What went wrong at AIG? Since the uproar over the firm's bonuses, it's become fashionable to distinguish between the masters of the universe at AIG Financial Products, the subsidiary that nearly torched the global economy, and the working stiffs at the rest of the company. So compelling is this dichotomy, in fact, that even the AIG basher-in-chief has invoked it. "You've got a company, AIG, which used to be just a regular old insurance company," President Obama explained during his recent "Tonight Show" appearance. "Then they decided--some smart person decided--let's put a hedge fund on top of the insurance company and let's sell these derivative products to banks all around the world."
There's clearly something to this. At the very least, the marriage between the two was hardly a natural fit. The derivatives-meisters worked in lavish digs, had Ph.D.s from prestigious universities, and made gobs of money using powerful computer models. The insurance men hailed from no-name schools and prided themselves on paying less in claims then they collected in premiums. "It was different. That's why we never had them in the building," recalls Hank Greenberg, who ran AIG for more than 35 years before resigning in 2005.
But, these differences notwithstanding, it actually was pretty smart to put a hedge fund on top of an insurance company--at least for a while. For more than 15 years, the arrangement racked up big profits for AIG without exposing it to excessive losses. The real problem was more fundamental: Companies that deal in risk have a natural tendency to take on too much of it, whether they're arranging homeowner's policies or elaborate arbitrages. Over time, a steady march of profits desensitizes them to the dangers they once sweated; even institutional checks begin to weaken.
Which is why the difference between a successful risk enterprise and an unsuccessful one often has less to do with the complexity of its schemes than with its leaders' fanaticism about discipline. It was, among other things, the lack of such leadership at AIG in recent years that made the company a ward of the state.
AIG Financial Products began life in the mind of Howard Sosin, a Stanford-trained Ph.D. who once worked with junk-bond king Michael Milken at Drexel Burnham Lambert. In the mid-1980s, Sosin dreamt of leaving Drexel to start a company that would accept risk from people looking to unload it in exchange for a hefty fee. For example, a state government might pay Sosin's hypothetical firm to lock in an interest rate so as to avoid a potential increase down the road. (The contract, known as a "swap," would obligate Sosin to offset a higher interest payment, but allow him to pocket the difference if the interest payment fell.) Sosin would then turn around and unload the risk himself using a series of contracts called hedges, so that he would make money regardless of which way interest rates moved.
The only catch was that, in order to arrange all these contracts on favorable terms, Sosin needed the financial backing of an extremely reliable, deep-pocketed benefactor. When Sosin went looking for one, an associate put him in touch with former Connecticut senator Abraham Ribicoff--a friend of Greenberg's. Ribicoff brokered an introduction, and, in early 1987, the two men settled on a joint venture: Sosin would furnish the nerds and the algorithms, Greenberg would provide his company's triple-A rating, and the two sides would share the profits.
In the early days, many within AIG viewed Sosin's methods as something akin to alchemy. The AIG officials nominally overseeing his operation knew almost nothing about swaps, and they were dismissive of what they didn't understand. But, within months, AIG-FP was bringing in tens of millions of dollars. Suddenly, top AIG officials took notice. Worse, in light of all the revenue, it began to dawn on Sosin's AIG overseers that his terms were overly generous. "AIG probably thought, 'This thing--it's some Drexel wise guy. It'll make a little bit of money,'" recalls a former AIG-FP employee. "Instead, the thing was minting money. Suddenly ... [it was like]: 'You cut what kind of deal with him?'"
Over the next few years, Greenberg and AIG would revisit their contract with Sosin, but to little avail. Still, for all the haggling about money, the bigger divide was cultural. Greenberg was famously hard-charging, but he had modest tastes. He'd lived in an unremarkable three-bedroom apartment on Park Avenue for years after becoming CEO. His three sons had shared a single bedroom when they came home from college or boarding school. By contrast, Sosin's primary residence was a five-story mansion replete with elevator, squash court, and indoor pool, according to a Wall Street Journal article at the time. His neighbors in Fairfield, Connecticut dubbed it "the castle," and he'd paid a king's ransom for it--$5 million in cash.
Some of these differences bubbled over into business philosophy. Greenberg's was fundamentally conservative; Sosin's less so. For example, it was customary to offer large signing bonuses to lure executives from investment banks. Sosin was obliging, but Greenberg opposed this on principle and went along only grudgingly. Greenberg also wanted more of a say over major deals, something the independent-minded Sosin fought.
