AIG got greedy. At its peak, it had CDS liability of far in excess of its actual assets. Even if a fraction went bad they'd be insolvent. Lots of dumb managerial financial decisions were made by the banks, brokerage firms, and insurance companies that no one at the government forced them to make. They got greedy and they paid.Anyway, when the banks 'insured' these financial vehicles with CDSs, as soon as the belief that they were bad investments got around, the house of cards came down. The CDSs had to pay off, and AIG lost allot of money.
Well, it's that and mandatory mark to market accounting. Once something sells in the market, that's the GAAP price and that impacts your solvency. Furthermore, the MBS from subprime weren't paying out the money that they were believed to be worth and thus weren't worth what they were paid for. That's not up for debate. Once that starts, it's a mad dash to sell assets to maintain solvency.It's the lack of belief that the investments would be OK which spread like wildfire, and caused the bubble to pop. Remember, credit, Latin for 'to believe' as in the one who loans the money believes the borrower will pay it back, is a powerful thing, and when it's gone, well, it doesn't return easily or quickly.