If AIG insured Mortgages

[andy04]

Earlier today I heard the one of the main reasons for AIG to go broke was bcoz they insured mortgage or mortgage backed security for some shit like that and once the housing industry collapsed that had to say the policy owners. So if AIG was paying for bad mortgages why are banks failing due to mortgage crisis? Who exactly did AIG insure?

 

[mshan]

I think it has something to do with their derivatives exposure (credit default swap agreements they made with other banks around the world (?)

 

[GTKeeper]

Here is how the scheme worked.

Banks bought up all these sub-prime mortgages.... then they repackaged them into CDOs mixing some good and some bad mortgages. CDOs are basically collateralized debt obligations which are asset backed securities, in this case mortgage backed. Now the CDOs that were created were sold back and forth and treated as ASSETS instead of debt (mortgages are debt) because they slapped on the AAA rating that AIG had as an insurer. So AIG essentially is insuring a whole ton of CDOs by engaging in CDSs (credit default swaps).

Now the housing market fails, people go into forclosure.... the CDOs are now worth PENNIES on the dollar..... and no one wants to buy them.

SO

AIG is effected because it makes payouts when bankruptcy and defaults occur... it has to by law, its an insurer. So when it runs out of cash, it cannot operate.

The banks fail because they can no longer sell their CDOs because they are worthless (extremely risky, worth pennies on the dollar) so that causes write downs and further drains cash from the banks.

Does this make sense? And this is only the begininig.

 

[mshan]

Cartoon slideshow of what GTKeeper said in second paragraph: http://www.businesspundit.com/the-sub-prime-primer/

 

[Thump553]

Excellent explanation GTKeeper. You got the gist across without getting arcane.

 

[ohnoes]

Wouldn't mortgages be considered debt to the homeowner, but assets to the bank & wall street?

 

[GTKeeper]

Originally posted by: ohnoes
Wouldn't mortgages be considered debt to the homeowner, but assets to the bank & wall street?

Thats what I meant. Part of the great finance sector run of 2002-2005 was buying all these CDOs.... housing prices go up, CDOs go up in value so overall asset value / company value increases.

The problem with CDOs also is that financial institutions packaged their own debt sold it and resold it amongst themselves and brought it back on their books as assets..... we will have to see how deep the rabbit hole goes.