By 1993, the partnership was over. Greenberg had been gradually building a team of replacements, and, when Sosin balked at another proposed renegotiation, the two sides went their separate ways. A lawsuit stemming from the breakup revealed that AIG-FP had made more than $1 billion in profits between 1987 and 1992--a staggering sum in those days.
Greenberg put AIG-FP on a tighter leash after Sosin's departure, but several of Sosin's top lieutenants stayed behind, and its character remained intact. According to a Washington Post series in late December, Sosin had created a committee when he launched AIG-FP to vet every single transaction the firm undertook at the close of each day. The idea was to weed out the deals that didn't hold up to withering scrutiny. Under Sosin's successor, a mathematician named Tom Savage, the firm continued to apply an "academic rigor" to each deal, Savage told the Post.
But, when Savage left in 2001, Greenberg elevated a less obvious candidate to run the unit on his recommendation: Joe Cassano, its chief financial officer. Cassano didn't have a background in math or finance, nor did he have a pedigree to match Sosin or Savage. He'd attended Brooklyn College and made his name at the firm overseeing what the former AIG-FP official calls "plumbing." Cassano supervised the employees who set up contracts and accounts for each deal, who routed payments to the right parties, and who made sure AIG-FP and its customers were honoring their contracts (for example, by posting collateral if necessary). The lawyers and accountants all reported to him.
These were the least glamorous parts of the enterprise, but Cassano performed them ably. Colleagues respected his competence, and Greenberg respected his drive. "He was smart, tough, aggressive. Those are not bad characteristics," Greenberg told me. And, though Cassano sometimes alienated co-workers with his vulgar, in-your-face style, he treated the CEO with genuine reverence. He was fond of telling colleagues about a relative who knew almost nothing about AIG but nonetheless advised him: "Don't ever sell the stock unless something happens to Mr. Greenberg."
Cassano quickly demonstrated an aptitude for, if not financial wizardry itself, then selling financial wizardry. One Wall Street analyst recalls attending an AIG "investor day" early in Cassano's tenure and watching him tout various AIG-FP ideas. In one case, Cassano explained how AIG-FP could help banks operate with less capital than regulators typically demanded by essentially insuring their loan portfolios. And the best part was that the deal exposed the company to "no risk." When Cassano spoke, the once-inscrutable company always made perfect sense. Unfortunately, the feeling rarely lasted. "I get back to my desk at the investment house to write up what I learned," the analyst says, "and it's like, 'Tell me again how you take trillions of dollars of notional risk and not actually have any risk?'"
Was it a mistake to hand AIG-FP over to someone with such a weak conceptual grasp of the business? Greenberg maintains that there were enough people around Cassano with quantitative backgrounds to set his mind at ease--and that officials at the corporate parent scrutinized AIG-FP transactions exhaustively. (Former employees basically agree with this.)
But, in March 2005, Greenberg resigned from AIG amid allegations of accounting improprieties. Within three weeks, AIG saw its precious triple-A credit rating downgraded. This was a body blow to AIG-FP, which relied on the rating to secure favorable terms for the contracts it signed. Many were so-called credit-default swaps (CDS)--essentially insurance for bonds that investors had purchased. The weaker its credit rating, the more AIG had to pledge in collateral to grease the deals--money it would have to fork over if the bonds suddenly depreciated. In general, the downgrade made AIG-FP less attractive to customers, who relied on the company's credit rating as a guarantee it would pay up if the insurance were needed.
A colleague recalls that Cassano became enraged by the development. He first turned on Greenberg, blaming his former benefactor and casting himself as a victim who'd been let down by the company. Cassano would rant about the cosmic unfairness of it all and refer to Greenberg as a "shithead" who'd always given him a hard time. He began frantically groping for ways to sell outsiders on the idea that, for all the parent company's problems, AIG-FP had produced enormous returns. Though the immaculate credit rating had been the foundation of his business, Cassano would routinely insist that "there are only a few things we do that are dependent on the triple-A rating." "I remember thinking he just desperately wanted to figure out a way to attract business back to himself," says the colleague.
