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Document Type

Case Study

JEL Codes

G01, G28

Abstract

Starting in mid-2007, American International Group (AIG) faced increasing collateral calls from counterparties looking to protect their positions in credit default swap (CDS) contracts that AIG had written on residential and commercial collateralized debt obligations (CDOs) (US COP 2010, 28-30). Per these agreements, the AIG parent company was responsible for insuring the value of the CDOs against the risk of a negative credit event, such as default (GAO 2011, 5; US COP 2010, 29-30). AIG’s immediate need for liquidity on September 16, largely driven by a securities lending program and those collateral calls, prompted the Federal Reserve to lend the company $14 billion, a loan that grew into an $85 billion revolving credit facility (Baxter and Dahlgren 2010, 2, 4). But the company continued to face pressing liquidity needs, market losses, and rating agency downgrades. The Fed and Treasury decided they had to restructure AIG’s federal assistance to shore up its balance sheet and reassure market participants and rating agencies about the company’s viability (Baxter and Dahlgren 2010, 4).

As part of that restructuring, the Federal Reserve Board authorized the creation of Maiden Lane III (ML III), a special-purpose vehicle that would purchase CDOs from AIG’s counterparties in exchange for the cancellation of their CDS contracts. This would end the liquidity-draining collateral calls and cap AIG’s exposure to further losses on the CDS contracts (FRBNY 2017; US COP 2010, 73-74). The purchase was funded by a $24.3 billion senior loan from the Federal Reserve Bank of New York and a $5.0 billion equity contribution from the AIG parent company FRBNY n.d.2). The establishment of ML III helped to lessen AIG’s exposure to the deteriorating CDO market, end unmanageable collateral calls, and avoid downgrade pressures (Baxter and Dahlgren 2010, 4).

Date Revised

2021-04-16

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