American International Group has purchased $16 billion of complex financial instruments in an effort to reduce its exposure to insurance guarantees written against the instruments. The insurer bought investments known as collateralized debt obligations (CDOs), which are bonds backed by various slices of debt such as mortgage-backed securities.

AIG had written insurance-like contracts, called credit default swaps, to protect investors against default of the CDOs. By purchasing the CDOs, AIG was eliminating the need for insurance contracts against their default. This reduces AIG’s risk of needing to make insurance payments. You will recall that AIG received $150 billion in loans from the government to keep the company in business. AIG was in trouble – most of it self-inflicted – and the Bush White House came to its rescue.

Source: Associated Press

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