Large numbers of investment-grade companies in different countries and different industries were indeed unlikely to default on their debt at the same time. The credit default swaps sold by AIG FP that insured pools of such loans proved to be a good business. By 2001, AIG FP, now being run by a fellow named Joe Cassano, could be counted on to generate $300 million a year, or 15 percent of AIG’s profits. But then, in the early 2000s, the financial markets performed this fantastic bait and switch, in two stages. Stage One was to apply a formula that had been dreamed up to cope with corporate credit...
In a matter of months, AIG FP, in effect, bought $50 billion in triple-B-rated subprime mortgage bonds by insuring them against default.
Like the credit default swap, the CDO had been invented to redistribute the risk of corporate and government bond defaults and was now being rejiggered to disguise the risk of subprime mortgage loans. Its logic was exactly that of the original mortgage bonds. In a mortgage bond, you gathered thousands of loans and, assuming that it was extremely unlikely that they would all go bad together, created a tower of bonds, in which both risk and return diminished as you rose. In a CDO you gathered one hundred different mortgage bonds—usually, the riskiest, lower floors of the original tower—and used...
The long answer was that there were huge sums of money to be made, if you could somehow get them re-rated as triple-A, thereby lowering their perceived risk, however dishonestly and artificially. This is what Goldman Sachs had cleverly done. Their—soon to