What's up guys and welcome to wall street millennial, the 2008 financial crisis saw the world fall into the deep recession, with millions of workers, unemployed and millions more losing their homes. The roots of the financial crisis are complicated, including the explosion of subprime mortgage lending in a speculative bubble in many residential housing markets. But it is undeniable that many of these excesses were caused by banks and other financial institutions taking on excessive risk trading, complex and opaque derivative instruments. Much of the blame goes to investment banks such as lehman brothers, who traded in mortgage-backed securities and enabled the explosion of subprime credit.

However, the irresponsible risks investment banks took on paled in comparison to the single biggest offender, which was insurance behemoth. Aig aig wrote insurance contracts for hundreds of billions of dollars worth of mortgage-backed securities when the housing market crashed aig didn't have nearly enough money to make good on its obligations. If aig were allowed to default, it would have caused a domino effect that would drive many of its financial counterparties into bankruptcy as well. This would have threatened to cause a complete collapse of the global financial system of a similar magnitude to the great depression of the 1930s.

To prevent this, the u.s federal reserve was forced to bail out aig to the tune of 150 billion dollars in the largest transaction of this type in history. In this video, we'll explain what aig did to take on so much risk how this almost destroyed the financial system and how they were billed out by the us government aig was founded in 1919 by american businessman, cornelius vanderstarr or cv star in shanghai. China originally called american asiatic underwriters. The company expanded rapidly in the 1920s selling general policies such as life and casualty insurance using shanghai as its base cv star expanded the business rapidly throughout china and southeast asia in 1939.

Aig moved its headquarters from shanghai to new york. To avoid the impending japanese invasion of china during world war ii in 1984, the company listed its shares on the new york stock exchange. By this time there were an international behemoth with operations in more than 80 countries. Given the company's historical success at rapid expansion, investors came to expect this growth to continue to meet these investor expectations.

Aig had to expand beyond traditional insurance policies such as life, insurance or property insurance. They started writing novel policies such as pollution, liability, insurance and political risk. Insurance for companies operating in emerging markets, they also expanded into areas unrelated to insurance, in partnership with private equity. Firm blackstone aig created an advisory arm for corporations seeking strategic advice by the mid 2000s.

They had a broad portfolio of financial subsidiaries, ranging from asset management to derivatives trading. They were no longer a regular insurance company. They were a diversified financial institution with operations spanning all corners of wall street. In the early 2000s, aig saw an opportunity to take advantage of the booming real estate market, fueled by low interest rates and the global search for yield.

Many institutional investors started increasing their portfolio allegations to residential mortgages to increase the yield. Many investors turn to subprime mortgages. Subprime mortgages are mortgages made by borrowers with low income and poor credit. These borrowers have a much greater probability of default than prime borrowers to compensate for the risk subprime mortgages, have higher interest rates and provide more yield to investors who buy them.

Hedge funds, pension funds and other institutional investors wanted to have their cake and eat it too. They wanted the high returns of subprime mortgages, but also wanted to minimize the default risk associated with them. This is where aig came in for a fee. They promised to insure those investors against the potential losses that they would face if the subprime mortgages defaulted, these contracts were called cds's or credit default swaps, as the default risk was swapped from the investor to aig with aig's, strong reputation and credit rating.

It was assumed that they'd be able to make good on their cds obligations in any scenario with aig insuring against defaults. Investors viewed their mbs portfolios as essentially risk-free and thus use inordinate amounts of leverage to juice. Their returns. Aig's, aggressive expansion into cds's started to pay off with their profits increasing in their stock price, rising by 2008.

They had written cds contracts on roughly 400 billion dollars of mortgages, of which almost 60 billion were sub-prime. Aig did not have nearly enough cash on hand to pay for all these liabilities. They relied on opaque statistical models to judge the default risk on the mortgages. They figured that a large-scale mortgage default was highly unlikely in any given year.

Only a small percentage of the mortgages would default, so they only needed a few billion dollars of cash on hand to cover their cds liabilities. Aig's traders were compensated with millions of dollars of bonuses every year which were tied to how many cds they could sell. They were thereby incentivized to make liberal assumptions regarding default risk. The strategy was to sell as many cds as possible book as much quarterly profits as possible and downplay the risk as much as possible.

