Matt Taibbi

It's refreshing when a reporter "gets it". In the current Rolling Stone, Taibbi portays the global financial crisis in the context of the AIG mess. He patiently dissects the complexities in an entertaining and educational way.

" A CDO (collateralized-debt obligation) is like a box full of diced-up assets...What the inventors of the CDO did is to divide up the box into groups...To get AAA ratings, the CDO's relied...on crazy mathematical formulas...

As banks and other investors of all kinds took on more and more in CDO's...they needed some way to hedge their massive bets..."

That's where AIG enters. They began selling Credit Default Swaps (CDS's) which insured the value of the CDO's. For a small premium relative to the potential risk, the CDS guarantees the insured asset.

The type of insured asset which became most prominent in the early 2000's was the mortgage. AIG guaranteed mortgages through their CDS's.

Because this activity had been essentially unregulated, AIG could sell an almost unlimited number of CDS's without any financial backup. As a result they exposed themselves to losses beyond the scope of their massive balance sheet.

Back to the mathematical models, it wan't supposed to happen. According to the models, CDO's and CDS's couldn't default at the rates they ultimately did. The models didn't take account of non-historical patterns, like a collapse of the U S housing market.

OOPS.

As Taibbi reports, the rest is history. AIG's debt rating fell requiring them to cough up assets as collateral at an alarming rate. Now the government is in the derivative business in an attempt to undo the mess.

Can we do it?

Yes we can.

Lee