AIG's Downfall, Part 2: 'Almost Free Money'

Credit default swaps change the game
By Kevin Spak,  Newser Staff
Posted Dec 30, 2008 2:20 PM CST
The AIG logo is shown Wednesday, Sept. 17, 2008 in New York.    (AP Photo/Mark Lennihan)
camera-icon View 1 more image

(Newser) – According to the computer models, credit default swaps almost couldn’t fail. They were the latest derivative contract in 1998, and AIG Financial Products decided to get on board, the Washington Post reports, in the second part of its series on the insurer’s self-destruction. When AIG struck its first default swap deal, no one realized it was a turning point that would doom the company; the computers said the deal was 99.85% safe.

Credit default swaps are essentially insurance on debt, but they were never regulated as such. Instead, investors often used them to gamble on other people’s loans. Their very nature ran against everything Financial Products was founded on — they represented a hard-to-calculate risk that couldn’t be hedged. “In retrospect,” says the firm’s then-president,  “perhaps those deals should never have been done.”