http://www.acredittrader.com/?p=65#comments

The AIG Fiasco or How Not To Manage your CDO Exposure

The best / most original part of this write-up:

“Why did Banks buy Protection from AIG?
Did the banks realize the value of its protection held against AIG was zero? Of course they did - they aren’t as dumb as the media suggests. The reason they continued to pay the full market CDS offer (rather than a much lower level due to AIG’s massive wrong-wayness) to AIG was because they considered it a cost that allowed them to continue originating CDOs. If they could not offload super-senior risk to someone, their originating desks would be effectively shut down.

So, while the trading desks continued to buy super-senior protection from AIG, the risk management desks, realizing that the protection was effectively worthless, bought protection on AIG itself from the street and clients in large size. In fact, I would imagine the size they needed to buy was too large and they likely ended up buying puts on the AIG stock or just shorting outright. Let’s hope the Fed unwinds of AIG’s trades took into account the huge gains these banks took on the AIG hedges.”