Final answer:
AIG's near insolvency was due to its engagement in mortgage-backed securities and credit default swaps, which became problematic when the real estate market collapsed and defaults increased. The federal government intervened, nationalizing institutions and enacting the Dodd-Frank Act to stabilize the economy and reform the financial system.
Step-by-step explanation:
The near insolvency of American International Group (AIG) during the financial crisis was largely due to its heavy investment in mortgage-backed securities and its exposure to credit default swaps (CDSs). As the real estate market began to falter after its peak in 2007, the value of these securities plummeted. AIG had provided insurance-like coverage for these assets through CDSs, which obligated them to cover losses, leading to a financial strain that nearly resulted in the company's collapse.
This situation was further exacerbated when mortgage lenders began to fail, and defaults on loans increased, causing AIG and many other financial institutions to face demands for payment they could not meet. In response to the potential collapse of the finance system, the federal government nationalized institutions like Fannie Mae and enacted regulatory reforms through the Dodd-Frank Act, aiming to prevent such a crisis from occurring again. This included taking over the financial obligations of AIG by the Federal Reserve, which avoided a complete collapse of the insurer and mitigated further systemic risk.