American International Group (AIG)

American International Group (AIG) is a global insurance corporation that became the poster child for the catastrophic risks lurking in the modern financial system during the 2008 Financial Crisis. While it operates a vast, traditional insurance business covering everything from property to life insurance, its name is forever etched in history for its near-collapse and subsequent massive government bailout. Before 2008, AIG was an insurance titan, a seemingly invincible giant. However, a small, London-based unit called AIG Financial Products (AIGFP) engaged in selling vast quantities of a complex derivative known as a Credit Default Swap (CDS). This division effectively sold “insurance” on bundled mortgage debt without setting aside the necessary capital, believing a widespread housing crash was impossible. When the impossible happened, AIG faced a liquidity crisis that threatened to bring down the entire global financial system, making its story a crucial, if terrifying, lesson for every investor.

AIG's story begins not on Wall Street, but in Shanghai, China, in 1919. Founded by American entrepreneur Cornelius Vander Starr, the company grew from a small local insurer into a sprawling international empire under the legendary leadership of Maurice “Hank” Greenberg. For decades, AIG was a symbol of relentless growth and profitability. It expanded into over 130 countries, becoming the largest insurance company in the world. Its core business was sound, but its ambition led it into the labyrinthine world of financial engineering, a move that would ultimately prove to be its undoing.

The fuse for AIG's implosion was lit within its AIGFP unit. This division, staffed by financial wizards, became the world's largest seller of Credit Default Swaps. Here's the simple breakdown:

• The Product: A CDS is like an insurance policy. Banks and investment funds bought these from AIG to protect themselves in case the mortgage-backed securities they held went bad. For years, AIG collected billions in premiums for selling this protection.
• The Flaw: It was a catastrophically flawed business model. AIG operated under the assumption that the U.S. housing market would never collapse on a national scale, so it would never have to pay out on all these policies at once. Because the CDS market was largely unregulated, AIG was not required to hold sufficient capital reserves to back the enormous risk it was taking on. It was like selling fire insurance for every house in the country without having any money in the bank to pay claims if a firestorm hit.
• The Collapse: When the subprime mortgage market imploded in 2007-2008, the firestorm arrived. The value of mortgage-backed securities plummeted, and AIG's clients came knocking, demanding billions of dollars in collateral to cover their potential losses. AIG didn't have the cash. The failure of Lehman Brothers in September 2008 created panic, and AIG's counterparties—the biggest banks in the world—demanded immediate payment. AIG was just days, if not hours, from bankruptcy.

Faced with AIG's collapse and the certainty of a subsequent domino effect that would obliterate the global banking system, the U.S. government and the Federal Reserve stepped in. They deemed AIG Too Big to Fail. The government extended a colossal rescue package that ultimately totaled over $182 billion in loans and investments in exchange for nearly 80% ownership of the company. This unprecedented bailout was deeply controversial but was seen by policymakers as the only way to prevent a complete economic meltdown.

The AIG saga is a treasure trove of lessons for the value investor. It’s a powerful reminder that what you don't see can hurt you the most.

• Complexity Kills: Warren Buffett famously says, “Never invest in a business you cannot understand.” AIG became a prime example of this rule. Its financial statements were so opaque and its exposure to derivatives so complex that almost no one, including its own executives and regulators, truly understood the scale of the risk on its books. For a value investor, if you can't explain a company's business model on the back of a napkin, stay away.
• The Balance Sheet Is Not a Suggestion: The income statement might tell a story of profitability (AIG's CDS premiums looked like pure profit for years), but the balance sheet reveals the truth about risk. A diligent investor must scrutinize liabilities, both on and off the balance sheet. AIG's true liabilities were hidden in its massive, unfunded CDS obligations.
• Beware of “Free Money”: AIGFP's business model seemed like a magic money machine—collecting premiums with little perceived risk. This is a classic red flag. High returns with seemingly no risk often conceal a catastrophic tail risk. Always ask, “What has to go wrong for this to blow up?”
• Understand Systemic Risk and Moral Hazard: The AIG bailout highlights the interconnectedness of the financial world (Systemic Risk) and the dangers of creating a system where institutions believe they will be rescued if their bets go sour (Moral Hazard). While you can't predict bailouts, understanding these forces helps you appreciate the unpredictable nature of markets, especially within the financial sector.