AIG insured the housing bubble with swaps it never hedged — and needed a $180B rescue

American International Group (AIG) was one of the world's largest insurers. Through a small London-based unit called AIG Financial Products, it sold enormous quantities of credit default swaps — essentially insurance against the default of mortgage-backed securities and other debt. The business looked highly profitable: AIG collected premiums and, for years, paid out few claims. Crucially, AIG did not hedge the risk or set aside reserves against the possibility that many of these securities might default at once.

The bet was that the US housing market would not collapse broadly. When it did, in 2007-2008, the losses on the securities AIG had insured mounted fast, and the counterparties that had bought the swaps demanded collateral and payouts that AIG could not meet. Because AIG was so large and so interconnected with major banks and financial institutions around the world, its failure threatened to cascade through the entire global financial system.

In September 2008, the Federal Reserve stepped in with a rescue that ultimately reached about $180 billion, the largest bailout of the financial crisis, and the US government took a controlling stake in the company. The Financial Crisis Inquiry Commission later attributed AIG's failure to its 'massive sales of unhedged' credit default swaps. AIG eventually repaid the government about $205 billion (with interest) by 2012, but the episode had helped push the world to the brink of a second Great Depression.