What happened at AIG?
In short, a non-insurance unit of AIG “sold hundreds of billions of dollars of credit default swaps.” New York’s Superintendent of Insurance Eric Dinallo related events leading up to AIG’s liquidity crisis when he testified this morning before the U.S. House of Representatives Committee on Oversight and Government Reform. Swaps began as legitimate (although unregulated) hedges by parties who held bonds, in case the issuer of the bond were unable to pay interest and principal. However, according to Dinallo, “most swaps now are used by speculators who do not own the bond and the value of swaps outstanding are generally much more than the value of a company’s debt. Swaps bought by speculators are known as ‘naked swaps.’ … With a naked swap, there is no risk mitigation. In fact, there is risk creation. In fact, these contracts are not really swaps at all because there is no transfer of risk. Instead, the contract allows the buyer to place a one-sided bet.” Dinallo said New York state is
