Underestimating the tails

Collective wisdom about the location of Ground Zero for the credit crisis seems to be coalescing around AIG’s Financial Products Unit (AIGFP), which basically invented the credit default swaps at the center of the whole mess. TPMmuckraker provides an excellent history of AIGFP: its inception, rise, and eventual downfall (taking AIG and the economy with it).

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Collective wisdom about the location of Ground Zero for the credit crisis seems to be coalescing around AIG’s Financial Products Unit (AIGFP), which basically invented the credit default swaps at the center of the whole mess. TPMmuckraker provides an excellent history of AIGFP: its inception, rise, and eventual downfall (taking AIG and the economy with it).

JP Morgan approached AIG, proposing that, for a fee, AIG insure JP Morgan’s complex corporate debt, in case of default. According to computer models devised by Gary Gorton, a Yale Business Professor and consultant to the unit, there was a 99.85 percent chance that AIGFP would never have to pay out on these deals. Essentially, this would happen only if the economy went into a full-blown depression.