securities were bought by investors, as they tried to reduce the risk of the securities if the borrowers could not pay back and defaulted. If AIG went bankrupt, it would cause a domino effect and the companies that bought these swaps would go down with it. AIG's swaps against subprime mortgages brought it to the verge of bankruptcy. As the mortgages against the swaps defaulted, AIG had to raise capital in millions just to keep up.
The stockholders eventually got a hold on this information and sold their shares and that was another blow to an already sinking ship and AIG couldn’t cover up for the swaps. AIG had enough assets to cover the swaps but it couldn't sell them before the swaps came due. That pushed them in a position where they didn’t have enough cash to deal with the situation The Federal Reserve gave an $85 billion loan to AIG to help their situation and to stop it from getting worse. As they knew this would impact not only the US but the global economy. The government received 79.9% of AIG's equity and the power to change the management. In October 2008, the Federal government hired CEO Edward Liddy. The government planned to sell of AIG piece by piece to pay off the loan But the as the stock market plummeted it became impossible. The Treasury Department purchased preferred shares from in AIG of 40 billion as part of its Capital Repurchase Plan. $52.5 billion in mortgage-backed securities were bought by the fed. Credit default swaps we’re being retired rationally with these funds this is considered as the world’s largest financial rescue. The 90% of all home mortgages by the end of 2008 were guaranteed by Fannie Mae and Freddie Mac. That is why they made it on the list of players I am discussing. They were creating securities by purchasing mortgages from the bank. Due to the high return the investors were interested in these securities and bought them. Home loans were given to everyone even the ones who couldn’t afford a single apartment was buying 3 apartments as he was able to get the financing for it (sub-prime loans), which then were sold as securities. Thousands of dollars on these securities were being spent by investors on these securities. Now when the Mortgage’s defaults started to increase in number and the economical utopia created by the illogical investment regiment was finally revealed to be what it actually was nobody was happy. $100 million in their mortgages were written by the US treasury, in effect returning them to government ownership. If Fannie and Freddie had fallen, the housing market would have fallen as well The book also discusses a few precautions that could have been taken at the time and have been taken since then. Since the Glass-Steagall Act of 1933 the Dodd-Frank Wall Street Reform Act (Dodd- Frank) is the most comprehensive financial reform. It sought to regulate the financial markets and make another economic crisis less likely. It set up the Financial Stability Oversight Council to prevent any more banks from becoming too big to fail.
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- Spring '20
- Government, Federal Reserve System, Fractional-reserve banking, AIG, Subprime mortgage crisis