Posted on 01 Jul 2010
Joseph Cassano, the former head of American International Group's derivatives unit, said Wednesday that he could have saved taxpayers billions of dollars by negotiating harder with banks, including Goldman Sachs Group, in the wake of the government's massive bailout of the insurer in 2008.
Cassano retired from AIG in early 2008 and has said little publicly about the company's near-collapse. He appeared Wednesday in front of the Financial Crisis Inquiry Commission, which is investigating causes of the global market meltdown. Read "Former AIG exec and Goldman COO swap stories."
"I think I would have negotiated a much better deal for the taxpayer," Cassano said during the testimony.
AIG was undone by credit-default swaps, or CDS, that the insurer's derivatives unit, AIG Financial Products, sold to banks, including Goldman Sachs and Societe Generale.
The swaps were sold as protection against defaults on complex mortgage-related vehicles known as collateralized debt obligations, or CDOs. As the housing meltdown grew into a full-blown financial crisis, AIG was forced to post billions of dollars in collateral on these contracts, pushing it to the brink of collapse.
The insurer was saved by the government, which committed more than $100 billion of taxpayer money to the bailout. A lot of that money was quickly transferred to major banks that were counterparties on the CDO-linked derivatives. Goldman and SocGen were among the biggest recipients of this money.
The bailout has been among the most controversial of the financial crisis because the banks were paid 100 cents on the dollar during a period when similar obligations were being settled at large discounts.
Cassano said Wednesday that he still scratches his head when thinking about these settlements, which he said transferred roughly $40 billion to AIG's derivatives counterparties.
The CDS contracts gave AIG the right to negotiate big discounts on the amount of collateral the insurer had to post to counterparties, he explained.
During "severe" market environments, when trading dries up, the contracts allowed for a poll of derivatives dealers to gauge activity, Cassano said.
"If this dealer poll fails -- which it would have because nothing was trading -- you would have been back to negotiating," he said. "You would be negotiating deep discounts on these collateral calls."
Cassano also said he was "always" able to negotiate "extremely steep discounts" on all the large requests for collateral from counterparties.
"I left the company in March," he added. "I wish I was able to have stayed on and helped through this process."
Cassano said he didn't understand why, in September 2008, people didn't look at AIG's CDS contracts and use the rights the insurer had to preserve its liquidity.
"I would have been able to negotiate substantial discounts such that the taxpayer would not have had to accelerate the $40 billion to the counterparties," he said. "I see that as the linchpin of the issues we're discussing."
"I can see the counterparties were paid off at 100 cents on the dollar," Cassano added. "I don't know how the negotiations went."
Goldman Chief Operating Officer Gary Cohn defended the investment bank's derivatives deals with AIG in prepared testimony for the same hearing on Wednesday. Read about Cohn's statements.
Cassano also defended the original underwriting that was used to value the CDS the insurer sold on CDOs.
AIG guaranteed so-called super-senior parts of CDOs, which were the least risky bits. These securities had AAA-rated layers below them, so the theory was that the mortgages and other assets underlying the structures would have to default on a grand scale for losses to reach the top layers.
Cassano said Wednesday that he still thinks cash flows from the underlying assets will be enough to support the super-senior CDO tranches that AIG guaranteed.
AIG got into trouble because it had to value its guarantees based on market prices. In the midst of the crisis in 2008, trading seized up, making the contracts very difficult to value, according to Cassano.
"It's clear these things don't trade anymore," Cassano said. "The market isn't trading unless it's a government-guaranteed mortgage product."
Indeed, Cassano said he would have been happy to conduct this business within a regulated insurance subsidiary of AIG, rather than in the unregulated over-the-counter derivatives market. Insurance companies don't have to value the guarantees they sell on a mark-to-market basis, he noted.
"It would have saved us the issue of having to find a fair value for these contracts when no market existed," Cassano added. "I would have encouraged that kind of regulation."