ASSIGNMENT –PART 1
A.I.G. is often called the largest insurance entity in the world. A.I.G.’s total assets were $860 billion on 12/31/2008 (dwarfing any other insurance entity) with 116,000 employees, operating in 130 countries, with 71 U.S. based insurance companies, and 176 other companies representing non U.S. insurers and other financial services. Many regulatory issues are raised by A.I.G.’s structure: regulatory arbitrage in its multitude of companies and countries and its selection of a Gramm-Leach-Bliley regulator; its extreme unregulated systemic risk; and its complete lack of regulation of certain “insurance-like” components.
Review the paper titled: On the Financial Regulation of Insurance Companies written by Viral V. Acharya, John Biggs, Mathew Richardson and Stephen Ryan and answer the following problems. It is also strongly suggested you complete additional reading as is relvevant.
1. describe A.I.G’s business model and structure and why it was considered a systemic risk?
2. Identify and discuss the major factors which led to the failure of A.I.G.
3. describe how moral hazard and adverse selection materialized during the financial failure of A.I.G?
4. How did A.I.G and monoline insurers aid commercial and investment banks in avoiding capital adequacy requirements?
Assignment –part 2
Lehman Brothers Holdings was a global financial services firm which, until declaring bankruptcy in 2008, participated in business in investment banking, equity and fixedincome sales, research and trading, investment management, private equity, and private banking. On September 15, 2008, the firm filed for Chapter 11 bankruptcy protection following a technical run and a significant devaluation of its assets by credit rating agencies. Previously valued at over $60 per share, Lehman was now being traded in pennies. Your reading and research on the failure of the Lehman group would help you to answer the problems below and understand substantive reason for financial regulation.
1. Identify and discuss the weakness in Lehman’s governance practices.
a. What was the quality of the reporting to the Board by management;
b. What was Lehman’s treatment of internal limits and risk management mechanisms in an attempt to boost profitability?
2. What is leverage? Was Lehman leverage ratio consistent with that considered safe by regulators? What prevented Lehman from being able to safely and quickly deleverage?
3. List and discuss the financial events led to the erosion of Lehman’s capital base?
4. Define stress testing. What weaknesses & unusual practices were identified as it relates to Lehman’s stress testing.
The answers to both parts combined should not exceed 1500 words. Please provide answer written and bound on the date of presentation. No changes allowed once the presentation and discussions have taken place. Please provide answer written and bound on the date of presentation –October 28th no changes allowed once the presentation and discussions have taken place.
1. Why did the Federal Reserve rescue A.I.G but allowed Lehman Brothers to fail?
2. Does the rescue of institutions labeled ‘too big too fail’:
a. Strengthen the longer-term stability of financial services sector? If so how?
b. Encourage excessive risk-taking in the knowledge of an implicit ‘safety net’? If so describe why?
3. Discuss Lehman’s rationale for not hedging the illiquid aspects of its portfolio that were a result of its growth strategy.
4. Describe the business model of origination and distribution of mortgages. Discuss inherent risks brought by this model to Lehman, especially in light of the origination of subprime assets.
5. Discuss the im pact that Lehman’s compensation policies had on its subsequent failure.
6. How did Lehman’s liquidity challenges impact its capital adequacy position?
7. Define moral hazard and adverse selection?
8. Did A.I.G have any concentration risk? If so identify the type of concentration.
What impact can concentration risk potentially play in the solvency and liquidity of a financial institution? How does the A.I.G paper define systemic risk?
9. How did the subprime mortgage market impact A.I.G?
10. Define Counterparty Risk. Give 3 exs of how the Banking system is interconnected.
11. Define and describe Credit Default Swaps.