I know this is long but, please read. This is directly word for word from AIG's Website explaining what happened. I have highlighted the most important - notice they say the problem was Credit Default Swaps - (which were illegal until 2000). Every other policy AIG has is required to be backed by assets --- Credit Default Swap were not backed by any tangible assets. *_The AIG Financial Crisis: A Summary_ AIG traces its roots back 90 years when an American entrepreneur named C.V. Starr founded AIG’s earliest predecessor company in Shanghai. What began as a small insurance business grew to become one of the world’s largest companies. By early 2007 AIG had assets of $1 trillion, $110 billion in revenues, 74 million customers and 116,000 employees in 130 countries and jurisdictions. Yet just 18 months later, AIG found itself on the brink of failure and in need of emergency government assistance. What Happened? Building upon its premier global life franchise and general insurance, AIG expanded into a range of financial services businesses. One of these, created in 1987, was AIG Financial Products (AIGFP), a company that provides clients with risk management solutions. Among other activities, AIGFP sold credit default swaps to other financial institutions to protect against the default of certain securities. Many of these securities at the time were given a bond rating of AAA and higher. However, in late 2007, as the U.S. residential mortgage market began to deteriorate, these securities were severely impacted. As a result, AIG recorded severe unrealized valuation losses on AIGFP’s credit default swap portfolio. At the same time, AIG incurred heavy losses in the value of its securities lending operation, which invested in high-grade residential mortgage-backed securities. Through this program, AIG made short-term loans of certain securities it owned to generate revenues. At the same time, other AIG real estate-related investments also suffered sharp value losses. It is important to note that throughout the crisis, AIG’s insurance businesses were – and continue to be – healthy. The losses that occurred as a result of AIGFP’s action had no impact on AIG policyholders. AIG’s insurance companies are closely regulated by New York and other states and regions worldwide. Their reserves are protected through regulations that prevent the removal of capital so that each AIG member insurance company has adequate assets to back each policy and meet all policyholder obligations. Even though AIG had incurred virtually no actual credit losses, the severe write-downs led to downgrades in its credit ratings. In addition, AIG was forced to post billions of dollars in collateral to cover potential losses to holders of AIG credit default swaps. Meanwhile, the world capital and credit markets deteriorated rapidly, making it virtually impossible to access other sources of capital to fund these collateral requirements or meet other cash needs. Worsening conditions in global financial markets only made matters worse for AIG. The collapse of respected financial institutions such as Bear Stearns and Lehman Brothers sent shockwaves through the world economy. The failure of the U.S.-sponsored mortgage companies Fannie Mae and Freddie Mac added to the financial disruption. During this time, AIG was seeking private capital solutions to its liquidity problem, exploring possible solutions with state insurance regulators in New York and Pennsylvania. However, as the market deteriorated further, AIG’s share price dropped. In mid-September 2008, AIG’s credit ratings were downgraded once again, triggering additional collateral calls and cash-flow issues in excess of $20 billion. Suddenly, AIG, although solvent, faced an acute liquidity crisis. Because of its size and substantial interconnection with financial markets and institutions around the world, the federal government and financial industry immediately recognized that an uncontrolled failure of AIG would have had severe ramifications. In addition to being the world’s largest insurer, AIG was providing more than $400 billion of credit protection to banks and other clients around the world through its credit default swap business. AIG also provides credit support to municipal transit systems and is a major participant in foreign exchange and interest rate markets. Investment From the U.S. Government To stabilize AIG and prevent the potential ripple effects should it fail, the United States government extended a two-year emergency loan of $85 billion on September 16, 2008. The facility carried a rate of LIBOR (the London Interbank Offered Rate – a widely used benchmark used to set short-term interest rates) plus 8.5%, a commitment fee of 2% on the loan principal and a fee on the undrawn portion of 8.5%. Additionally, the government would be entitled to 79.9% ownership of the company and also, at the government’s request, AIG agreed to elect a new Chairman and Chief Executive Officer. After consultation with the U.S. Treasury and Federal Reserve Bank of New York, AIG’s Board of Directors elected Edward M. Liddy Chairman and Chief Executive Officer. With the loan in place, Mr. Liddy devised a plan to enable AIG to sell many of its leading businesses around the world and pay back the government loan with interest. However, AIG still had to address the two principal sources of its liquidity losses: the multi-sector credit default swap portfolio and the securities lending operation. As the financial industry continued to falter, it became apparent that the terms of AIG’s original government loan would not provide the flexibility necessary for AIG to resolve its financial challenges. Congress and the administration acted to provide new tools to cope with the spreading turmoil. On November 10, 2008, AIG and the Federal Reserve Bank of New York announced a comprehensive plan to address AIG’s liquidity losses and provided more time and greater flexibility to sell assets and repay the government. Among the provisions was the creation of two financing entities. Maiden Lane II and Maiden Lane III, to acquire AIG’s multi-sector credit default swap assets and AIG’s securities lending assets respectively. The entities were funded primarily by the government with a smaller capital contribution by AIG. Under the terms of the agreement, the majority of any appreciation in the securities held by the entities would go to the government. AIG’s Plans Going Forward While AIG’s insurance companies have remained healthy throughout this period of turmoil, the comprehensive assistance allowed AIG’s parent company to immediately stabilize itself and provided the necessary capital and time to rebuild its long-term viability. AIG is now focused on selling assets, repaying the government and the taxpayers, and continuing as an ongoing concern with an emphasis on U.S. commercial and foreign general insurance operations, as well as an ongoing interest in AIG’s high-growth Asian life insurance business. Although the current environment is a difficult one for selling assets, the companies AIG is selling are well-run, profitable businesses that could not be recreated today in some of the world’s most desirable markets. The support of the U.S. government allows AIG to follow an orderly sales process that maximizes value for the assets and minimizes disruption. To date, AIG has announced several divestitures, including the sale of its private banking business, Canadian life insurance business and a stake in AIG’s Brazilian joint venture to Unibanco. AIG also exited an investment in a major US energy company, announced the sale of its equipment breakdown and engineered lines insurance business and sold its commodities trading book of business. AIG is also working to ensure that it continues as a viable, competitive operation that provides value to its stakeholders. AIG is dedicated to maintaining its well-known underwriting discipline and providing value to policyholders, agents and the other business partners who are central to its success. AIG’s employees, the vast majority of whom have had nothing to do with the problems that have devastated AIG and wiped out some or all of their life savings, are at the heart of this effort. They have reduced costs and sharpened their focus on AIG’s customers despite very difficult conditions. AIG also recognizes the importance of its relationship with the U.S. government. *AIG has taken several steps in this regard, including restrictions on executive compensation, *suspension of federal lobbying and cessation of corporate political contributions. In addition, AIG is engaged in improving transparency by working with regulators on capital adequacy, appropriate accounting treatment during times of market disruption, and risk management metrics. Resolving the economic problems facing the U.S. and world markets will require a cooperative effort by the public and private sectors. AIG is committed to playing a constructive role in this process to ensure that it can serve shareholders and pay back taxpayers as it contributes to the U.S. and world economies.