Did you know that 15 years ago. It means, in the year 2008. The world was suffering from a financial crisis. Many big companies were declared as 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 blog Article we are going to know that how and why the whole world suffers from that crisis? and what was the role of the American Finance & Assurance company, AIG?
This financial crisis Took place in the year 2007 - 2008. But this crisis starts thriving in the late 90's. In fact, in the late 90's or early 2000's, America suffered from major events like 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 results 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.
what is Mortgage?
Mortgage is a contract between the bank and the borrowers According to it, if the borrower is unable to pay the loan's instalments. Then the bank can recover their amount by selling the borrower's Property. So, as mentioned in the before paragraph that American Banks were providing loans to the people who doesn't have any stable income source and not even a Good Credit Score. These types of loans are Called Sub-Prime Mortgage. Because the probability of defaults is high even the banks already know about this Risk, but they think if there will be any situation 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 (the problem of less amount of cash) and to solve this problem Banks had to take help from Collateralized Debt Obligation (CDO). In this situation, 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 CDO's 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 CDO's is totally zero but the problem was that the CDO prepared by Banks in them the number of Sub-Prime Mortgages was too Much as we told you that 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 that is CDS. Further that was the main reason behind the 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 CDO's. It means that if any CDO will get the default then AIG will bear the loss, and this is AIG's insurance policy was called CDS (Credit Default Swap). As a Reputed Company AIG was ensuring the CDO's, even the majority of Sub-Prime Mortgages this risk has been decreased and when there is no risk then then many third-party companies not even America many Investors and Insurance companies of other countries were also included. They started buying these CDO's to earn some profit and selling these CDS policies. It will be proved beneficial for AIG. In the next few years, they earn millions of dollars from this insurance policy. But here the problem was that that 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 became 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 single party was earning a good profit, but this profit was just a bubble that can burst at any time and at the 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 to they can repay the interest on their loans and as a result They stop paying the instalments as soon as the number of defaulters increase the value of CDO's started decreasing because of the mortgages defaulters the market values of the CDO's 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 become lower than the loan amounts, then the prime Mortgages stop paying the instalments 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 AIG's CDO 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 CDO's, but AIG paid the amount that it can. After that, on 15 SEPTEMBER 2008, all funds of AIG were finished on the same day one of the reputed banks of America, Lehman Brothers Bank also declared as Bankrupt then Sub-prime Mortgages crisis changed into a Financial Crisis. Why because, as many investors and insurance Companies had invested in that CDO's that's why 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 going to be Bankrupt. In fact, 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 the worst. So, to save AIG Federal Reserve came to handle this situation. Federal Reserve gave a loan worth $85 Billion to AIG and in return, they acquire 80% equity shares of AIG. Then the whole control came under American Government.
After that firstly, they appointed "Edward 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. In these ways 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.
It has been 15 years since this Financial Crisis. But it is still counted in the topmost financial crisis of the history.