Friends, did you know that 13 years ago. It means, in the year 2008. The world was suffering from a financial crisis. Many big companies were declared bankrupt. Even millions of people lost their jobs. And this did not happen in one country only. Even this crisis broke the backbone of the whole world. Even a powerful country like America.
Can’t survive during this crisis. In fact, the root of the crisis was America. So, in today’s blog post, we will come to know. How and why the whole world suffers from that crisis? And what was the role of the American Finance & Assurance Company, AIG? Let’s start the whole story. Friends, this financial crisis, Took place in the year 2007-2008.
But this crisis starts thriving in the late 90s. In fact, in the late 90s or early 2000. America suffered from major events like the Dotcom crash and terrorist attacks. That affected the whole economy. That’s why America’s Federal Reserve. Decrease the interest rate. To maintain price stability and economic growth in the economy. You will be surprised to know that Federal Reserve. Decrease their interest rate from 6.5% to 1.75%.
And its result was that most people. For fulfilling their psychological need. They start taking loans for cars, electronics, etc. Because the interest rate was very low. The people who were not eligible for loans because of their low credit scores. They also start trying to get loans from banks. In a true sense. They can’t get loans. But the banks became greedy.
And start providing loans at the mortgage. Let me tell you, what’s a Mortgage? It’s a contract between the bank and the borrower. According to it, if the borrower is unable to pay the loan’s installments. Then the bank can recover the amount by selling the borrower’s property. So, as I told you. American banks were providing loans to the people. That has not any stable income source. And not even a good credit score.
These types of loans are called Sub-Prime Mortgages. Because the probability of defaults is high. Even the banks already knew about this risk. But they think if there will be any situation of default loans. Then they will collect the amount by selling out the borrower’s property. As banks were providing loans to most people. Then they start facing the problem of liquidity. And to solve this problem. Banks had to take help from Collateriz Debt Obligation[CDO].
When the banks face the problem of liquidity. Then by making a bundle of thousands of mortgages. They sell them to third parties like investors, corporators, etc. in the form of bonds. And in return, the banks receive cash from third parties. That solves the problem of liquidity. And the banks that sell the bonds of the mortgages. That is called CDO. Means Collateralized Debt Obligation. The third parties buy the CDOs.
Because the borrower. Repay the loan amount to the third parties with interest. And they earn a good profit. And according to Statistics. The probability of default of these CDOs is totally zero. But the problem was that. That the CDO is prepared by banks. The no. of Sub-Prime-Mortgages was too much. As we told you.
The probability of defaults of Sub-Prime-Mortgages is too high. Then who wants to bear this risk? So, to decrease the risk. America’s Multinational Finance & Assurance Company, AIG. They brought its special Credit Default Swap policy i.e. CDS. That was the main reason behind this crisis. For your kind information. At the time, AIG was one of the reputed companies of America. Whose business was spread in more than 80 countries.
Then AIG starts providing insurance on risky CDOs. If any CDO will get the default. Then AIG will bear the loss. Friends, this is AIG’s insurance policy. Was called CDS. As a reputed company, CIG was ensuring the CDOs. Even the majority of Sub-Prime Mortgages. The risk has been decreased. And when there is no risk.
Then many third-party companies. Not even America. Many investors and insurance companies of other counties were also included. They start buying these CDOs to earn some profit. And selling these CDS policies. It will be proved beneficial for CIG. In the next few years. They earn millions of dollars from this insurance policy. But, here the problem was that.
The AIG company became greedy for profit. And in greediness, they made a mistake. That made the situation of crisis worst. Whenever a company sells out its insurance. To repay the insurance. They must have good enough funds. But AIG had not much enough funds. According to the previous data. AIG was assured.
That there will be no need the repay the insurance policy. And the banks become worry-free. And keep providing loans for many years at low-interest rates. That increased the housing market price in America. Here the conclusion is. From ordinary people to AIG. Every involved party was earning a good profit. But this profit was just a bubble. That can burst at any time.
And at last, in the year 2006. It starts leaking. In fact, America’s Federal Reserve. Increased the interest rate from 1.75% to 5.2%. Because of the increase in the interest rate. It affected the borrowers a lot. But the Sub-prime-mortgages borrowers were mainly affected. Because their income was not much enough. They can repay the interest on their loans.
And as a result. They stop paying the installments. As soon as the no. of defaulters increases. The value of CDOs starts decreasing. Because of the Mortgage defaulters. The market values of the CDOs decrease. That banks earned by selling then the third parties. And then offered it in form of loans. In this situation.
Banks start selling out the houses of the defaulters. From which the supply of houses was increased in the housing market. And as a result. The prices of the houses were very high. Came to the bottom in a single strike. And when the value of houses becomes lower than the loan amounts. Then the prime mortgages stop paying the installments too. This means the people that can repay the loan amount easily. Because of the sudden crash of the housing market of America.
This becomes a matter of concern for the banks and the third parties. But they were still satisfied. That their CDO are insured by CIG’s CDS insurance policy. And they can recover the loss from the loan amount. But as we told you earlier. That AIG had not much enough funds. That they can repay the loan amounts of CDOs. But AIG paid the amount that it can. After that, on 15-Sep-2008.
All funds of AIG were finished. On the same day. One of the reputed banks of America, Lehman Brothers Banks Declared as Bankrupt. Then sub-prime-mortgage crises changed into a financial crisis. As many investors and insurance companies had invested in that CDOs. We got to see the effect not only in America but even on the whole world. And because of the crisis, inflation took place, which is called as Great Recession. Because of the insufficient of funds.
AIG was gonna be bankrupt. Many banks and insurance companies of the world. Were collaborated with AIG. Even the Federal Reserve knew. If AIG will be declared bankrupt. Then the financial crisis will become worst. So, to save AIG. Federal Reserve came to handle this situation. Federal Reserve gave a loan worth $86 Billion to AIG.
And in return, they acquire 80% equity shares of AIG. Then the whole control came under American Govt. Firstly, they appointed ED. Liddy as a new CEO of AIG. And change the company’s leadership. Even then, Federal Reserve spent a lot of money. In which the money paid to settle the cases filed against AIG was also included. To save the AIG. Federal Reserve had to spend a total of $122 Billion. After that, AIG came the right way.
And you will be shocked. In 2012 recovered all the amount from AIG. That Federal Reserve sells out the AIG state at a profit of $22 Billion. 13 years has been passed away. But it is still counted in the topmost financial crisis. Friends, it’s enough for today’s post. Thanks for providing your precious time by reading our blog posts.