Cassano Defends AIG Swaps, Lewis Says `We Were Wrong'

Joseph J. Cassano, whose derivative bets on subprime loans forced American International Group Inc. into a U.S. bailout, defended the deals while the insurer’s chief risk officer said the firm was “wrong” on the trades.

Cassano, 55, head of AIG’s Financial Products unit until March 2008, said he “never compromised our standards” on the credit-default swaps blamed for the firm’s losses, according to remarks submitted to the Financial Crisis Inquiry Commission. Three years ago, AIG executives couldn’t envision a “scenario within any kind of realm or reason that would see us losing $1 in any of those transactions,” Cassano told analysts then.

“Often repeated are my words during an earnings call in August 2007 that I did not expect any realized, economic losses (as opposed to unrealized accounting losses) on this portfolio,” Cassano said in prepared remarks for today’s hearing in Washington. “I meant exactly what I said.”

AIG, once the world’s largest insurer, received a 2008 bailout designed to protect banks that bought $62.1 billion in swaps from the firm. The FCIC is reviewing decisions that led to the New York-based insurer’s rescue as lawmakers seek to prevent another company from accumulating so much risk that its collapse could threaten global economic stability.

While the securities linked to swaps hadn’t defaulted in late 2008, the market value of the assets collapsed, triggering collateral calls that drained AIG of cash, Robert Lewis, AIG’s chief risk officer, said in prepared remarks.

‘We Were Wrong’

“We were wrong about how bad things could get,” Lewis said. “What ended up happening was so extreme that it was beyond anything we had planned for.”

Goldman Sachs Group Inc. President Gary Cohn and Chief Financial Officer David Viniar are also slated to appear before the FCIC during the two-day hearing. Goldman collected $12.9 billion after the rescue from contracts with AIG.

Viniar has said that collateral agreements would have helped protect the firm, among AIG’s biggest counterparties, against default. AIG’s $182.3 billion bailout ensured that Goldman Sachs was paid in full.

Cassano had shied away from public statements while regulators investigated his role in the swaps trades. The U.S. Justice Department and the U.K.’s Serious Fraud Office dropped probes last month, and the U.S. Securities and Exchange Commission closed its investigation, AIG and Cassano’s lawyers said this month.

‘Even More Prudent’

Cassano “was a person with extraordinary knowledge of the inner workings of that company and the relationships with others,” FCIC Chairman Phil Angelides said yesterday in a conference call with reporters.

The former AIG Financial Products head said he decided in late 2005 to cease creating swaps tied to subprime mortgages on concern that loosening underwriting standards would lead to more risk. The decision “looks even more prudent” now, he said.

Selling the swaps “was an act of incredible corporate irresponsibility,” Steve Kohlhagen, a former finance professor at the University of California, Berkeley, and an ex-AIG Financial Products executive, said in prepared remarks.

As part of a November 2008 revision to AIG’s rescue, banks received payments in exchange for delivering collateralized debt obligations linked to the $62.1 billion in swaps. The securities were placed in a taxpayer-funded vehicle called Maiden Lane 3.

Few Losses

“As I look at the performance of some of these same CDOs in Maiden Lane 3, I think there would have been few, if any, realized losses on the CDS contracts had they not been unwound in the bailout,” Cassano said in his testimony.

Cassano said an AIG committee that included Lewis approved his transactions. Lewis said accountability for risks assumed by AIG businesses resides “within the business units themselves.”

In November 2007, Cassano proposed a special incentive plan to retain employees of the business after it “became apparent that AIGFP’s accounting losses would be substantial,” he said. Bonuses paid to the derivatives staff in March 2009 sparked a backlash against AIG as President Barack Obama chastised the firm and employees received death threats.

Cassano earned $280 million in eight years at Financial Products, Representative Henry Waxman said during a 2008 hearing into the bailout. After Cassano stepped down, he was kept on as a consultant at $1 million a month, Waxman said.

AIG Chief Executive Officer Robert Benmosche has said Financial Products will be shuttered by year-end, with most trades wound down and a profitable portfolio overseen by the insurer or outside managers. The trades shrank to about $755 billion on March 31 from $941 billion at the end of 2009.

‘Flying Blind’

The business was founded in 1987 by ex-employees of Drexel Burnham Lambert, the securities firm that helped popularize “junk-bond” investing before it collapsed.

Financial firms and regulators were uninformed about the risk of derivatives, according to remarks today from Angelides, who will report findings to Congress and Obama in December.

“When clarity mattered most, Wall Street and Washington were flying blind,” Angelides said. “In the case of derivatives, my fellow commissioners and I are seeing something we’ve seen many times in our investigation: enormous risk, reckless leverage, and early warning signs being ignored.”

FCIC Commissioner Brooksley Born had warned in 1998, as chairman of the Commodity Futures Trading Commission, that the unregulated over-the-counter derivatives market posed a danger to the global financial system. She moved to address changes in how swaps based on interest rates, commodities or currencies were traded and was stopped by Alan Greenspan, Arthur Levitt and Robert Rubin, who all argued the market could regulate itself.

‘Special Interests’

Born said last year that the banks that caused the crisis were trying to stop the congressional overhaul of the market.

“Special interests in the financial-services industry are beginning to advocate a return to business as usual,” Born said in May 2009 as she accepted a Profile in Courage award from the John F. Kennedy Library Foundation.

A conference committee of House and Senate lawmakers passed a financial-services overhaul bill last week that would regulate the $615 trillion private derivatives market for the first time. The legislation included requirements for standardized interest- rate, credit-default and other swaps to be traded on exchanges or swap execution facilities before being guaranteed by clearinghouses, which are intended to lessen the effects of a bank default by ensuring counterparty payment.

Housing Bubble

Kohlhagen said the government’s push to increase homeownership, rather than the use of derivatives, should be blamed for creating the freeze in credit markets. The contracts delayed the collapse of the housing bubble by supporting demand for CDOs, packages of mortgage loans, he told the commission.

“Credit-default swaps had absolutely no role whatsoever in causing the financial crisis,” said Kohlhagen. “The bubble would have been shorter-lived and the resulting financial crisis would have been less severe” had swaps not been used to guarantee CDOs, he said.

Losses from mortgage lending and on securities that packaged those loans totaled more than $1 trillion since 2007, the largest part of about $1.78 trillion in writedowns for financial firms worldwide, according to data compiled by Bloomberg. Losses from default swaps and other derivatives have totaled $64.7 billion, or about 3.6 percent of overall writedowns, according to Bloomberg data.

To contact the reporters on this story: Hugh Son in New York at hson1@bloomberg.net; Matthew Leising in New York at mleising@bloomberg.net; Inyoung Hwang in New York at ihwang7@bloomberg.net.

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