Most of these efforts were for naught. In a conference call about AIG's results from the fourth quarter of 2005, a Wall Street analyst grilled Cassano on why his revenue and profits were down. But there was one type of creditdefault-swap customer still keen on doing business with him: the investors then gobbling up bundles of securities backed by subprime real-estate loans. Between March, when Greenberg left AIG, and the end of 2005, Cassano's division issued more than $40 billion in credit-default swaps (essentially insurance) for portfolios of securities backed by subprime mortgages. This was more than half of all the insurance of this type the company had on its books.
Worse, in contrast with the Greenberg era, there was now effectively a vacuum at the top of AIG. Greenberg's successor, Martin Sullivan, was a traditional, meat-and-potatoes insurance man who "didn't have the ability to figure out what was going on there," says another former AIG official. And, even if he'd been able to scrutinize it, Sullivan didn't consider AIG-FP a priority. "He saw his role as going around, meeting every state regulator in the country, and saying, 'We intend to cooperate fully with all investigations of [the] company,'" says this person. For his part, chief financial officer Steve Bensinger found himself completely preoccupied with AIG's accounting statements, whose revision it fell to him to oversee.
The man in charge of keeping an eye on Cassano was a well-respected executive named Bill Dooley. But, former colleagues say, Cassano rebuffed Dooley at every turn, often aggressively. (Greenberg believes Dooley should have appealed to AIG's board if Sullivan didn't support him. Sullivan, Bensinger, Dooley, and Cassano did not respond to requests for comment.) Years of only really answering to Greenberg seem to have convinced Cassano that there was no one else at the company worth listening to.
AIG-FP finally put the brakes on its subprime spree in late 2005. According to the Post, some of Cassano's subordinates began to worry that the assets were far, far riskier than AIG-FP had believed and persuaded him to reconsider. At the same time, another AIG division called American General Financial Services, which was actually in the mortgage business, had become alarmed by the subprime market and was balking at approving new subprime loans. One former official says word spread from American General to AIG-FP that the subprime business was a minefield.
Whatever the reason for the decision, Cassano made it extremely grudgingly. It pained him to give up a large source of profits, and, as late as August 2007, he still seemed miffed over the development. "It is hard for us, without being flippant, to even see a scenario within any kind of realm of reason that would see us losing one dollar in any of those transactions," he famously told analysts. Alas, by the following February, the market value of the subprime securities would plummet, and the losses wouldn't be one dollar but ... billions. Like that relative said, Cassano should have sold his AIG stock when something happened to Mr. Greenberg.
Noam Scheiber is a senior editor at The New Republic.
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COMMENTS (27)
Wow, all this discussion about how greedy-reckless-evil businessmen are, but no mention whatsoever of the mark-to-market rule imposed on them by the government that actually caused the paper losses triggering the collateral calls. Now why is that? Could it be because if the mark-to-market rules are found to be wrong, then AIG is absolved of any blame, the private sector was the innocent victim in all this, and it is the government(s) that is entirely to blame for the financial crisis?
What an unmitigated nightmare that would be for the American left.
Tick tock.
Wow, all this discussion about how greedy-reckless-evil businessmen are, but no mention whatsoever of the mark-to-market rule imposed on them by the government that actually caused the paper losses triggering the collateral calls. Now why is that? Could it be because if the mark-to-market rules are found to be wrong, then AIG is absolved of any blame, the private sector was the innocent victim in all this, and it is the government(s) that is entirely to blame for the financial crisis?
What an unmitigated nightmare that would be for the American left.
Tick tock.
So what did go wrong at AIG? Was it Sosin? Or Cassano? Or Greenberg? Or Sullivan? How about Milken? I like that choice. He made a fortune selling junk bonds to the S&Ls, funded of course with government insured deposits. Having learned well from the master, Soskin figured that he too could get rich using a government guarantee, in this case to limit the risk (or so he thought) of insuring those mortgage-backed securities in a perpetually expanding housing market (funded of course (to a large degree) by the quasi government agencies, Freddie and Fannie). Both Milken and Sosin took what were good government programs (government insured deposits and (quasi) government funding for h ... view full comment
So what did go wrong at AIG? Was it Sosin? Or Cassano? Or Greenberg? Or Sullivan? How about Milken? I like that choice. He made a fortune selling junk bonds to the S&Ls, funded of course with government insured deposits. Having learned well from the master, Soskin figured that he too could get rich using a government guarantee, in this case to limit the risk (or so he thought) of insuring those mortgage-backed securities in a perpetually expanding housing market (funded of course (to a large degree) by the quasi government agencies, Freddie and Fannie). Both Milken and Sosin took what were good government programs (government insured deposits and (quasi) government funding for housing) and exploited them to the (enormous) benefit of a few. The lesson: never underestimate the ability of a few greedy individuals to ruin a good thing for many. Or no bad deed goes unrewarded.