In the early 2000s, the real estate market was booming and defaults were very low. Aig's strategy of aggressively selling cds's seemed to be a winning strategy, making them billions of dollars of profit every year, but years before the financial crisis, investors should have been wary of aig's integrity and risk management. In 2005 federal regulators charged the insurance giant 1.6 billion dollars. In fines regarding unlawful accounting practices in the early 2000s aig boosted, its quarterly profits by transferring non-existent loss reserves from the general reinsurance company, which is one of its financial counterparties.

This, along with similar gimmicks artificially boosted aig's recorded profits by 3.5 billion dollars. While these accounting scams are not directly related to cds's, it casts serious doubt about the integrity and transparency of the company aig fostered a corporate culture which prioritized short-term profits at the expense of risk management and honesty. This would become dramatically apparent just a few years later. During the global financial crisis in 2007, the real estate bubble finally burst with prices plummeting more than 25 nationally many subprime borrowers found themselves with mortgage balances exceeding the price of their homes.

This led to a massive wave of defaults across the entire country. The investors who bought cds contracts from aig came to collect on their policies in light of the mortgage defaults aig, was now facing hundreds of billions of dollars worth of claims on their cds contracts, and they didn't have nearly enough cash on hand to fund these liabilities. They needed to raise capital fast or they'd, be forced to declare bankruptcy. Aig started recognizing huge losses relating to their cds positions and their stock was tanking precipitously from 2007 to 2008, aig stock lost almost 98 of its value, with their equity almost worthless.

They were not able to raise enough capital through a traditional at the money offering they needed to find a strategic investor who could bail them out in september of 2008, aig's management made a desperate call to warren buffett, who was one of the few investors with a Financial wherewithal to save the company buffett looked at aig's financials within just a few hours. He told him that there is no way he could make an investment in the dying company unable to find a private investor. The company would run out of money within a matter of days. The bankruptcy of aig would have been a complete unmitigated disaster for the global financial system.

If they went bankrupt, they'd be unable to pay their obligations to the investors, who held the cdss, and those investors would likely go bankrupt as well. These bankruptcies would cause financial strain on these investors. Creditors causing a domino effect on financial institutions throughout the world. The result would be a tightening of financial conditions, making it harder for non-financial companies to receive loans unable to secure funding capital.

Intensive businesses would be unable to buy new equipment and be forced to lay off their employees. The us was on the verge of the depression. Rivaling the severity of the great depression of the 1930s. Just a few months earlier, the investment bank lehman brothers declared bankruptcy that news caused widespread panic in stock market crashes throughout the world.

Aig was much bigger and more complex than laymen. If it were allowed to fail. The economic fallout would have been even worse: federal reserve, chairman ben bernanke, decided that aig was a systemically important institution unable to find private investment. The government had no choice but to step in and bail out.

The institution aig was too big to fail. In september of 2008, the new york federal reserve gave aig 85 billion dollars in exchange for an 80 equity stake in the company over the following years. Both the fed and the treasury department poured in more money bringing a new investment to a grand total of 150 billion dollars. This capital allowed aig to make good on its financial obligations and avoid a broader meltdown in the financial industry.

The bailout caused discontent and sparked protests on wall street people felt that the government was helping out their rich friends on wall street, while regular people were forced to suffer the high unemployment and foreclosures brought about by the recession. However, the term bailout is somewhat misleading. The shareholders of aig suffered massive dilution and lost close to 100 of their value. In fact, taxpayers actually benefited from the transaction.

By 2012, the government had sold out of its taking the company and reported a 23 billion profit from the investment, including interest paid to pay off its debt to the government. Aig was forced to sell off many of its businesses and lay off the majority of its workforce, while it was saved by the government. It operates today as a mere shadow of its former self aig is a quintessential story of corporate greed. Their executives were myopically focused on maximizing short-term profits and collecting quarterly bonuses.

They ignored the inordinate risk that the company was taking on and drove the company within an inch of bankruptcy, while they did end up making good on their obligations with the help of a government. Bailout their precarious position greatly contributed to the chaos and confusion in financial markets. This deepened the great recession and ordinary people ultimately paid the price. Alright guys that wraps it up for this video.

What do you think about aig? Let us know your thoughts in the comments section below, as always. Thank you guys so much for watching and we'll see in the next one wall, street millennial signing out.