http://www.nytimes.com/2009/03/08/business/08gret.html?_r=1&ref=businessGood description of CDS. This goes to the crux of the problem - if AIG had been forced to reserve collateral and priced its premiums on the CDS reasonably, I doubt the Bush Depression and welfare bailouts would have occurred.A.I.G. nearly barreled off the cliff last September, when it couldn’t meet its obligations to customers who had bought a version of derivatives called credit default swaps. Such swaps are like insurance policies; bondholders buy them to protect themselves from default on various forms of debt.
When A.I.G. couldn’t meet the wave of obligations it owed on the swaps last fall as Wall Street went into a tailspin, the Federal Reserve stepped in with an $85 billion loan to keep the hobbled insurer from going bankrupt; over all, the government has pledged a total of $160 billion to A.I.G. to help it meet its obligations and restructure operations.
So is A.I.G. the taxpayer gift that keeps on taking? Sure looks that way. And while no one can say with certainty whether more money will be needed, the sheer volume of derivatives engineered by a small London unit of A.I.G. suggests that taxpayers haven’t seen the bottom of this money pit.
Some $440 billion in credit default swaps sat on the company’s books before it collapsed. Its biggest customers, European banks and United States investment banks, bought the swaps to insure against defaults on a variety of debt holdings, including pools of mortgages and corporate loans.