Why is AIG in crisis?
1) CDS: Unlike most other insurance companies, AIG plunged into the market for credit default swaps, which are contracts that act like insurance by protecting investors against default in a range of assets, including subprime mortgages and corporate bonds. Swap buyers make regular payments to sellers like AIG, who in turn have to make payouts if a default or bankruptcy occurs. As the risk of default on the assets has increased, AIG has had to write-down the value of the protection it sold and post collateral to its counterparties.
2) MORTGAGES: AIG also has other businesses that are exposed to the troubled housing market, including a unit that makes mortgage loans to consumers and a unit that promises to make payouts to lenders if a borrower can’t pay the mortgage.
3) INVESTMENTS: Like any insurance company, AIG funnels premiums paid by policyholders into myriad investments aimed at generating profits to fund future claims. Amid the upheaval in the markets, some of those investments have fallen in value.
http://blogs.wsj.com/wallstreetcrisis/2008/09/16/questions-and-answers-on-aig/
Thanks so much for the excellent summary!