One problem of Derivatives- It can bankrupt a solid company

Derivatives- we all used to love them as the financial invention and they sounded like all win-win until the sub-prime mess came up.
I am sure you know what happened with AIG. Here is my explanation of AIG mess-up for a common man. AIG's businesses are strong. However like many insurance companies, they found an easy avenue for 'Free' money I guess 10 years back. This money was there in 'insuring bonds' of other companies and mortgages. (Fancy word for this is: CDS Credit Default Swap. Technical Defination of CDS: A credit default swap (CDS) is a credit derivative contract between two counterparties. The buyer makes periodic payments to the seller, and in return receives a payoff if an underlying financial instrument defaults)
Like any auto insurance or a home insurance, which pays you money in case of an accident or a loss to you, 'bond insurance' pays the bondholders if something goes wrong with the bond-prices or the bond-issuing company (watch the words- bond-issuing company, say Abitibi or General Growth Properties, vs bond-insuring company- AIG). Let us say you are holding these bonds but you are scared that Abitibi might go bankrupt or its bond-prices may plummet, so to protect yourself, you can go to AIG which will write you an insurance policy to protect you. Innovative, right? In return of this protection, you will pay 'insurance premium' of say 1% per year. In normal world, based on historical data, AIG and others expected the defaults to be on average say 0.70% (I am just throwing up this number) so for them, there is .30% of total premiums to keep as profit every year, or as long as the party is going well LOL.
Sailing is smooth as long as weather is fine., but when it got stormy, many ships started sinking. The bond prices started going down and AIG had problems keeping their promises. For say 30 cents profit, they were taking risk for as much as 100 dollars!!! They needed billions to pay to their Bond Insurance policy holders!!! This is what caused them to run out of money. For gain of few pennies, they risked thousands!! As long as things were normal, they enjoyed the profit. Then things got bad and you and me got stuck with their losses (I mean US Government)

I am getting on a sidetrack. (also running out of time..Got to go out and do jogging so will come back to this one later on.)