AIG's ordinary insurance businesses used established actuarial tables to determine the insurance premiums they charged for life insurance, etc. It supposedly was a solid business based on sound practices.
OK
AIG also had a financial unit that ran a gambling house. They wrote policies that guaranteed the debt of companies and governments. Those policies were sold to any Tom, Dick or Harry who was willing to cough up a few thousand dollars a year to guaranty that a few million dollars worth of bonds issued by say, Lehman Brothers or Bear Stearns would not go into default.
NOT SO OK
When Lehman went under they had less than $1 billion in outstanding corporate bonds. So one would expect that AIG or anyone else who was insuring the solvency of Lehman bonds would have guarantied no more than the outstanding $1billion of Lehman corporate bonds.
THAT WAS NOT THE CASE.
One didn't have to own Lehman bonds to buy an insurance contract on those bonds.
Wall Street was/is a casino where anyone who wanted to bet that Lehman would go down could pay AIG a few thousand per year to get some skin in the game that Lehman wouldn't survive.
There was as much as $400 billion worth of insurance written against Lehman debt.
When tax dollars were pumped into AIG, billions of dollars immediately went out the door to companies such as former Treasury Secretary Hank Paulson's company, Goldman Sachs, supposedly in part to settle the CDS and pay off Goldman and others for the bets they placed against Lehman, Bear Stearns, etc.
Were these paid off at 100 cents on the dollar? Given that writing these wild insurance "policies" destabilized AIG and made it insolvent, these bets were NOT worth 100 cents on the dollar but were virtually worthless unless taxpayers picked up the tab.
I watched the former chairman of AIG testify before Congress. He was asked whether he had fired the guy who ran the CDS Dept. He said "yes". Then he was asked why he later hired him as a consultant for $1million per year. He didn't deny it but couldn't answer. The obvious answer was that the senior management of AIG had no clue what this guy was doing but they left him alone because he was bringing in so much money by selling these contracts. Little did they know that these contracts would become the undoing of the company.
These casino bets were called Credit Default Swaps because if they had been called Credit Default Insurance, they would have been under the scrutiny of the insurance regulators.
Greenspan's adored financial derivatives were in this case simply a way around prudent regulation.
There may be as much as $62 trillion dollars of Credit Default Swaps or CDS outstanding. That staggering number overwhelms the GDP of the whole world and is a hugely destabilizing financial force. Taxpayers should not be expected to pay off these gambling bets.
Companies such as Barrons and Reuters and Time and Newsweek have been writing about the financial "tsunami" that unwinding these CDS will unleash.
Here's a Time article from May 2008 that's well done.
http://www.time.com/...
Here's the link to wikipedia definition of CDS:
http://en.wikipedia.org/...
googling this subject gets too many articles to list here but I think it's a very serious issue and that CDS should be segregated from the losses that taxpayers become responsible for.