Wendy.....
That is the most convoluted, rationalizing, excuse-laden, denial-of-denial hyperbole I've ever read. If you don't agree with government regulation, that's fine. There are a variety of opinions that are equally valid on this topic. Government regulation is often too little, too late to level the playing field.
But, to make the argument that the regulations, the "rules" of the road, so to speak, are actually the CAUSE of the abuse is just stretching logic and credulity way too far.
The regs may be imperfect and inadequate, but to excuse the shameless greed and manipulation of players like Cassano is not one of their weaknesses. If the regs are wrong, then change them, but don't bla ... view full comment
Wendy.....
That is the most convoluted, rationalizing, excuse-laden, denial-of-denial hyperbole I've ever read. If you don't agree with government regulation, that's fine. There are a variety of opinions that are equally valid on this topic. Government regulation is often too little, too late to level the playing field.
But, to make the argument that the regulations, the "rules" of the road, so to speak, are actually the CAUSE of the abuse is just stretching logic and credulity way too far.
The regs may be imperfect and inadequate, but to excuse the shameless greed and manipulation of players like Cassano is not one of their weaknesses. If the regs are wrong, then change them, but don't blame them for causing the bad behavior in the first place. That's akin to the wife beater excusing his or her behavior by claiming that the abused party caused the jealousy that led to the beating. or, the alcoholic claiming that the close proximity of the liquor store to his house caused him to get drunk, wreck the car and injure the pedestrian.
If the Bush administration taught us anything, it taught us that for too long we have tolerated excuses, denial and rationalization instead of responsibility and accountability. It's not the government's job to protect us from our base selves.
After yesterday, finger pointing articles about this entire economic collapse seems to be just more of the same. Yesterday, Obama fired the CEO of GM, a private citizen in a private company. I don't care who did what to whom, or who is a fault, or who you hate or what your politics are. This is unprecedented. I worked for nearly 10 years in the former Soviet Union. I've seen first hand the way that officials in "private companies" act in business situations that are supposedly "free" of government control in the new Russian economy, but where everyone knows who is really pulling the strings behind the scenes. Fear is King. Don't get me wrong here, I am not going down the path of righ ... view full comment
After yesterday, finger pointing articles about this entire economic collapse seems to be just more of the same. Yesterday, Obama fired the CEO of GM, a private citizen in a private company. I don't care who did what to whom, or who is a fault, or who you hate or what your politics are. This is unprecedented. I worked for nearly 10 years in the former Soviet Union. I've seen first hand the way that officials in "private companies" act in business situations that are supposedly "free" of government control in the new Russian economy, but where everyone knows who is really pulling the strings behind the scenes. Fear is King. Don't get me wrong here, I am not going down the path of right wing radio in saying that Obama is a socialist. But this act should cause everyone to pause and think, "where the hell are we going?" I certainly didn't vote for this.
Wendy,
Yer ten shades of gullible if you think mark to model accouting would have stopped AIG (or Lehman or Bear, etc..) from imploding in the manner they did. Even the most generous accounting model can not overcome dead loss and the loss of lender confidence which follows. The counterparties would have still pulled their tickets. But dream on baby, dream on...
Wendy,
Yer ten shades of gullible if you think mark to model accouting would have stopped AIG (or Lehman or Bear, etc..) from imploding in the manner they did. Even the most generous accounting model can not overcome dead loss and the loss of lender confidence which follows. The counterparties would have still pulled their tickets. But dream on baby, dream on...
good lord, save us from the Wendy types who hear on Fox news that it is all mark to market. Instead of it being 'marked to model' in a hypothetical or synthetic manner using estimated valuations derived from financial modeling, and sometimes marked in a manipulative way to achieve spurious valuations.
Hey Wendy, do you even know what Mark to market means? Can you explain, clearly, why mark to model is superior to mark to market?
Republican delusion states if we just continue to pretend housing prices are increasing, and people are not defaulting on their subprime loans, then the good times will roll on forever.
good lord, save us from the Wendy types who hear on Fox news that it is all mark to market. Instead of it being 'marked to model' in a hypothetical or synthetic manner using estimated valuations derived from financial modeling, and sometimes marked in a manipulative way to achieve spurious valuations.
