Money And Banking For American Institution Group

Describe the Money and Banking For American Institution Group.

Reasons for AIG Credit Crisis

American Institution Group was founded in 1919, Shanghai China. AIG is a multinational insurance company that has branches in over 80 countries. Example Pakistan, Kenya, Indonesia (Patrick, 2017).AIG has its main headquarters in United States of America. AIG offers insurance products to both consumers and commercial clients. Commercial products include mortgage, property casualty and institutional. Consumers insurance involves pension, medical (maternity, optical and dental) and life assurance. Most of AIG`s profit come from consumer product insurance. In 2001-2004, AIG was able to make a net profit of 9.9 million. Despite all AIG sunk into a credit crisis in 2008. It had a total debt of $182 (Cummins, & Weiss, 2014). The US government decided to bailout AIG through credit by Federal Reserve.

The reasons as to why AIG went into crisis include:

AIG lacked the knowledge to hedge its investments from risk. According to general reinsurance corporation, insurance companies have to reinsure themselves against losses or risk.

Poor decision making was also an impact of credit crisis. Maurice Greenberg was hired by C.V Starr. Greenberg was to renovate its services, turnover international crisis and boom health business. However, Greenberg decided to sell most of its insurance products to brokersinstead of agencies. This is encouraged bids rigging from AIG to its competitors. Most competitors lowered their premium and improved their benefits. Encouraging people to swift from AIG products to its competitor’s products.

Carl Icahn, a financial analyst and activist. He is a major investor in AIG holding $40 million shares. Carl Icahn who is a representative was able to protect (hedge himself from losses). He states that AIG was caused by heavy capital requirements which would be used to finance their pool fund.

Formation of cartel in AIG. Maurice Greenberg and Mr Spitzer agreed to have taking money from the company. When the company hit $9.9 million profit, there was evidence that it was a cause of financial crisis.

Poor management practice. Due many multinational branches it has lead to no collateral and minimum supervision.

Credit crisisoccurs due to high claims from client (creditors).This is when a large number of insured clients claim for insurance whereas the pool is insufficient. Adverse selection is lack of symmetric information between insurer and insured. The insured tends to hold back information from the insurer.

Moral hazard is the action or behaviour that happens when the insured has a cover(insurance). Example when person insures herself against burglary. Before she got the cover would hire a guard at her apartment. After she got the cover, she no longer needs the guard Insurance tends to initiatives like screening and signalling. Signalling is where the insurance requires warranties from durable goods in order to be insured.?? (θ?) ≠? (θ) screening is when advantages are looked over before underwriting.

Theories related to the topic

AIG credit crisis affected some institutions like: Security and exchange commission which is head of exchange rates and pricing of stocks. In the event of 2008, stocks dropped which lead to a loss. Reinsurance General Corporation is a regulator to all insurance companies in the US. Wall Street suffered a major reputation since Mr Spitzer was involved in fraud allegations (Patrick, 2017). This requires insurance companies to observe its guidelines.

Monetary policy attempts to regulate money supply and interest rate in the economy.Federal Reserve ensures that the economy maintains a fixed exchange rate. This is by controlling money demand and supply to be equal.  If interest rate is low demand for credit will increase while supply will decrease high. If interest rate is high demand for money will be low and supply will be high and it causes the point of intersection shows equilibrium (Grubel, 2014). This shows stability in the economy. Equilibrium helps to eliminating national debt, global financial crisis and interest rates.

Money supply and demand (dd/ ss)

Series 1 is money supply curve

Series 2 is money demand curve

According to capitalist, quick liquidity encourages high risk in most financial institution (Frieden, 2015).Initial public offer traded little sharesunder low divideds returns once the crisis happened.

There is a direct relationship between credit crisis and lack of liquidity in the debt market.  AIG went was unable to pay it's debt by converting assets into cash(liquidity).  These  caused AIG's operations frozen until it gained stability in 2012

Credit default swap is a contract between a buyer and seller in case of a credit event. The institution is covered before the maturity date.

