The insurer generated a sizable business helping European banks lower the amount of regulatory capital required to cushion against losses on pools of assets such as mortgages and corporate debt. It did this by writing swaps that effectively insured those assets.
So AIG got into a mess by helping international banks get around applicable rules (the CDSs that AIG sold are regulated neither as banking instruments nor as insurance, even though they are actually both).
The Economist, naturally, blames government (no link for now, their site is down):
Although politicians made the mistakes that allowed Sir Fred [of RBS] to get away with his cash, the row sustains the comfortable fiction that the government's sensible policies were traduced by greedy bankers. (...) Avoiding future disasters means allocating blame acurately; and most of it lies with bad policy, not with greedy bankers.
This, of course, coming from one of the publications that have most consistently pushed for de-regulation of financial instruments, in the name of "freedom" and wealth "creation," and supported investment banks' lobbying efforts to get rid of policies that put any kind of restraint on what financiers did (arguing along the way that bankers are smarter than regulators and will always find ways around rules)
The above explains why the Economist has officially become a joke (the Rush Limbaugh of finance?); thankfully, some financial publications are showing a bit more sense:
The UK government has to make a decision. If it believes that costly bail-out must be piled upon ever more costly bail-out, then the banking system can never be treated as a commercial activity again: it is a regulated utility – end of story. If the government does want it to be a commercial activity, then defaults are necessary, as some now argue. Take your pick. But do not believe you can have both. (Martin Wolf in the FT)
In other words: either banking is necessary, and it has to be made boring, or it is not, and we should let its current incarnation die.
The problem is that freedom has been equated with "freedom to make money", and "freedom to use money to influence and corrupt those in power", and that those that have been entrusted with the ultimate public good, money, have been busy siphoning off an increasing portion of it, while presenting this as being "successful" and as a desirable outcome. It was certainly successful within the narrowly defined vision of that word they have managed to impose upon society, but it was rather not desirable.
In any case, it's time to talk about the heart of the matter: the place of money in society, and how to trust those that have the power to move it around, for themeselves or on behalf of others.
Which fundamentally means getting rid of the grip financiers and financial analysts have on "Serious Opinion." That means keeping politics away from money, policy away from financial analysis, and journalists and politicians away from bankers. The way to do that is to (i) bring back high rates of marginal taxation (because they make the pursuit of high incomes possible, and lobbying to make that both possible and easy a core activity), (ii) separate completely and hermetically regulated utility banking from the unregulated gambling/"investment" kind (break up the existing behemoths accordingly, identify regulated activities and send to prison anyone that does unregulated activities within a regulated entity), (iii) put up enough money for regulators to attract capable people (and fordid them from ever going to work for the industry they regulate), (iv) provide enough public money to fund political parties and campaigns so as to make private money irrelevant, (v) break up media groups.