Hey Wendy, do you even know what Mark to market means? Can you explain, clearly, why mark to model is superior to mark to market?
Republican delusion states if we just continue to pretend housing prices are increasing, and people are not defaulting on their subprime loans, then the good times will roll on forever.
"but no mention whatsoever of the mark-to-market rule imposed on them by the government that actually caused the paper losses triggering the collateral calls"
nor the government imposition of uneconomic lending practices, nor the incessant insistance by governent officials that mortgages are "low risk", nor the curiously concurrent pressure by government officials to "spread the risk", nor the repeal of the Glass-Steagall act.
AIG is like a pizza delivery boy taking the fall for Tony Soprano for a mob hit that Tony himself engineered.
"but no mention whatsoever of the mark-to-market rule imposed on them by the government that actually caused the paper losses triggering the collateral calls"
nor the government imposition of uneconomic lending practices, nor the incessant insistance by governent officials that mortgages are "low risk", nor the curiously concurrent pressure by government officials to "spread the risk", nor the repeal of the Glass-Steagall act.
AIG is like a pizza delivery boy taking the fall for Tony Soprano for a mob hit that Tony himself engineered.
This explanation is way too complicated. As we should have learned from Long-Term Capital, extreme leverage inevitably results in failure no matter how well the masters of the universe imagine they are managing risks. AIG is a case of leverage gone wild due to absurd accounting rules that allow institutions to keep the assets and liabilities implied by derivatives off their balance sheets. If anyone had seen an honest balance sheet for AIG years ago, their eyes would have rolled back in their heads. With honest disclosure, AIGs credit would have been cutoff by the market and failing that by regulation long before it could have threatened the system.
Sorry wendy, it is dishonest accounting ... view full comment
This explanation is way too complicated. As we should have learned from Long-Term Capital, extreme leverage inevitably results in failure no matter how well the masters of the universe imagine they are managing risks. AIG is a case of leverage gone wild due to absurd accounting rules that allow institutions to keep the assets and liabilities implied by derivatives off their balance sheets. If anyone had seen an honest balance sheet for AIG years ago, their eyes would have rolled back in their heads. With honest disclosure, AIGs credit would have been cutoff by the market and failing that by regulation long before it could have threatened the system.
Sorry wendy, it is dishonest accounting that is the cause of problem, not the honesty of mark to market. What a nightmare for the American right -- its frauds just blew up the world economy. Not tick tock, kaboom! Figures that the right wants to perpetuate the fraud now. The flat-earth crowed believes that if we merely avert our eyes from a problem, it goes away. Faith-based accounting.
raylward, Fannie and Freddie are not the culprits. Sub-prime means that the mortgage does not qualify for Fannie or Freddie financing. Had we stuck with them, we would not be in this fix.
Look a little further and you'll see that "the govt" acted only as prodded by the very companies now calling foul. It applies to all the major events that set the stage for the financial meltdown: the modifications made to Glass-Steagall allowing commercial and investment banks to merge, the regulatory agencies that would oversee them, whether CDS would be considered under gambling or securities laws - they ended up being defined as neither and therefore actually went un-regulated, as well as the accounting rules such as MTM.
While MTM is pro-cyclical - providing a nice kicker in the up years, and a steeper drop in the down years - MTM did not cause the liquidity problems at Lehman and ... view full comment
Look a little further and you'll see that "the govt" acted only as prodded by the very companies now calling foul. It applies to all the major events that set the stage for the financial meltdown: the modifications made to Glass-Steagall allowing commercial and investment banks to merge, the regulatory agencies that would oversee them, whether CDS would be considered under gambling or securities laws - they ended up being defined as neither and therefore actually went un-regulated, as well as the accounting rules such as MTM.
While MTM is pro-cyclical - providing a nice kicker in the up years, and a steeper drop in the down years - MTM did not cause the liquidity problems at Lehman and Bear that lit the bonfire - that was pure over-leverage and a nasty rumor mill on Wall Street. But it did play a big part in making it so contagious among banks. Now you'll hear the big banks saying modifying MTM won't help them, the truth will depend on how MTM is redefined and which assets will qualify, then how successful the banks are in off-loading other toxic assets to the govt. The more they are stuck with, the more they will need it changed. And of course, they'll be very active influencing legislators throughout the process.
