Bloomberg investigates the fall of AIG: amongst the factors, traders selling Credit Debt Obligations (CDOs), then changing the collateral supporting the CDOs:
Replacing good collateral with bad helped erode Davis Square III’s (a CDO fund–ed.) value. Declines in quality added to the cash AIG had to pay to holders of its insurance because its Financial Products division, headed by Cassano, made agreements with banks that included what are called collateral triggers. That was a feature other bond insurers didn’t offer, (former non-AIG trader Thomas–ed.) Adams said.
The possibility of downgrading the collateral was mentioned in the prospectus, so that made It All Okay.
Just like you know the pea is going to get switched in the old shell game.