Downgrades and Downfall, the last story in a three-part series on AIG, published today in the Washington Post makes for some great reading between ballgames.
The contracts were flying out of AIG Financial Products. Hardly anyone outside Wall Street had ever heard of credit-default swaps, but by early 2005, investment banks were snapping them up to insure all kinds of deals in case of default, fueling one of the great financial booms in U.S. history.
During twice-monthly conference calls that originated from the company’s headquarters in Wilton, Conn., president Joseph Cassano would listen as marketing executive Alan Frost listed the latest swap transactions for associates in the firm’s offices in London, Paris and Tokyo.
Once a small part of the firm’s business, the increasingly popular contracts had helped boost the company’s profits to record levels. The company’s computer models continued to show only a minute chance that the firm would ever pay out a dime on the contracts, and it turned down deals that didn’t meet its standards. (emphasis added)
But the swaps also exposed Financial Products and its parent AIG, the global insurance titan, to billions of dollars in possible losses. By spring 2005, some Financial Products executives were questioning the surge in volume. Among them was Cassano, an early advocate for the swaps business who ran the firm from its London office.
“How could we possibly be doing so many deals?” one executive recalls Cassano asking Frost, the firm’s liaison with Wall Street dealers, during one conference call.
“Dealers know we can close and close quickly,” Frost said. “That’s why we’re the go-to.”
Efficiency wasn’t the only reason. Frost didn’t have to say aloud what everyone at the firm already appreciated. Financial Products had become the “go-to” for credit-default swaps in part because of its knowledge and reliability, but also because it had AIG’s backing. The parent company’s top-drawer, Triple A credit rating and its deep pockets assured customers that they could rest easy.
Their comfort turned out to be illusory. The credit-default swaps became a primary force in the disintegration of AIG as a private enterprise and a massive government rescue aimed at preventing catastrophic damage to the world’s financial system. Never in U.S. history has the government invested so much money trying to save a private company…
Financial Products was itself an entrepreneurial success story, with the numbers to prove it: an investment portfolio in excess of $50 billion; a trading operation that dealt in dozens of currencies, 18 commodities and a host of credit and equity services; a reputation for finding innovative ways to assess and manage the risks in interest rates, equities and other deals for its clients.
“And who are our clients?” Cassano asked. “It’s a broad global swath of mostly high-grade institutions, mostly high-grade entities around the world and it includes banks and investment banks, pension funds, endowments, foundations, insurance companies, hedge funds, money managers, high-net-worth individuals, municipalities and sovereigns and supranationals.” (emphasis added)
The availability of computer models to project the risk of payout and the fact that insurance companies were among the customers purchasing the the high-risk credit default swaps points toward Katrina and should make all SLABBED readers want to read more.
Part 1 | Twenty years ago, a bold experiment fueled by greed on Wall Street and blindness in Washington helped cause the financial system’s crash.
Part 2 | By 1998, AIG Financial Products had made hundreds of millions of dollars. Then it subtly turned in a dangerous direction.
Part 3 | How could a single unit of AIG cause the giant company’s near-ruin and become a fulcrum of the global financial crisis?