IMHO, our understanding of ability to hedge risk is still in infancy. The idea of complete diversification of risk is only good on paper and a lot of mess is a result of companies naively (or greedily) thinking that they can achieve it. I recently attended a presentation by some very respected actuaries where they showed empirical evidence that while risk can be diversified in general (across assets as well as asset classes) in the tail end of economic scenarios all asset classes have strong positive correlation. In other words in general you can ensure consistent returns by diversification, when things go bad, you are screwed and nothing much you could have done would prevent that; writing derivative contracts which would save you from such scenario are contingent on counter-party not defaulting, which it did (until the US Gov. paid the counter party taxpayer money to prevent defaults).

At the end of the day, yes, it feels right to not only AIG but those counterparties should also feel the pain.. at least they should not be given 100 cents on a dollar!