AIG Bailout

The AIG bailout was a series of government rescues of American International Group (AIG), the world’s largest insurer, which faced collapse in September 2008 due to losses on credit default swaps it had sold on mortgage-backed securities. The government ultimately provided $182 billion in support, making AIG the most expensive government bailout of the financial crisis. The massive intervention sparked outrage about corporate compensation and moral hazard.

AIG’s hidden liabilities

American International Group was a massive insurance company with operations in property and casualty insurance, life insurance, and financial services. The company had historically been conservative and well-managed. But in the 2000s, it expanded into financial engineering, particularly a division called AIG Financial Products (AIGFP).

AIGFP sold credit default swaps (CDS) on mortgage-backed securities. A CDS is a type of insurance: a buyer pays a premium, and if the underlying security (in this case, mortgage-backed securities) defaults or declines in value, the seller must compensate the buyer. AIG sold these swaps based on the assumption that mortgage-backed securities were safe. The premiums collected were lucrative, boosting reported earnings.

But AIG was essentially unhedged: if mortgage-backed securities declined in value, AIG would face massive losses and potentially be unable to pay the claims. The accounting for these swaps also allowed AIG to take large profits upfront rather than mark liabilities conservatively as the underlying securities deteriorated.

The crisis and the rating downgrades

As the housing market collapsed and mortgage-backed securities declined in value, AIG’s liabilities grew enormous. By September 2008, mark-to-market losses on CDS positions were over $50 billion. AIG faced a capital call.

When credit rating agencies downgraded AIG’s credit ratings in September 2008, the company faced a death spiral: lower ratings meant that counterparties (other financial institutions) could demand collateral immediately; AIG did not have enough liquidity to meet these demands.

The rescues

On September 16, 2008, the Federal Reserve initiated the first in a series of rescues. The Fed provided an $85 billion credit facility to AIG. In October, the Treasury provided an additional $40 billion as a capital injection. By the end of the crisis, the government had provided roughly $182 billion in support — more than any other single financial institution.

The support came in various forms: Federal Reserve emergency loans (collateralized by AIG’s assets), Treasury capital injections, loans to subsidiaries, and eventually the government took a controlling stake in AIG, effectively nationalizing the company.

The bonus scandal

In March 2009, it was revealed that AIG had paid $165 million in retention bonuses to employees in the Financial Products division — the division that had created the CDS liabilities. The bonuses, designed to keep talented employees from leaving, were paid even as the company was being bailed out with taxpayer money and was insolvent without the government support.

The public outrage was immediate and intense. Congress held hearings. The administration considered clawing back the bonuses. The scandal illustrated the perverse incentives in the financial system: the people responsible for creating the crisis were being rewarded for staying on to manage the ruins.

The recovery

Over the following years, AIG stabilized. The company received much of the government support in the form of loans (which had to be repaid) and preferred equity (which had priority over common equity but paid interest). As the financial system stabilized and AIG’s underlying business improved, the government support was gradually repaid.

By 2012, the government had recovered most of its investment. By 2015, the last of the government’s shares in AIG had been sold back to the private market. The total cost to taxpayers was roughly $25–30 billion (the difference between the $182 billion injected and the amount recovered).

Legacy: Moral hazard and systemic risk

The AIG bailout, more than any other intervention, crystallized debates about moral hazard and systemic risk. Critics argued that bailing out AIG rewarded reckless behavior and created expectations that large firms would always be rescued. Defenders argued that AIG’s failure would have triggered a complete collapse of the financial system and the broader economy.

The AIG case became the central example for debates about “too big to fail” — the moral hazard created when large institutions know they will be bailed out in a crisis.

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