This is pretty thin. A key point Cassano got over $100 million in bonuses.
The key souce appears to be a quant. Face facts, the quants were among the worst actors in this mess.
Their models failed completely, most of them should go back to physics they are a waste of space in finance.
Look at Berkshire's 2002 annual report where WB describes a liquidity crunch brought on by CDS callateral calls if the seller suffers a credit rating drop. This is what happed to AIG.
That and a total breakdown of corporate control.
This is pretty thin. A key point Cassano got over $100 million in bonuses.
The key souce appears to be a quant. Face facts, the quants were among the worst actors in this mess.
Their models failed completely, most of them should go back to physics they are a waste of space in finance.
Look at Berkshire's 2002 annual report where WB describes a liquidity crunch brought on by CDS callateral calls if the seller suffers a credit rating drop. This is what happed to AIG.
That and a total breakdown of corporate control.
I'm baffled by the previous two comments. AIG-FP's rise and fall had little or nothing to do with any government programs. AIG-FP was overseen by the Office of Thrift Supervision, but they don't seem to have been too tough on the company. This is all strictly private sector stuff -- not government-guaranteed. It also has nothing to do with mark-to-market accounting or the "government." The collateral calls that have virtually destroyed the company were driven by fairly standard provisions in AIG's derivatives contracts with its counterparties relating to its credit rating.
I'm baffled by the previous two comments. AIG-FP's rise and fall had little or nothing to do with any government programs. AIG-FP was overseen by the Office of Thrift Supervision, but they don't seem to have been too tough on the company. This is all strictly private sector stuff -- not government-guaranteed. It also has nothing to do with mark-to-market accounting or the "government." The collateral calls that have virtually destroyed the company were driven by fairly standard provisions in AIG's derivatives contracts with its counterparties relating to its credit rating.
MTM need not be used for REGULATORY purposes for BANKS, to the extent that the assets being marked are funded with long-term funds. Insured demand deposits, the bulk of bank liabilities are normally very stable - effectively long term. Non-bank funding varies but marks need a sliding scale which reflects a fair asset/liability match. As Duncan mentioned, the requirement that banks MTM for regulatory capital purposes, welcomed by the banks when everything was rosy, created excessive capital ratio volatility, which turned ugly on the downside. Banks should be required to disclose the difference between REG mark-to-whatever, and current mark-to-market. Non-banks, I suspect, simply need lowe ... view full comment
MTM need not be used for REGULATORY purposes for BANKS, to the extent that the assets being marked are funded with long-term funds. Insured demand deposits, the bulk of bank liabilities are normally very stable - effectively long term. Non-bank funding varies but marks need a sliding scale which reflects a fair asset/liability match. As Duncan mentioned, the requirement that banks MTM for regulatory capital purposes, welcomed by the banks when everything was rosy, created excessive capital ratio volatility, which turned ugly on the downside. Banks should be required to disclose the difference between REG mark-to-whatever, and current mark-to-market. Non-banks, I suspect, simply need lower leverage, if public, or a partnership structure with long-term capital, and tough luck if it doesn't work out.
Roi:
-Yes, it was extreme leverage. But there were many culprits.
-Fan/Fred did get involved with Subprime and Alt-A, in an attempt not to lose market share.
-The fraud was nonpartisan, and global.
-"not tick tock, kaboom!" excellent line
prelude n. An introductory performance, event, or action preceding a more important one; a preliminary or preface.
The prelude to the sorry performance of AIG was Eliot Spitzer's ambition. Spitzer relentlessly attacked better men than himself in order to gain political advantage in his quest for the New York statehouse and then the White House. Too bad he ran into an obstacle while whoremongering. Spitzer accused Greenberg of fraud before the charges were dropped, but not before severely affecting AIG's viability.
Every statement in this article and the first two comments concern the minutiae of after-the-fact nuts and bolts, while ignoring the Rock of Gibralter/quicksand on which the toxi ... view full comment
prelude n. An introductory performance, event, or action preceding a more important one; a preliminary or preface.
The prelude to the sorry performance of AIG was Eliot Spitzer's ambition. Spitzer relentlessly attacked better men than himself in order to gain political advantage in his quest for the New York statehouse and then the White House. Too bad he ran into an obstacle while whoremongering. Spitzer accused Greenberg of fraud before the charges were dropped, but not before severely affecting AIG's viability.
