If you have as difficult a time as I do following the ups and downs of Wall Street, the ups but mostly downs of the economy, keep a watchful eye on IMproPRieTies, beginning with this post, on AIG, which I think I almost understand:
This crisis is complicated by innovative financial instruments that Wall Street created and distributed. They’re making it harder for officials and Wall Street executives to know where the next set of risks are hiding and also spreading the fault lines of the crisis.
The latest trouble spot is an area called credit-default swaps, which are private contracts that let firms trade bets on whether a borrower is going to default. When a default occurs, one party pays off the other. The value of the swaps rise and fall as market reassesses the risk that a company won’t be able to honor its obligations. Firms use these instruments both as insurance — to hedge their exposures to risk — and to wager on the health of other companies. There are now credit-default swaps on more than $62 trillion in debt — up from about $144 million a decade ago.
One of the big new players in the swaps game was AIG, the world’s largest insurer and a major seller of credit-default swaps to financial institutions and companies. When the credit markets were booming, many firms bought this insurance from AIG, believing the insurance giant’s strong credit ratings and large balance sheet could protect them from bond and loan defaults. AIG, which collected generous premiums for the swaps, believed the risk of default was low on many securities it insured.
Read the rest here