Crashed: How a Decade of Financial Crises Changed the World

by Adam Tooze

In a dramatic burst of expansion from the 1990s onward, the Financial Products division of AIG had developed into a major player in the derivatives markets. In total in 2007 it had a book of $2.7 trillion in derivatives contracts.22 Of this total, credit default swaps accounted for $527 billion. Of these, $70 billion were on mortgage-backed securities, and of those, $55 billion had exposure to dangerous subprime. Given its inside knowledge of the property market, AIG had stopped writing new CDS already in 2005. But given the relatively small size of the portfolio and the AAA rating of the assets it had written CDS on, it had not thought it necessary to insulate itself against losses. It was a fatal mistake. Out of a total of 44,000 derivatives contracts on the books of AIGFP, there were, it turned out, a cluster of 125 CDS on mortgage-backed securities that were about to go bad in a spectacular way. Those 125 contracts would inflict book value losses on AIG of $11.5 billion, twice what the ill-fated AIGFP unit had earned between 1994 and 2006. This was a heavy blow, but given its enormous global business, AIG could absorb portfolio losses on this scale.

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