Though most of America focused on Monday marking the five-year anniversary of Lehman Brothers' collapse, it also marked the anniversary of American International Group's (NYSE: AIG) bailout by the federal government. With the insurance behomth's recovery firmly under way, it makes sense for investors to take a look back at what really happened in 2008 and how the company has moved on from there. Below is a timeline that provides you with information not only on what brought AIG to its knees, but also what has brought it back to success.
A little context
We all know AIG was involved in risky bets on securities, and that ultimately lead to its near-collapse, but to better understand its failing, investors should know how the company's bets really worked. AIG entered contracts with outside parties (banks, etc.), creating a portfolio of credit-default swaps. The swaps were essentially insurance policies on securities, where AIG would collect a fee to guarantee the securities -- but if the securities went down in value, AIG was left on the hook. Though we know differently now, at the time, the portfolio of swaps was thought to be almost risk-free, even though over $61 billion of the portfolio was derived from securities with exposure to sub-prime mortgages.
AIG's risk, and ultimate downfall, came in two distinct channels: 1) losses from the securities themselves; and 2) calls from its contract counterparties for the insurer to post collateral against the declining securities value or if AIG itself became less creditworthy. The combination of these two financial strains is what really took AIG's feet out from under it.
During a conference call with investors, several high-ranking officials at AIG reassured their listeners that the risk associated with the credit-default swaps portfolio was close to nil.
Joseph Cassano, head of AIG Financial Products: "It is hard for us, without being flippant, to even see a scenario within any kind of realm of reason that would see us losing a dollar in any of those transactions."
AIG's chief risk officer: "The risk actually undertaken is very modest and remote."
Martin Sullivan, AIG's CEO: "That's why I am sleeping a little bit easier at night."
One of AIG's largest swaps customers, Goldman Sachs (NYSE: GS), requests that the insurer post $1.5 billion in collateral against its exposure to the portfolio. AIG agrees to $450 million.
Goldman requests another $3 billion in collateral -- AIG posts $1.5 billion.
AIG disclosed $352 million in unrealized losses related to its CDS portfolio in an SEC filing, though states that it would be "highly unlikely" for the company to see actual losses. The company also notes that it is in a disagreement with some if its counterparties over the actual collateral required by the contracts, though it does not disclose the amount it has posted thus far.
CEO Sullivan is privately warned by outside auditor, PricewaterhouseCoopers, that the company could have a material weakness related to the risk management of its swaps portfolio.
In another SEC filing, AIG discloses a further $1.05 billion to $1.5 billion in unrealized losses (2007 Total: $1.5 billion). Sullivan assures investors on a conference call that any losses associated with housing will be "manageable," and that the company's risk-management efforts will show through. The substance of this call led regulators to later investigate whether Sullivan misled investors on the riskiness of the business.
AIG discloses PWC's warnings of material weaknesses in the swaps portfolio's valuation in an SEC filing. The company corrects its stated, unrealized losses to $5.96 billion through November 2007.
In its annual filing, AIG reports that its total 2007 losses from its swaps portfolio tops $11.5 billion and that it has so far posted $5.3 billion in collateral. CEO Sullivan states that he believes that the losses will reverse over the remaining lifetime of the portfolio, so they are not "indicative of the losses AIG Financial Products may realize over time." It's also announces that Joseph Cassano will resign as head of AIGFP (and responsible for the CDS portfolio), though Cassano does stay in touch -- through a $1 million-per-month consulting contract.
In its first-quarter filing, AIG discloses that its losses have totaled $9.1 billion in the first three months of 2008 -- bringing its grand total to $20.6 billion so far. It also notes that it has posted $9.7 billion in collateral to date.
Former CEO Hank Greenberg files a statement with regulators that the insurer is in a crisis and that investors have lost over $80 billion since the mortgage market began to slump the previous year.
AIG is forced to raise $20 billion in private capital to deal with the mounting issues from its CDS portfolio.
CEO Sullivan is replaced by Robert Willumstad.
In its second-quarter filing, AIG updates its total losses to $26.2 billion and aggregate collateral to $16.5 billion.
Standard & Poor's downgrades AIG's credit rating due to "the combination of reduced flexibility in meeting additional collateral needs and concerns over increasing residential mortgage-related losses." The downgrade forces another $14.5 billion in collateral, putting the insurer near collapse.
The Federal Reserve, with the support of the U.S. Treasury, authorizes the New York Fed to lend up to $85 billion to AIG through a revolving credit facility in return for a 79.9% equity interest.
The rest is history...
There is a lot more to the rescue and recovery of AIG than what happened on September 16, 2008. But for current investors, it's important to look back at a company every now and then to see how it managed problems and risks. For AIG, management didn't really address the issue, and they eventually led the company down a big hole. If you look at the company's current leaders, you'll see a very different set of approaches than the ones mentioned above, and that should be a huge relief to investors. By making sure you keep track of how the company's top personnel led it through troubled waters, you can help yourself recognize weaknesses and help avoid history repeating itself.
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