The insurance giant whose credit default swaps fueled the financial crisis now appears to be in better straits. AIG will be releasing earnings on Friday, and this will be a must-watch event.
How AIG almost fell apart
Here’s the 30-second explanation of AIG’s role in the crisis: investors were concerned about the subprime mortgage securities that they were purchasing, so they also purchased insurance on those securities in case they defaulted. That insurance is called a credit default swap (CDS), and AIG was one of the main issuers. For a while, this was a very profitable business for AIG as the company reaped in insurance premiums, and after all, nothing could possibly go wrong in the housing market, right? Right?
Unfortunately, AIG completely underestimated the risk of subprime, and hence when investors started making claims on the CDSs to call in the insurance, AIG did not have enough capital to cover.
An article in the August 2009 issue of Bloomberg Markets Magazine had an interview with Gerry Pasciucco, who was hired in October 2008 by AIG to unwind their CDS division in order to restore stability in the company. His work appears to have been successful. Bloomberg reported Monday that AIG is showing "stable revenue for its insurance units and improving its ability to repay taxpayers 17 months after a bailout that swelled to $182.3 billion.”
It could be then that the insurance giant is coming back to life. Credit default swaps almost destroyed the company—but they were not AIG’s only product. If CDSs were AIG’s only poisonous division and the rest of the company was solid, then AIG could potentially stage a comeback.
This company is still far too speculative for me to give a solid buy recommendation, but it is worth watching as a high-risk/high-reward opportunity. Watch the earnings release on Friday closely, and also watch Bernanke’s testimony today and Thursday, as the federal government of the United States is AIG’s largest shareholder.