On ‘Meltdown Monday’ (15 September, 2008) as Lehman Brothers goes bust, American International Group’s credit rating tumbles, writes Paul Coleman.

   News emerges that AIG, the world’s largest insurer, owes $13 billion via Credit Default Swaps to investors. CDS insured investors against potential failure of their Collateralised Debt Obligations. CDOs were based mainly on America’s subprime mortgage boom that peaked during 2005-07.

   AIG’s Financial Products division based in London’s Mayfair had issued $500 billion of unregulated CDS during 2000-07. AIG’s Mayfair traders personally pocketed multi-million dollar bonuses.

   CDO investors used CDS like an insurance policy, paying AIG a quarterly premium. If the CDO turned ‘bad’ or ‘toxic’ through large-scale subprime mortgage defaults, AIG promised to cover the investors’ CDO losses.

Buying ‘crap’

But some investment banks also secretively bought CDS to actively bet against CDOs. Banks concurrently sold these CDOs as ‘good buys’ to other investors. Traders knew the CDOs would likely turn to ‘crap’ and they could bag a profit on CDS payouts from AIG.

   But by September 2008 American borrowers on average and low incomes are now defaulting on their subprime mortgages in droves. The CDO/CDS system buckles. Local lenders cannot get their money back. Wall Street investment banks won’t buy any more CDOs (bundled loans) so lenders go to the wall.

   In turn, Wall Street’s top investment banks want AIG to pay them back on the CDS as the CDO market crashes. AIG simply doesn’t have the $13 billion being demanded.

Exposure

AIG’s exposure panics other investment banks and major global companies who have insured their own financial high risk-taking with AIG. Some $307 billion of AIG’s $447bn guarantees prop up major European banks and businesses. AIG is now a global default insurer with its own massive debt problems. An AIG collapse would ripple huge losses around the global financial system.

Too big to fail

On Tuesday morning, 16 September, AIG urgently demands a $40bn US government loan. Close to midnight, AIG share values halve. But the US government, headed by President George W. Bush, deems AIG, unlike Lehman, as ‘too big to fail’ – and not just for AIG’s centrality to global finance.

   AIG also leases passenger jets to airlines and so operates as the biggest customer of world aerospace manufacturers like Boeing and EADS. If AIG crashes, existing planes won’t fly and new planes won’t be built.

   The US government bails out AIG with an $85bn loan but takes a massive 80 per cent stake in the company. Free market ideologues berate this as ‘state capitalism’, even more galling to them as it is authorised by free-market fellow travellers, Paulson, Bernanke and Bush. 

But by Wednesday morning, 17th September, their moans can’t be heard above fresh panic-stricken cries sounding loudly in London.

© Paul Coleman LONDON INTELLIGENCE 2012