02 July 2010
On Wednesday, June 30, the Financial Crisis Inquiry Commission finally heard from Joseph Cassano on his role in American International Group (AIG) in the period leading up to the financial crisis of 2008.
Joseph Cassano, who ran a sort of high-risk prop desk within AIG, known as "Financial Products" or AIG FP, is often credited/debited with setting off the 2008 crisis. Indeed, Cassano wears the biggest black hat in Michael Lewis' book, The Big Short.
Describing a period beginning in late 2004, Lewis writes: "The 'consumer loan' piles that Wall Street firms, led by Goldman Sachs, asked AIG FP to insure, went from being 2 percent subprime mortgages to being 95 percent subprime mortgages. In a matter of months AIG FP, in effect, bought $50 billion in triple-B rated subprime mortgage bonds by insuring them against default. And yet no one said anything about it -- not AIG CEO Martin Sullivan, not the head of AIG FP, Joe Cassano ....The deals, by all accounts, were simply rubber stamped inside AIG FP, and then again by AIG brass."
AIG FP stopped writing such deals in late 2005 -- except for those that were still "in the pipeline."
The news out of the hearing room Wednesday, though, was that Cassano was notably unapologetic. You can read his written submission to the committee for yourself, of course here.
To use the appropriate jargon, AIG FP was writing CDS' on CDOs. Or: it was writing credit default swaps on collateralized debt obligations. Or, as Lewis summarized it in the passage above, it was -- through a chain of instruments by which it hid the risk from itself -- implicitly buying bundled-up subprime mortgages.
Even in retrospect, after the blow-up, Cassano shows a touching faith in the ability of his quants in this statement. "You have asked about the way in which we calculated fair market value for our portfolio. This was, to be sure, a challenging, first-of-its-kind process at AIG-FP, but I believe we developed a reasonably strong analytic method for estimating fair value. We selected a model developed by Moody's (the Binomial Expansion Technique, or "BET") in September 2007. We customized it to provide the most accurate valuation estimate possible."
But of course, if Lewis is at all right than the damage had been done before September 2007. The plane hadn't crashed yet but it was on an auto-pilot course for the mountainside.
Cassano's back-and-forth with the committeemembers is more fun than his pre-hearing statement. Watch that here Go to FCIC Panel Two, and fast forward it to about 37:20, "We were working in an opaque market," and keep it running until he takes offense at the notion that he was making a "one sided bet."
That does seem to be what he was doing, umbrage notwithstanding,
Knowledge is warranted belief -- it is the body of belief that we build up because, while living in this world, we've developed good reasons for believing it. What we know, then, is what works -- and it is, necessarily, what has worked for us, each of us individually, as a first approximation. For my other blog, on the struggles for control in the corporate suites, see www.proxypartisans.blogspot.com.