PIMCO Sues AIG Regarding Credit Default Swaps
April 6, 2015 by Arthur D. Postal, arthur.postal@innfeedback.com
WASHINGTON – PIMCO asset management company has filed a lawsuit seeking unspecified damages from American International Group (AIG) relating to what PIMCO termed AIG’s “colossal” bet on credit default swaps.
The suit is a bitter reminder of the problems caused by the financial meltdown in 2008, including the need for the federal government to become involved in regulating the industry in a significant way.
The legal action was filed on behalf of the 63 investment funds managed and/or advised by PIMCO, a subsidiary of Allianz.
In the complaint, PIMCO alleges that it filed the suit because of what it called “AIG’s failure to disclose, and misrepresentations to investors concerning, the company’s massive accumulated exposure to the U.S. housing and subprime mortgage markets.”
“AIG’s colossal bets on unregulated credit default swaps and residential mortgage-backed securities for which the company claimed its exposure was ‘remote, even in severe recessionary market scenarios’ lay at the heart of the financial crisis and carried AIG, once the world’s largest insurance company, to the brink of insolvency,’ the complaint said.
The suit relates to the decision of AIG’s financial products unit to insure against losses on mortgage bonds purchased by institutional investors. The decision forced AIG to seek a federal bailout in September 2008.
The PIMCO lawsuit was filed in California Superior Court by Bernstein Litowitz Berger & Grossmann.
Pimco opted out of a proposed settlement of a 2008 lawsuit against AIG dealing with the derivatives debacle. PIMCO had until Jan. 5 to accept the terms of that deal, negotiated in U.S. District Court for the Southern District of New York. The settlement was approved in July 2014 by most plaintiffs. Under the deal, AIG made a cash payment of $960 million in October 2014; a hearing was held to finalize the deal March 20.
“While AIG was rescued by the federal government, its investors suffered significant harm, including plaintiffs and other investors in the company’s securities offerings between 2006 and 2008 pursuant to which AIG raised more than $27 billion in violation of the federal securities laws,” the lawsuit alleges.
Among the claims alleged by PIMCO’s attorneys was that AIG “massively exposed itself to subprime mortgages through credit default swaps; chased profits through risky investments in its securities lending program; weakened its risk controls” as it continued to pursue credit default swap purchases. In addition, PIMCO contends that AIG failed to mark down its credit default swap portfolio as the subprime mortgage crisis escalated.
AIG spokesman Jon Diat responded to the lawsuit by saying, “We regret that rather than participate in the fair and reasonable settlement negotiated in the class action proceeding involving substantially the same issues, these plaintiffs have filed an individual copycat action in an effort to obtain a windfall recovery. We will defend the case vigorously.”
The credit default swap business constituted only 6 percent of AIG’s revenues at its peak, according to statements made by an insurance industry official in 2009.
The problems related to credit default swaps required the Federal Reserve Board, which effectively acquired control of AIG in September 2008, to dispose of what turned out to be $2.77 trillion notional value of credit default swaps. This is according to statements by a Fed official at a 2009 hearing convened by the Senate Banking Committee.
AIG also purchased an additional $65 billion in mortgages of various grades through collateralized debt obligations secured by its 13 life insurance subsidiaries, which were headquartered in Houston at the time.
Through cash and various securities facilities, the government cash investment in AIG peaked at more than $300 billion. To pay off the investment, the government sold off large pieces of AIG’s prime insurance units. There were mostly difficult-to-replicate insurance companies that did business outside the U.S., especially in Asia, which holds the potential for huge growth.
Key foreign units were sold to MetLife and Prudential, and another through an initial public offering. AIG retains a minority share in that company, AIA Group, based in Hong Kong.
A host of other AIG businesses, including an aircraft leasing unit as well as other asset financing ventures and even some U.S. businesses were sold off before the government divested itself of its AIG holdings by end of 2012. AIG recently filed a registration with the Securities and Exchange Commission to sell off the remainder of its holdings in the aircraft leasing subsidiary, now called AerCap.
InsuranceNewsNet Washington Bureau Chief Arthur D. Postal has covered regulatory and legislative issues for more than 30 years. He can be reached at arthur.postal@innfeedback.com.