Every statement in this article and the first two comments concern the minutiae of after-the-fact nuts and bolts, while ignoring the Rock of Gibralter/quicksand on which the toxic mortgages were established.
The toxic mortgages were established in the laws of the United States, as passed by the Democratic Congress, Community Reinvestment Act 1977 (Carter), and as modified by the Clinton Administration, and summarized in "Closing the Gap: A Guide to Equal Opportunity Lending" by the Boston Federal Reserve Bank. Every toxic mortgage, and the banks, lending institutions, rating agencies (D&B), and insurance companies (AIG) that dealt in toxic mortgages were following Democratic Party guidelines in strict accordance with US law, as passed by Democratic congresses and signed by Democratic presidents.
Anyone who denies this is ignorant or lying. There are a lot of ignorant liars out there.
You can talk all you want about the need to put derivatives on balance sheets, but how do you properly value the assets and liabilities for derivatives? What is the value of a contingent liability - especially when there is no good way of estimating the probability of having to pay out? With things like hurricane and fire insurance, there is a long history that actuaries can use. With CDS that will only have to pay out in a Depression-like meltdown, how can you estimate the value of something like that? Maybe the concept of the balance sheet needs to be extended and have a place to disclose contingent liabilities whose probability of payout is non-estimable.
This is why I always laugh when so ... view full comment
You can talk all you want about the need to put derivatives on balance sheets, but how do you properly value the assets and liabilities for derivatives? What is the value of a contingent liability - especially when there is no good way of estimating the probability of having to pay out? With things like hurricane and fire insurance, there is a long history that actuaries can use. With CDS that will only have to pay out in a Depression-like meltdown, how can you estimate the value of something like that? Maybe the concept of the balance sheet needs to be extended and have a place to disclose contingent liabilities whose probability of payout is non-estimable.
This is why I always laugh when someone quotes the rate on CDS for US Tresasury debt. If the US Treasury actually defaulted, no one in the world would have the means to make good on the CDS. The insurance would be worthless.
ds111,
Your point about not necessarily using mtm for regulatory purposes is well taken. Implicit in what you are saying is that liabilities are not market to market, but if they and the assets are matched, then they should be marked on the same basis as the assets. However, it is only true up to a point. If the marking down to market is due to increased default risk, then the capital may indeed be gone for any purpose. If the marking down to market is due to an increase in the market yield demanded, for whatever reason, then the assets and liabilities of similar duration would indeed move together.
I think the basis point stands, that it was extreme leverage in various forms, including th ... view full comment
ds111,
Your point about not necessarily using mtm for regulatory purposes is well taken. Implicit in what you are saying is that liabilities are not market to market, but if they and the assets are matched, then they should be marked on the same basis as the assets. However, it is only true up to a point. If the marking down to market is due to increased default risk, then the capital may indeed be gone for any purpose. If the marking down to market is due to an increase in the market yield demanded, for whatever reason, then the assets and liabilities of similar duration would indeed move together.
I think the basis point stands, that it was extreme leverage in various forms, including the leverage implicit in securitized lending where there is zero equity capital, that led to the debacle, aided and abetted by accounting rules that condoned hiding the leverage.
I don't accept either that the fraud was non-partisan. The anti-regulatory fervor is Reaganite Republicanism. That many Dems, such as Summers and Rubin, fell in line behind it when it seemed for a time that it "worked" and that they could not do otherwise without paying politically does not change the fact that this was right-wing ideology at work. Just ask Greenspan.
Amongst all the dreadfulness, it is a minor pleasure to hear Wendy, Fox News, the American Enterprise Institute, and many other conservative thought leaders articulate how it is that markets no longer efficiently estimates value.
Amongst all the dreadfulness, it is a minor pleasure to hear Wendy, Fox News, the American Enterprise Institute, and many other conservative thought leaders articulate how it is that markets no longer efficiently estimates value.
And this, dear Wendy,is why Rush never allows an intellegent liberal past his phone screeners. His wing nut arguments can not stand up to scrutiny or debate, because they are generally fact free. Unchallenged, they sound smart. Subject them to intelligent debate and they crumble like an AIG balance sheet.
