American International Group (NYSE: AIG) will sue Bank of America (NYSE: BAC) for $10 billion because the insurance company claims the big bank misrepresented the risks of mortgage-backed paper. The legal action further muddies the waters of who is to blame for the credit crisis. Did the credit ratings agencies turn a blind eye to risks when they gave mortgage paper AAA ratings? Did large financial firms like Bank of America and Goldman Sachs (NYSE: GS) know that their mortgage-backed products carried terrible risks of defaults? Should the buyers of the securities have done their own due diligence?
The answer is that buyers did not bother to read the fine print carried on most securities. There is no guarantee that the instruments will perform as marketed. The value of all financial products fluctuates, sometimes rapidly and with great effect.
AIG was the largest insurance company in the world when it bought mortgage-backed securities from Bank of American and other firms. AIG’s business was, above all, to access risk. That, more than any other single factor, is at the core of the insurance industry. AIG had an army of analysts. Any multibillion investment made by the firm could have and should have been vetted, if AIG cared enough to calculate its risk.
Bank of America may have made claims about its mortgage products that did not include a highlighting of the worst case result. The bank may have done little to explore those possibilities itself. But, AIG knew better than to purchase novel securities without a background check of its own.
Douglas A. McIntyre
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