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Liquidity Risk Management Case Study: These non-traditional insurance instruments insured the counterparty in the event of default on collateralized debt obligation payments.
The company believed that the risk was very small because they primarily insured AAA- rate tranches which they presumed would be close to risk-free. However what they failed to factor was the significant risk factor that as per contractual agreement they were required to post collateral with the counterparties in the event that values on the underlying CDOs declined; also that in the eventuality of a down-grade in their credit ratings they would be required to post additional collateral with their counterparties.
During the years prior to the financial crisis and even during the crisis AIG was confident that the risks that they were exposed to, in terms of declining values of CDOs and down-grades, were negligible because they believed that the market would eventually recover and that they were too big an entity to fail.
In Augustsubsequent to growing delinquencies in the subprime market and falling values of mortgage-backed instruments, Goldman Sachs demanded that AIG post collateral to cover its exposure to the fall in market value of its CDO portfolio. However AIG also reported that they would most likely not realize these losses as they believed that the market would recover.
What they also reported was that there were disagreements between counterparties and AIG regarding the amount needed as collateral. This suggested that there were differences in the valuations given to the underlying CDO portfolio by the insurance company and their counterparties. Despite this substantial increase in losses AIG continued to tell investors that based on their risk models they believed that there was a very negligible possibility that any of these losses would actually be realized.
On 11th February the company disclosed the concerns of their auditor regarding the material weakness of their valuation and risk models used for the CDS portfolio. This turned out to be the first of a number of bailouts provided by the government to AIG to keep it from failing.
In the case of the latter, AIG had lent clients securities in return for cash which it had in turn invested in other securities.
Due to the loss in value of these other securities AIG could not honor the demands of its clients. With the new bailout facility the Fed agreed to borrow these other securities in return for cash so that AIG could in turn close the outstanding deals with its clients.
The government also imposed bonus and pay restrictions for its employees and executives on AIG. AIG continued to use the loan to pay off its obligations on credit default swaps purchased to hedge against defaults of Lehman and other bankrupted entities.
It also announced plans to sell of its life insurance operations in various countries. In light of this the government announced a third bailout on 10th November However news reported indicated that CEO was not going ahead with plans to fund bailout loan repayments through the sales of AIG assets because of the difficulty in finding strong potential buyers and because of the declining valuation of its insurance assets.
Since receiving its first bailout AIG has continued to sell its assets, including its asset management businesses and major insurance subsidiaries, using the proceeds to pay-off its loan to the government. In addition it would pay off the Federal Reserve loan through earnings and asset sales.Case Study.
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He was extremely dissatisfied within . Access to case studies expires six months after purchase date. Publication Date: May 13, A client asks Luc Giraud, CEO of the structured finance solutions provider Nexgen Financial Solutions.
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