Here’s The Untold Story Of How AIG Destroyed Itself

The collapse of American International Group (AIG) was largely the result of a little understood investment strategy that allowed the insurance giant to make optimistic bets on the housing market and other asset classes without having to actually buy the bonds backed by mortgages or other assets.

The details of AIG’s investment strategy have been largely obscured by the analogy with insurance. In the typical telling, AIG is depicted as insuring mortgage bonds packaged by banks. AIG often seems to be almost a passive and unsophisticated player that came in after the deal.

In reality, AIG was deeply involved in the creation of the financial products it insured, according to a person familiar with the matter. 

AIG was frequently involved right from the start of deals to securitize assets. It conducted its own due diligence on asset backed securities, sometimes going further than the banks that were actually buying the securities. Its financial professionals at times pitched deals AIG wanted insure to underwriters. It was an active participant in the market with a sophisticated, if risky, strategy for investing in the housing markets and infrastructure projects.

AIG As A Buyer Of Risk
AIG’s financial products division became what is known on Wall Street as a “synthetic buyer” of a variety of asset backed securities, including mortgages and infrastructure linked bonds. AIGFP would sell credit default swaps that performed for the company much like an ordinary bond would for a bond investor. As long as the insured bonds were performing, AIG would receive a regular revenue stream from the buyer that mirrored the regular payments of interest and principle that a bond holder would receive. AIG was able investing in the bonds without actually having to buy them.

AIG, in other words, was essentially performing the financial product equivalent of buying a house with out having to make a down payment.

Goldman Sachs, which has been depicted in the press as “stuffing” AIG with risk to bad mortgages, frequently found itself packaging bond deals specifically to meet the demand from AIG for mortgage exposure, sources familiar with the matter say. 

For AIG, investing in the bonds synthetically by selling credit default swaps had a major advantage over buying the bonds directly. Much of AIG’s capital was tied up in regulated insurance business, which meant that despite its huge balance sheet it could only deploy investment assets in…