Notable Failures & Corporate Collapses
What Happened
AIG, one of the world’s largest insurance companies, nearly collapsed in September 2008 after suffering massive losses tied to mortgage-related securities and credit default swaps (CDS).
For years, AIG Financial Products sold CDS protection on mortgage-backed securities, essentially guaranteeing billions in assets without holding sufficient capital to cover potential losses.
When housing prices fell and mortgage defaults surged, the value of insured securities collapsed — and AIG faced enormous collateral calls from counterparties.
Liquidity evaporated almost instantly. AIG could not meet collateral demands, repo markets tightened, and its credit rating was downgraded, triggering even more required payments.
Fearing systemic collapse — AIG was intertwined with nearly every major global bank — the U.S. government stepped in with an $85 billion emergency loan, later expanded to more than $180 billion.
AIG was effectively nationalized, restructured, and eventually stabilized, but only through one of the largest corporate rescues in U.S. history.
What Drove the Collapse
Massive CDS Exposure Without Capital: AIG sold hundreds of billions in CDS guarantees on mortgage securities without reserving adequate capital or hedging risk. Small losses became catastrophic.
Underestimated Housing and Correlation Risk: AIG assumed nationwide housing declines were nearly impossible. When correlations rose, losses multiplied far beyond model expectations.
Collateral Requirements & Downgrades: CDS contracts required AIG to post collateral as the insured securities fell in value. Credit-rating downgrades forced even larger collateral calls.
Liquidity Crisis, Not Immediate Insolvency: AIG owned valuable insurance subsidiaries, but their assets were illiquid. The company needed cash immediately and couldn’t access it.
Systemic Counterparty Interconnectedness: Major global banks depended on AIG’s guarantees for their own balance sheets. Its failure would have triggered cascading losses across the financial system.
Weak Risk Management & Oversight: AIG Financial Products operated with limited supervision from the broader company. Executives did not fully understand the scale of risk the division had taken.
AIG didn’t fail because its core insurance business broke — it failed because one division made enormous leveraged bets the broader company could not support.
The Investor Lessons
Liquidity can matter more than solvency — even firms with strong underlying assets can collapse if they cannot meet short-term obligations.
Selling insurance-like products without enough capital is a hidden form of leverage that can create explosive downside risk.
Complex derivatives concentrate risk in ways that can fool even large institutions.
Counterparty exposure is critical: if one giant player fails, losses spread across the system.
Credit ratings can shift rapidly during crises and trigger mechanical, spiraling obligations.
Understanding the structure of a business — not just profitability — is essential; risk can hide inside one division while the rest of the company appears healthy.