Why AIG Failed

This front page story in Sunday's NYT offers a fascinating account of how small division of AIG essentially torpedoed its parent company. Read the whole story, but here's a quick summary of what happened:

AIG Financial Products, a small firm in London, began selling insurance to financial institutions on packages of debt known as “collateralized debt obligations.” Customers paid a premium for the insurance, AIG-FP never had to post collateral on the insurance, and they never assumed that they would have to pay any claims. So they took in a lot of money without every preparing for the possibility that they insurance they were selling was going to be necessary.

Enter the credit crisis. The value of the underlying securities AIG-FP had insured declined. (Whoops!) AIG-FP had to put up collateral on the losses. Any obligations they could not meet were passed along to its corporate parent, AIG. In other words, AIG had to foot the bill for the reckless practices of AIG-FP. That's why AIG failed.

377 dudes in London killed a company with a trillion-dollar balance sheet and 116,000 employees.

Saturday, September 27, 2008