AIG buys $16B of CDOs to reduce its exposure to risk

NEW YORK -- AIG bought about $16 billion of investments known as collateralized debt obligations, or CDOs, through a financing company set up by the insurer and the government to help relieve AIG of its exposure to the riskiest portion of the credit markets.

By buying up the CDOs, AIG has eliminated its exposure to insurance-like contracts, called credit default swaps, written to cover defaults on the CDOs.

"It's a positive as it further reduces AIG's exposure to losses on its credit default swaps portfolio," AIG spokesman Nicholas Ashooh said.

CDOs are securities backed by pools of mortgages or other assets. They have plummeted in value since the credit crisis erupted more than a year ago as investors fled all but the safest forms of debt. Credit default swaps are essentially contracts that insure against the default of bonds and corporate debt such as CDOs.

Sellers of swaps, such as AIG, are obligated to repay buyers of the swaps if the value of the underlying bonds or debt declines.

By purchasing the underlying bonds, AIG has eliminated the need to make payments on the swap contracts it wrote.

The writing of swaps contracts was one of the reasons AIG nearly collapsed in September before it was bailed out by government loans. An initial $85 billion loan package AIG received in September was later replaced with a $150 billion government loan package.

Part of that package was set up to help AIG buy CDOs so it could terminate swap contracts on what are considered the riskiest CDOs — those backed by residential mortgage-backed securities. The government and AIG set up a company called Maiden Lane III that buys CDOs to eliminate swaps contracts. The $16 billion in recently purchased CDOs are now held by Maiden Lane.

The $16 billion purchase was the second this month by AIG and the government. On Dec. 2, $53.5 billion of CDOs were purchased to cut AIG's exposure to other swaps contracts it had written.