Taibbi Explains It All

Rolling Stone's Matt Taibbi lays it all out: AIG, Geithner, Bush, Greed, the Gramm-Leach-Bliley Act, and the largest power grab in the history of the world, headed by AIG's financial products division head, Joseph Cassano. (mind the language, he pulls no punches.)

What Cassano did was to transform the credit swaps that Morgan popularized into the world's largest bet on the housing boom. In theory, at least, there's nothing wrong with buying a CDS to insure your investments. Investors paid a premium to AIGFP, and in return the company promised to pick up the tab if the mortgage-backed CDOs went bust. But as Cassano went on a selling spree, the deals he made differed from traditional insurance in several significant ways. First, the party selling CDS protection didn't have to post any money upfront. When a $100 corporate bond is sold, for example, someone has to show 100 actual dollars. But when you sell a $100 CDS guarantee, you don't have to show a dime. So Cassano could sell investment banks billions in guarantees without having any single asset to back it up.

Secondly, Cassano was selling so-called "naked" CDS deals. In a "naked" CDS, neither party actually holds the underlying loan. In other words, Bank B not only sells CDS protection to Bank A for its mortgage on the Pope — it turns around and sells protection to Bank C for the very same mortgage. This could go on ad nauseam: You could have Banks D through Z also betting on Bank A's mortgage. Unlike traditional insurance, Cassano was offering investors an opportunity to bet that someone else's house would burn down, or take out a term life policy on the guy with AIDS down the street. It was no different from gambling, the Wall Street version of a bunch of frat brothers betting on Jay Feely to make a field goal. Cassano was taking book for every bank that bet short on the housing market, but he didn't have the cash to pay off if the kick went wide.

In a span of only seven years, Cassano sold some $500 billion worth of CDS protection, with at least $64 billion of that tied to the subprime mortgage market. AIG didn't have even a fraction of that amount of cash on hand to cover its bets, but neither did it expect it would ever need any reserves. So long as defaults on the underlying securities remained a highly unlikely proposition, AIG was essentially collecting huge and steadily climbing premiums by selling insurance for the disaster it thought would never come.

And as long as the housing market went up, Cassano made AIG billions. When it collapsed, AIG suddenly owed these counterparty banks more than half a trillion dollars. Even better, these counterparty banks were allowed to treat that bet as a 100% asset. So, now they had assets to cover their own bets and could use the liquid cash they had to buy and sell more of these CDOs and CDSs.

Then subprimes went under. The resulting meltdown has put us in the situation we're in now.

Do read the whole thing. Taibbi explains the whole scheme, from CDOs to credit default swaps to the obsessive greed that made everyone from the newbie temp to the federal government look the other way. The last 10 years of our economy was a massive lie, folks.

Now we have to face the truth.

The truth is America is insolvent.