stock, i can't believe it. This forum is great. I wanted to let everybody know I hired the lawyers behind the Phen-Fen Settlements

    www.stockloss.us.com to help me get my money back Napoli Bern Ripka

  • Report this Comment On September 18, 2008, at 6:04 PM, jlsfool wrote:

    Okay, so about three or four years ago, AIG bought Valic--which manages my retirement funds. I called my account manager and was told that the only money I could lose would be on whatever AIG stock was in my mutual fund portfolio. So, great. How do I figure out how much AIG stock is in my portfolio?

  • Report this Comment On September 18, 2008, at 8:52 PM, crca99 wrote:

    Will some Fool please write an article to help me grasp the leverage concept? I understand levers and how crowbars pick up rocks. I understand how borrowing against collateral to buy non necessities makes one look rich. I do not understand how these quotes relate, "Here's how its leverage (assets to equity) stacked up," and "explanation of why leveraging your equity 11-to-1 is a good thing." much appreciated.

  • Report this Comment On September 19, 2008, at 8:04 AM, Shoganai wrote:

    Foget the leverage issue... Focus instead on the question of why selling CDS (Credit Derivative Swaps - a.k.a. CDOs) was ever within the risk management competency of AIG. Providing a guarantee against default of a securitized product should indicate familiarity at a detail level of the underlying obligations. AIG never performed any such DD (Due Diligence) except by a broadbrush approval process of piggybacking on suspect ratings from credit agencies . What in fact established AIG as a credible seller of CDS ( i.e. insurance ) in the global marketplace was basically the company name itself. AIG management sold (i.e. leveraged) the good faith and credit of their corporate reputation name against a longshot that MBS (Mortgage Backed Securities) never would fail. What they lost in the bargain was exactly what they wagered...

  • Report this Comment On September 19, 2008, at 12:38 PM, kmdchi wrote:

    Its call GREED, folks....plain and simple!

  • Report this Comment On September 19, 2008, at 2:28 PM, smootheP wrote:

    It's not about leverage... many insurance companies are levered much higher than AIG (see PRU and its 22x leverage for starters)...it's about AIG not understanding what products it was selling and the huge underlying risk. Leverage made their problems worse, but it wasn't the catalyst.

  • Report this Comment On September 19, 2008, at 2:33 PM, smootheP wrote:

    By the way, Shoganai, CDS = Credit Default Swaps - they are basically insurance on the other party defaulting on the bond you bought. CDO = Collateralized Debt Obligation - a collection of different debt instruments. AIG lost money due to drastically under-estimating the risk on the CDSs it wrote and sold. CDOs do not equal CDSs.

  • Report this Comment On September 19, 2008, at 2:56 PM, KWT8011 wrote:

    "Does anyone out there think that ANYBODY is going to jail for ANYTHING relative to this massive failure ?"

    I only took 3 criminal justice courses in college, but never ran across the law saying private companies aren't allowed make risky investments.

  • Report this Comment On September 19, 2008, at 5:15 PM, patjmp wrote:

    Everybody pay attention. Buy stocks now, especially AIG. If you invest $1000 or $10,000 now you should make probably 10 times your investment over time. The stocks go up eventually, and the time to buy is when they are down, and they are really down now. I bought 6 different stocks after 911 when Bush said we should invest now in our country, and I did, and they have appreciated considerably. You can make some money short term or probably a lot more long term. I'm no financial genius, but now is the time. Buy low, sell high, and now is one of the few times you can!!!

  • Report this Comment On September 19, 2008, at 6:31 PM, 1mississippi wrote:

    Why is this administration and congress throwing all this money that they don't have at every problem that they have allowed to happen? Bush says that he doesn't want new taxes or the repeal of the corporate tax breaks that he and congress passed on the back of the so called balanced budget he was handed when he started this administration. There never was a balanced budget, much less a surplus. The government has been using the social security surplus money and the FDIC insurance money and who knows what else to fool the everyday American into beleiving that we are on a sound fiscal policy. We are headed for double digit inflation and possible financial collaspe as a nation. Where Reagan caused the financial collapse of the Soviet Union Bush will be remembered for eternity for the ruin of the USA.

  • Report this Comment On September 19, 2008, at 11:10 PM, spiels wrote:

    Maybe rule 1a) should come from the doctors creedo

    Rule 1A) Do No Harm!

