My basic points are the following
1. From comments made by AIG executives it appears that the company fundamentally misunderstood the nature of risks that it was underwriting. Those risks were
a) much more highly correlated than they assumed (due to the nature of bonds in CDO structures as well as the likely performance of super-senior tranches in event of impairment)
b) actually mark-to-market risk, not default risk which made AIG’s business much riskier than it thought. This is because long before super-senior tranches became impaired (the only risk AIG was worried about), AIG will have had to post more collateral than the cash it had on hand effectively guaranteeing its bankruptcy.
2. The logical consequence of the previous point is that buying protection from AIG on ABS CDO’s is horribly wrong-way (discussed below) or, to use an analogy, akin to buying deep out-of-the-money puts from a company on its own stock. In other words, that protection is worthless.
The financial equivalent of Cheney. With the same level of accountability and shame.