Posted on 30 Jun 2010
The former head of American International Group Inc.'s derivatives-trading unit will defend his tenure at the firm Wednesday, saying AIG would have realized few losses from credit derivatives if the trades hadn't been unwound in the U.S. government's 2008 bailout of the company.
Speaking publicly for the first time in more than two years, Joseph Cassano, who was chief executive of AIG's Financial Products division from 2002 to early 2008, will testify before the Financial Crisis Inquiry Commission about the unit's sale of credit-default swaps that insured more than $70 billion in debt pools backed by U.S. mortgage assets.
When values of subprime-mortgage securities plunged during the housing downturn, AIG was driven to the brink of collapse when it had difficulty meeting large collateral demands from U.S. and European banks that had bought the protection. To prevent an AIG failure, the government rescued the insurer in September 2008 and has spent more than $130 billion in the AIG bailout.
The panel is seeking answers about the role that derivatives played in the financial crisis and has summoned current and former executives from AIG and Goldman Sachs Group Inc., including Goldman's President and Chief Operating Officer Gary Cohn, to testify in two days of hearings.
Goldman was a key beneficiary of the AIG bailout following a November 2008 decision by the Federal Reserve Bank of New York to pay off AIG's trading partners in full to cancel credit-default swaps on $62 billion in soured mortgage securities, a move aimed at stemming the insurer's cash bleed. Goldman received $14 billion of that sum, while AIG realized billions of dollars in losses when the contracts were unwound. The mortgage securities AIG previously insured, known as collateralized-debt obligations, are now held by a company called Maiden Lane III, which is largely financed by the New York Fed.
According to prepared remarks, Mr. Cassano will tell the bipartisan panel that he believed most mortgage CDOs that AIG insured weren't as "tainted" by lax underwriting standards, and that the debt pools wouldn't experience realized losses in the long run—in spite of market-value drops and accounting losses AIG had to book during the downturn. As a result, AIG chose not to hedge its portfolio in 2006 and 2007.
"As I look at the performance of some of these same CDOs in Maiden Lane III, I think there would have been few, if any, realized losses on the credit-default contracts had they not been unwound in the bailout," he said in prepared testimony.
His testimony didn't address what would have happened if AIG couldn't come up with cash to meet its collateral calls from banks and defaulted on its financial obligations.
The Justice Department recently dropped a long-running criminal probe into whether Mr. Cassano made misleading statements to investors and auditors about AIG's exposure to the deteriorating mortgage market.
Among the areas examined by investigators was whether Mr. Cassano had failed to tell outside auditors and AIG executives about an accounting adjustment that allowed the financial products division to avoid writing down the value of its swaps.
Evidence later surfaced to suggest Mr. Cassano did make the disclosures, and on Wednesday he said he still stands by both his past statements regarding potential realized losses on the mortgage-backed portfolio and the accounting adjustment.
"We believed then, and I still believe now, that it was a wholly appropriate adjustment," he said in the prepared statement. He said he disagreed with the auditors' decision to disallow the adjustment and was shocked when auditors said there was a "material weakness" in AIG's oversight of its mark-to-market valuation.
Mr. Cassano also is expected to discuss the awareness among AIG's risk managers of his unit's trading positions and the compensation scheme that was in place in his division.
After AIG executives testify, executives from Goldman will get their chance to discuss their derivatives trading. The Wall Street firm already is facing criminal and civil probes into whether it misled investors on mortgage-bond deals, and the commission is likely to pepper Goldman executives with tough questions surrounding Goldman's exposure to AIG.
In his testimony, Mr. Cohn plans to flatly deny that the company took bets against clients who had a different view of the housing market.
"During the two years of the financial crisis, Goldman Sachs lost $1.2 billion in its residential mortgage-related business," he said in his prepared remarks. "We did not bet against clients, and the numbers underscore this fact."
He also will apologize to the commission in response to complaints that the firm hasn't been cooperative in providing responses to its inquiries.
The Financial Crisis Inquiry Commission's hearings on derivatives comes just as Congress is in the final stages of trying to pass a bill that would bring sweeping new rules to the over-the-counter derivatives market.