AIG, Goldman Sachs, and the 2008 Bailout Scandal

The Insurance Gambit: Setting the Stage

In the marketplace leading up to the 2008 economic crisis, lenders, ratings agencies, and insurance companies were working together to create wealth from bad debts — loans given to homeowners unlikely to repay them. These debts, the ones most likely to default, were bundled and sold in tranches to investors who believed, or at least allowed themselves to think (or did not even care to question), that they were receiving AAA-rated bonds (Lewis). When it became clear that banks — the biggest buyers of these "time-bomb" bundles — were overexposed, and that demand for the bundles was drying up as investors realized they were holding junk bonds rather than sound investments, the price of insurance on those bundles skyrocketed. Banks began dumping the bundles, and overnight, as in the case of Lehman Brothers and others, financial institutions around the world found themselves threatened with extinction as their investments in bad debt came back to bite them. Those who had purchased insurance on the bad debts expected to be paid accordingly.

When American International Group (AIG), which had sold insurance on the bad debt — never really expecting to have to pay out, since the bundles had received favorable ratings from the ratings agencies — was faced with the prospect of forking over billions it did not have, the game was up. Someone from somewhere would have to intervene with a massive infusion of cash, or else the entire scheme would collapse. Fortunately for AIG and Goldman Sachs, the largest purchaser of that insurance, both firms had friends in high places.

As Matt Taibbi shows, the recession was the direct result of the irresponsible money-lending and financial directives of banks such as Goldman Sachs and insurance agencies such as AIG. Goldman had been buying toxic mortgages and having them insured by AIG by the billions. The plan was simple: wait until the loans default and collect the insurance. AIG did not have the money to cover all its policies and was faced with the prospect of liquidating its assets, which were spread across states throughout the nation. Faced with the possibility of losing its entire fortune in an attempt to compensate the banks to which it owed billions — including Goldman, which knew its bonds could never be covered yet kept purchasing them — and of creating a tidal wave of market collapse, the federal government, run by Goldman Sachs alumni such as Henry Paulson, decided to spare both AIG and Goldman Sachs the hardship they had brought upon themselves.

The federal government spared them — and companies like them — by placing the entire burden on the average American, to the tune of $700 billion in taxpayers' money. Their reward was not what should have happened in a legitimate, competitive market, where sound decisions are rewarded with success and irresponsible ones with failure. AIG was saved by taxpayers despite taxpayers' loud outcry. AIG, in turn, took the billions it was given and funneled the money into the pockets of Goldman Sachs, while millions of men and women across the country lost their homes and their jobs — as did Goldman's competition, Lehman Brothers, which received no bailout and was allowed to collapse entirely.

How the Scandal Was Uncovered

The scandal was uncovered by several individual investors, market analysts, and hedge fund managers who profited from the impending bust by shorting the market — the banks and insurance companies in particular. Among these perceptive "shorts" were Steve Eisman, Dr. Michael Burry, and Charlie Ledley, all of whom are profiled by Michael Lewis in his exposé on the subject, The Big Short. Each uncovered the depth of the looming disaster in his own way, but essentially they all recognized the extraordinary level of risk associated with credit default swaps and collateralized debt obligations. The risk was absurdly high, and no one in the banking industry, the ratings world, or at AIG seemed to be aware of it, as far as Eisman, Burry, Ledley, and others could tell.

They probed the marketplace and the men behind it and found that these shoddy bonds were being bundled and sold as sound investments when in reality they were built on the fragile loans at the root of the housing bubble, which was about to burst. One of the most glaring red flags these men identified was the fact that ordinary Americans were being given irresponsible loans they could not possibly repay. Eisman's babysitter, for instance, had essentially been loaned enough money to purchase multiple homes — all on a babysitter's salary. This nationwide lending policy, which prevailed in the early 2000s, was a giant red flag that the broader financial establishment chose to ignore.

Red Flags and the Revolving Door

Another major red flag — visible after the implosion of Lehman Brothers and the subsequent bailout — was the fact that all of this had been foreseeable ever since the worlds of finance and government began their merger in the 1980s. Anyone paying close attention then would have noticed that it was the Reagan administration that ushered in the era of Wall Street deregulation, a trend that continued under Bush (I), Clinton, Bush (II), and Obama. During that period, the position of Treasury Secretary had repeatedly been filled by men with deep roots in the financial sector: Donald Regan (Merrill Lynch), Robert Rubin (Goldman Sachs), Henry Paulson (Goldman Sachs), and Timothy Geithner (President of the Federal Reserve).

Moreover, at AIG, Joe Cassano was "generating $300 million a year, or 15% of AIG's profits" by selling insurance on the junk bonds that were passing as AAA-rated securities (Lewis 71), and Goldman Sachs was at the top of the list of buyers. Goldman had no fear: its former chief, Henry Paulson, was U.S. Secretary of the Treasury. If Goldman — or, more to the point, AIG — ever got into trouble, Paulson was positioned to ensure that Goldman would not be burned. And ensuring that outcome meant bailing out AIG.

Works Cited

Greider, William. "The AIG Bailout Scandal." The Nation. 6 Aug. 2010. Web. 30 Mar. 2015.

Lewis, Michael. The Big Short. New York: W.W. Norton, 2010. Print.

Taibbi, Matt. Griftopia. New York: Spiegel & Grau, 2010. Print.