They are many types of credit events such as restructuring and bankruptcy. Debt contract involves two parties: debtor and creditor. In case credit event does not happen before maturity date of the loan. Security of the seller will not make payments to the buyer (Kroszner, & Strahan, 2014).

Credit default swap is structured by the event principal value or shortfall of its interest.Ways to calculate the size of the payment by seller to buyer:

*No cap. In the event of the seller compensates his/her shortfall interest without limits.

*Variable cap. the seller compensates buyer from any shortfall interest but under limited set.

* Fixed cap. Maximum amount is paid to protect seller under fixed rates. Most institutions prefer this form of protection.

Method of Credit default swap value=expected present value –expected present value of fixed interest.

Discussion and analysis

Disadvantage of credit default swap includes default correlation and default probability.

If American International Group would have been allowed to fail? No. This is because AIG has shown drastic improvement. February 9, 2016 the company decided to cut on its fund portfolio. This was also followed up by hedging their investments due to high volatility and decreased liquidity (Andolfatto, 2017).

Federal reserve, US government and insurance regulators should limit stakeholders from making decisions on their own. For example AIG has $50billion as assets and little liquidity. There is no way stakeholders can decide to sell its shares over the counter. This encourages more regulations, restrictions and high supervision. This was not only decided for AIG but also other non banking and banking institutions (Zeng, 2013).

American International Group (AIG) should reduce consumer`s insurance products. This enables them to manage and supervise their pool fund. When AIG carefully underwrites its insurance contracts minimum losses will be assured. Some risks are too high for the insured to claim. Example medical cover for cancer stage 4. The insured will use all AIG`s funds in the pool reducing profitability.  AIG sunk into a credit crisis in 2008. It had a total debt of $182. The US government decided to bailout AIG through credit by Federal Reserve. AIG was able to repay the organisation fully by selling its assets (Patrick, 2017).

Most institutions that suffered from AIG crisis have recovered from the major. Security and exchange commission which is head of exchange rates and pricing of stock. In the event of 2008, stocks dropped which lead to a loss. Reinsurance General Corporation is a regulator to all insurance companies in the US. Wall Street suffered a major reputation since Mr Spitzer was involved in fraud allegations. This requires insurance companies to observe its guidelines.

AIG had cracks in their organisation example pest draining cartel. Mr Spitzer, attorney general investigated and found out that money was stolen from the company. When the company hit $9.9 million profit, there was evidence that fraud caused financial crisis in 2008. This would be resolved by the court. Allowing more room for AIG to recover and grow.

Conclusion

AIGis a global company that grew fast under leadership. AIG went into great credit crisis which was worse than its competitors. In different countries the government is to bailout potential companies that collapse into debt. The company received $182 from the US government. This was to help AIG recover back to its normal operations (insuring AIG`s claims made by insured clients). In 2009 AIG was able to sell some of its assets and business. AIG was able to repay the government back its money. Last year, AIG made a quarterly loss which frustrated investors. It will take time for AIG to improve on its performance with proper management and leadership.  

References

Andolfatto, D. (2017). A Theory of Money and Banking. Evolution, 5, 17.

Cummins, J. D., & Weiss, M. A. (2014). Systemic risk and the US insurance sector. Journal of Risk and Insurance, 81(3), 489-528.

Ericson, K. M. M., & Starc, A. (2015). Pricing regulation and imperfect competition on the massachusetts health insurance exchange. Review of Economics and Statistics, 97(3), 667-682. 

Grubel, H. G. (2014). A theory of multinational banking. PSL Quarterly Review, 30(123).

Frieden, J. (2015). Banking on the world: the politics of American international finance. Routledge.

Kroszner, R. S., & Strahan, P. E. (2014). Regulation and deregulation of the US banking industry: causes, consequences, and implications for the future. In Economic Regulation and Its Reform: What Have We Learned? (pp. 485-543). University of Chicago Press.

Patrick, S. C. (2017). Reform of the Federal Reserve System in the early 1930s: the politics of money and banking (Vol. 12). Routledge.

Zeng, Z. (2013). A theory of the non-neutrality of money with banking frictions and bank recapitalization. Economic Theory, 1-26.