An excellent New York Times article detailing the issue at A.I.G.F.P., a non-insurance part of the conglomerate based in London and run by a former executive with Drexel Burnham Lambert (the "Junk Bond" king which went bankrupt in the late 1980s).

 

From the article, here are some "money" excerpts:

... federal officials, who had let Lehman die and initially balked at tossing a lifeline to A.I.G., ended up bailing out the insurer for $85 billion.

Their message was simple: Lehman was expendable. But if A.I.G. unspooled, so could some of the mightiest enterprises in the world.

Although America’s housing collapse is often cited as having caused the crisis, the system was vulnerable because of intricate financial contracts known as credit derivatives, which insure debt holders against default. They are fashioned privately and beyond the ken of regulators — sometimes even beyond the understanding of executives peddling them.

Originally intended to diminish risk and spread prosperity, these inventions instead magnified the impact of bad mortgages like the ones that felled Bear Stearns and Lehman and now threaten the entire economy.

In the case of A.I.G., the virus exploded from a freewheeling little 377-person unit in London, and flourished in a climate of opulent pay, lax oversight and blind faith in financial risk models. It nearly decimated one of the world’s most admired companies, a seemingly sturdy insurer with a trillion-dollar balance sheet, 116,000 employees and operations in 130 countries.

“It is beyond shocking that this small operation could blow up the holding company,” said Robert Arvanitis, chief executive of Risk Finance Advisors in Westport, Conn. “They found a quick way to make a fast buck on derivatives based on A.I.G.’s solid credit rating and strong balance sheet. But it all got out of control.”

Notice that this company is a worldwide company and so who has regulatory control over A.I.G.  Maybe the question is better put: who would have regulatory say over AIGFP?  Furthermore, who will in the future, or does the Fed just bailout these companies when needed? 

The income of AIGFP, credit default swaps and collateralized debt obligations, as well as the $85 billion loan from the Fed to give AIG time to manage its assets safely is detailed in the article but too "wonkish" to go into here.

One last thing that DOES bear mentioning - The Insurance part of A.I.G. is strong and healthy!