I should have said notional value which dwarfs the size of the world's economy. It isn't that bad but it is very bad anyway. Here is an interesting article on the large numbers problem.
seekingalpha.com
As I understand it, AIG's problem, other than being gambling POSs, is that they didn't hedge their bets. I could be completely wrong but I thought the Lehman bankruptcy was nasty but not as bad as people thought because they weren't AIG.
reuters.com
"Most banks, though, were not all that bad off, because they were simultaneously on both sides of the CDS trade. Most banks and hedge funds would buy CDS protection on the one hand and then sell CDS protection to someone else at the same time. When a bond defaulted, the banks might have to pay some money out, but they'd also be getting money back in. They netted out.
Everyone, that is, except for AIG. AIG was on one side of these trades only: They sold CDS. They never bought. Once bonds started defaulting, they had to pay out and nobody was paying them. AIG seems to have thought CDS were just an extension of the insurance business. But they're not. When you insure homes or cars or lives, you can expect steady, actuarially predictable trends. If you sell enough and price things right, you know that you'll always have more premiums coming in than payments going out. That's because there is low correlation between insurance triggering events. My death doesn't, generally, hasten your death. My house burning down doesn't increase the likelihood of your house burning down.
Not so with bonds. Once some bonds start defaulting, other bonds are more likely to default. The risk increases exponentially.
Credit default swaps written by AIG cover more than $440 billion in bonds 2. We learned this week that AIG has nowhere near enough money to cover all of those. Their customers-those banks and hedge funds buying CDSs-started getting nervous. So did government regulators. They started to wonder if AIG has enough money to pay out all the CDS claims it will likely owe." |
