AIG sold credit-default swaps (a form of insurance, even though we don't call it that) with no capital behind them - that is, no ability to pay. Entering into a contract with full knowledge that you have no ability to perform is a fraudulent act - you are representing to someone that you have capacity to pay under the loss scenario, when you do not. ++++++++++++++++++++++++++++++++++
Purchasing "protection" of this sort at below the market rate of risk as determined by the spread is an uneconomic act. That is, the essential purpose of such a purchase is not to buy protection against the adverse event, but rather to intentionally misrepresent to regulators that your assets are "covered" and thus of better quality than they are, for the explicit purpose of not having to hold reserves against them. I argue that this is an act of fraud. The essential point is that nobody works for free - it is therefore impossible to buy a Bond that has a risk spread over Treasuries (of equivalent duration) of 3% plus a credit-default swap to cover it for less than the same spread. A seller of protection who does not charge at least the risk-adjusted spread will not have sufficient capital to pay, and a seller who does charge at least the risk-adjusted spread (and thus can pay) leaves you with a trade, in total, that yields less than the Treasury! If you desire a risk-free trade it makes no sense to purchase the more-risky bond and credit-default swap, as your total return will be lower than just buying the Treasuries!
++++++++++++++++++Why is this allowed to continue? +++++++"Where are the cops?"+++++++++++++Is the government a felon itself? ++++++++++++++