  • Report this Comment On September 20, 2008, at 2:10 AM, duckles10 wrote:

    Does everyone understand that in this case we are not bailing out AIG. AIG is a very compartmentalized company. The part that insured all of those swaps would have declared bankruptcy. All of the other insurance businesses which are highly regulated and have ample capital would not be harmed. In the worst possible senario the Mother company might have been forced to sell them. Who we are bailing out is all of the companies/investors who were smart enough to buy insurance on the risky investments they made.

  • Report this Comment On September 20, 2008, at 5:02 AM, AndreaKW wrote:

    "What a shame for the United States' reputation as a beacon of financial stability and conservatism"

    Sorry guys, I have to take you up on this. Outside of the US I doubt that many commentators would consider the USA as "a beacon of financial stability and conservatism"

    Rather, I think that the rest of the world has long seen that the US has exported some of the worst financial ideas seen in capitalism. In addition it has brutally dominated the world financial markets since the 70's as a result of making a unilateral decision to uncouple from gold and make the US $ the world standard for all other currencies. Greed is good is seen to be the fundamental creed of the US system, with the government looking the other way until the behaviour gets SO outrageous that it has to step in. the sad thing is, the Australian economy, which IS a beacon of financial stability and conservatism is being damaged by our cowboy allies. Cheers for that guys.

  • Report this Comment On September 20, 2008, at 11:45 AM, arivera4506 wrote:

    This article stated what is so true and obvious of most American companies: greed. Of course nobody will go to jail simply because the attorneys will blame the failure upon the economy; but us Fools know better than the general public. Given the situation of the US financial dilemma and the perception around the world, I believe more failures will be happening within the coming months. It's now a game of chicken between the public and the companies: who's going to flinch first.

  • Report this Comment On September 20, 2008, at 1:39 PM, hagworkin wrote:

    Once again what are your thoughts on the investment potetial for AIG here at 3-4dollars/share. Everybody has expounded on how terrible all the players are in this credit mess. we have no control over humans from the ones who wrote thousands of fraudulent mortages to people who had no business buying a house,collecting their couple hundred bucks to the banks who collected thousand of bucks,to the folks who bundled these useless pieces of paper and sold them to our investment banking genius's who insured them with triple A credit ratings from our wonderful Standard and Poors or Moody's on and on. Its all terribly american you have to admit. my question is how can we profit at this point. i guess i'm part of the problem not the solution.

  • Report this Comment On September 20, 2008, at 1:55 PM, Shoganai wrote:

    OK smootheP - a CDO and a CDS are not the same thing - granted - but a CDS is insurance on a CDO. Taking the two together, what AIG did was attach their CDS insurance (guarantee) to CDO products entering the secondary mortage markets - to give them "enhanced value". Because CDO securitized products are marketed as structured products, a single CDO can ultimately have numerous part owners such as Insurance Companies; Hedge Funds; Governments - foreign and domestic - all with varying legal rights to eventual cash flow. All of these various owners of structured CDO products with CDS guarantees are generally in-line to claim against that guarantee if the CDO enters technical default. Global financial markets and U.S. courts have no capability to clear the volume of CDS guarantees made by AIG and various other CDS underwriters on U.S.$ CDOs. Insolvency of AIG would have triggered a global tsunami of balance sheet write-downs and claims against CDS that would have crippled the international markets and also resulted in claims by foreign governments directly against the USFRB.

    <>Leverage indeed has nothing to do with with happened here

  • Report this Comment On September 20, 2008, at 5:45 PM, crca99 wrote:

    Ah...sigh...it's off topic now but I still don't know what financial leverage is. A little thing moves a big thing if there's a fulcrum and the force is applied right...is that the ball park?

