Most people have no real understanding of the impact
of the American Insurance Group or AIG on the mortgage market and the
global banking system and how close we came to Financial Armageddon.
All of a sudden the dominoes started to fall and the Federal Reserve
Bank of America started to pick and choose who they would save. Lehman
Brothers, the investment company posted losses of $3.9billion before
they filed for Chapter 11 bankruptcy protection and then collapsed.
Merrill Lynch was bought by the Bank of America for $50billion.

The
Federal Reserve Bank of America stepped in and agreed to lend AIG $85
billion in order to facilitate the sale of its global assets estimated
at over $1 trillion in exchange for essentially all the company\'s
equity. The Federal Reserve Bank is currently lending AIG the money
while they sell off their assets to pay their liabilities for all the
Credit Default Swaps that they insured. AIG are paying the Federal
Reserve Bank 8.5% above the 3-month Libor rate, currently 11.5% and
they currently own 79.9% of AIG.

An AIG bankruptcy would have
been the worst financial collapse in history if it had been allowed. So
what had happened and why did the Federal Reserve Bank stepped in? Most
of us thought it was saved by the Federal Reserve Bank because AIG was
the largest Insurance Company in the world with 74 million clients in
over 130 countries and its demise would have left us all uninsured if
it had gone bust. Wrong! Few of us actually understood the significance
of this take over by the Federal Reserve Bank and its impact if the
Federal Reserve Bank had not intervened.

The Past Decade

What had happened over the past decade was that the banks and
investment banks had been bundling up risky sub-prime mortgages that
they had sold and then selling these to investors or banks in Europe.
To make these mortgage investments more saleable they would purchase an
AIG Credit Default Swaps or also known as debt insurance contracts.
AIG\'s credit default swaps were insurance contracts which were not
regulated. Typically these insurance policies were for three to five
years. AIG did not have the capital reserves required to back up these
policies should they ever have to pay any claims out. This would prove
to be their downfall or their nemesis when their day of reckoning
arrived.

AIG was not required to hold any capital in reserve as
collateral on its credit default swaps as long as they maintained a
triple-A credit rating. AIG made hundreds of millions of dollars in
\'profit\' each year, without any collateral reserves. All the banks that
purchased these credit default swaps were able to assure their national
regulators that they were holding only triple-A credits mortgage
products instead of the sub-prime mortgages that they were really
holding which were high risk and toxic.

AIG\'s Day of Reckoning arrived

On the 15th September AIG\'s day of reckoning arrived when the major
credit-rating agencies Standard & Poor\'s, Moody\'s and Fitch
downgraded AIG\'s triple-A credit status. The credit rating agencies had
discovered the soaring claims being paid out by AIG for their credit
default swaps insurance policies. AIG was able to raise capital
$11billion only once from the market to repair the damage, but the
claims kept growing. The Largest Insurance Company in the world was
effectively bankrupt.

The domino effect had started, the first to
fall was Lehman Brothers they were reported to be the biggest
bankruptcy in history. Merrill Lynch was bought by the Bank of America.
The Federal Reserve Bank stepped into help AIG. AIG\'s problems could
still cause further turmoil in the market for the debt insurance
contracts. That market was considered to be worth $58 trillion
worldwide at the end of 2007. The biggest problem is that nobody really
knows how much of the $58 trillion AIG is responsible for? Frightening!

There
is still more to emerge and this is possible only the tip of the
iceberg. We have had Freddie Mac, Fannie Mae, the American car
manufacturers, I-Save the Icelandic bank, Royal Bank of Scotland,
Lloyds TSB, HBOS and others. These are the big and the great, what
about all the smaller banks and companies around that are now trying to
struggle on in the current circumstances

The consequences of AIG\'s

The mortgage bubble would never have grown so large had it not been
for AIG\'s involvement. The banks would never have made such huge
profits and the supply of money would not have been so easy to obtain
by everyone and the growth in the mortgage market would have been
controlled. Today the investment banks are now struggling as they have
no way of borrowing money as no one will insure their obligations any
more since the collapse of Credit Default Swaps or debt insurance
contracts.

The Impact of AIG

The collapse of AIG has had a major impact on the mortgage market
and the banking system worldwide. It has added to the dire situation we
all find ourselves in today with:

A worldwide recession

Unemployment rising

Home repossessions rising

Homeowners falling in to arrears with mortgage payments

Falling house prices

Negative equity

Mortgages that are hard to obtain

Lack of confidence between banks when lending money to each other

Falling stock markets

Falling interest rates

Government intervention to prop up the banking systems

Deflation on the horizon

Uncertainty in the financial markets.

The future for the next
two to three years is gloomy at present. We need to hope that a
consequence of all this spending by governments to ease this recession
does not lead to high inflation in the future in order to down value
the overall debt that all the governments will have in the future.