  • Report this Comment On September 21, 2008, at 3:26 PM, TMFDiogenes wrote:

    Hey crca99,

    Great question. Yeah, your metaphor is spot-on. The term leverage, the way it's used here, refers to debt or other financial instruments used to increase return on investment. For example, if I have $1,000 to my name, and I'm not satisfied with a 5% return, I could just borrow $11,000 against my $1,000. Now I make 5% x $12,000, or $600. That's a 60% return on my $1,000! (Hence the little thing ($1,000) moving a big thing over a fulcrum if you use a lever like debt, derivatives, or what have you.) The trouble is, and this is why volatility matters a lot if you're using leverage, let's say your investment momentarily goes down just 10%. now your return is -$1,200, or -120%, wiping you out in an instant! That's why normal people and (supposedly) traditional banks aren't allowed to lever 11x. -- it's stupid and there's a domino effect: It can really screw up the people who lent you the money if they borrowed 30x against the $1,100 they lent you. But Greenspan and other laissez faire ideologues encouraged the use of debt-mimicking instruments (loopholes) because they thought it would be good for "liquidity." The wisdom of that approach, of course, depends on the ability of these firms' sophisticated models to make absolutely certain (whoops) their risk was under control. These sorts of models always work until they don't. And there you have it -- a horrific (and entirely predictable) domino chain of financial blowups.

  • Report this Comment On September 21, 2008, at 6:22 PM, mikespimping wrote:

    to all you people asking why the CEO and staff of AIG aren't in jail "for corruption" what would they be put in jail for? taking unnecessary risk in investing for the company? why didnt you look at that BEFORE you bought the stock?

  • Report this Comment On September 21, 2008, at 10:00 PM, shanx24 wrote:

    AIG's leverage ratio (debt to equity) is 8:1 not 11:1 as claimed in this article, as per their balance sheet data from Yahoo Finance and other sources.

    This is certainly a mark of greed but not as egregiously morose as claimed here. AIG's demise stems more from their inability to properly price MBS derivatives.

  • Report this Comment On September 22, 2008, at 2:39 AM, beaconps1 wrote:

    Continuing with the leverage discussion. Paulson is using the government backed superSIV to take in bad paper that is eroding the leveraged base of many companies, especially investment banks. It is kind of a patch to buy time and possibly the election. While he wants a big checkbook, it doesn't seem to address any underlying issues. As Poole said, the devil is in the details.

  • Report this Comment On September 22, 2008, at 2:55 PM, crazygood wrote:

    "Why aren't these guys in jail?"

    I guess it's one thing if you run the corner candy store and screw up your finances and go bankrupt, but it's another thing to wreck the global economy.

    If they don't go to jail, then I think there should be a discussion about how big their parachutes are going to be.

    I don't care how big they are, actually, as long as those parachutes are made out of concrete, not gold...

  • Report this Comment On September 22, 2008, at 3:34 PM, MonkeyMan1140 wrote:

    If the congress and the government are so lazy, corrupt, and incompetent with money, then why are they the only ones who have it?

    If the financial markets are so packed with geniuses that know money more than Uncle Sam, why are they screaming for free billions to bail them out?

    I saw let these financial companies DIE. If Uncle Sam wants to bail out the mortgageowner, fine. Give them all free houses, but I don't want 1 penny going to bail out a stock market investor that played the games knowingly and lost.

  • Report this Comment On September 22, 2008, at 7:10 PM, loosoo wrote:

    For 30 years, as an educator I was involved with 403b with VALIC. Then AIG got involved and it was renamed AIG retirement. We were assured by reps, email, and others, that VALIC would not be affected by this catastrophe. That it is not involved in the mortgage part of the fiasco and should not affect our money. I say hogwash don't kid yourself. I plan to pull out, do rollover IRA with TDAmeritrade, and rid myself of this scum sucking, egocentric, greedy company . Motley Fool wrote in 2007 about VALIC and hit it right on the head. I wish I had pulled out sooner.

  • Report this Comment On September 22, 2008, at 9:51 PM, HemiJimmy wrote:

    So, on the less serious side. If I pick up 10,000 worth of AIG in the morning, do you think in 6 months I can pay cash for a new SRT8 Challanger. Or at least leverage a real good down payment???

  • Report this Comment On September 23, 2008, at 3:34 PM, BearTrend wrote:

    YES, if u were like me who brought AIG at $1.70, (going oppisite of what everyone else is doing) then u have enough money or downpayment for a Ferrari.

  • Report this Comment On October 13, 2008, at 4:08 PM, nooars wrote:

    At what point is bubba clinton who set up this homes for everybody get indicted.By passing legislation they forced fed money to fannie mae and freddy mac.This whole housing scheme was nothing more than a front to get the stock market moving so the rich could transfer the pensions over to us.They did the old we will match u dollar for dollar.Since when is big business care.Home building gets the economy moving and stocks.The biggest rape of the working man and our life

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