This is why talk radio is so afraid of the fairness doctrine. They know if their listeners heard both sides of an argument, they'd lose. So they just present their side and ridicule the other side. They manage to call Obama socialist and fascist in the same sentence, even though it is impossible to be both. They don't care. Its all smear and confuse. Let that logic get control of gove ... view full comment
And this, dear Wendy,is why Rush never allows an intellegent liberal past his phone screeners. His wing nut arguments can not stand up to scrutiny or debate, because they are generally fact free. Unchallenged, they sound smart. Subject them to intelligent debate and they crumble like an AIG balance sheet.
This is why talk radio is so afraid of the fairness doctrine. They know if their listeners heard both sides of an argument, they'd lose. So they just present their side and ridicule the other side. They manage to call Obama socialist and fascist in the same sentence, even though it is impossible to be both. They don't care. Its all smear and confuse. Let that logic get control of government, and you end up with the mess we're in.
A more "generous accounting" rule, my God! Haven't Eron taught Americans anything? Or should we implement the 2+2=5 principle so that the current system could survive?!
A more "generous accounting" rule, my God! Haven't Eron taught Americans anything? Or should we implement the 2+2=5 principle so that the current system could survive?!
Obviously ds111 is very bright and informed. Yes, many "culprits" exist, but not all are equally responsible. Roi makes an excellent point about the absurd accounting rules that allow the total amount at risk to remain hidden from investors; i.e, the public. With these rules corrected and in place ALONG WITH EVEN JUST SEMI-COMPETENT REGULATORY/AUDITING OVERSIGHT, AIG doesn't get over-leveraged, and this crisis is greatly mitigated.
The problem is how do we best ensure these rules get in place, and stay there? Yes, even Dems took bribes (let's call them for what they really are) in order to create/change the rules. Repubs certainly took bribes as well, and to the extent each party's "bene ... view full comment
Obviously ds111 is very bright and informed. Yes, many "culprits" exist, but not all are equally responsible. Roi makes an excellent point about the absurd accounting rules that allow the total amount at risk to remain hidden from investors; i.e, the public. With these rules corrected and in place ALONG WITH EVEN JUST SEMI-COMPETENT REGULATORY/AUDITING OVERSIGHT, AIG doesn't get over-leveraged, and this crisis is greatly mitigated.
The problem is how do we best ensure these rules get in place, and stay there? Yes, even Dems took bribes (let's call them for what they really are) in order to create/change the rules. Repubs certainly took bribes as well, and to the extent each party's "benefits" are comparable (don't ignore such "benefits" like Phil Gramm's wife on Enron's BOD, etc.) we can say the fraud was nonpartisan. However, it is a decidedly conservative plan to demonize government in order to get rid of regulation and regulators, and defer to private companies to "make the rules" and self-regulate. The real roots of the fraud - not just with AIG, but with Enron, Anderson, etc. - are very much conservative. They created the environment where companies can "go for it", and once the genie is out of the bottle, there's no stopping it. At a minimum, it's simply irresponsible (and one could argue traitorous) to demonize our own government, and it started with Reagan.
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Hello - the world's largest insurance company overseen by a backwater govt agency with one insurance expert on staff at the time? How do think that happened? Absolutely could not be that AIG went all out to convince the banking and finance committee that the no-risk line was for real - and they bought it - pun intended.
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Hello - the world's largest insurance company overseen by a backwater govt agency with one insurance expert on staff at the time? How do think that happened? Absolutely could not be that AIG went all out to convince the banking and finance committee that the no-risk line was for real - and they bought it - pun intended.
while they don't come out and say it, this implies the unraveling started when hank was forced out by spitzer. thanks eliot! any current lessons for overzealous AGs looking to occupy the governor's mansion. Cuomo, Blumenthal? Nah. would hank, who clearly had a firm grasp of the company he built, have prevented cassano from going too far? we'll never know. it takes at least two to build the perfect storm. greedy types like cassano? yes. corrupt politicians willing to shape legislation for a few bucks? absolutely. throw 'em both out!
while they don't come out and say it, this implies the unraveling started when hank was forced out by spitzer. thanks eliot! any current lessons for overzealous AGs looking to occupy the governor's mansion. Cuomo, Blumenthal? Nah. would hank, who clearly had a firm grasp of the company he built, have prevented cassano from going too far? we'll never know. it takes at least two to build the perfect storm. greedy types like cassano? yes. corrupt politicians willing to shape legislation for a few bucks? absolutely. throw 'em both out!
Because AIG was able to get a regulatory exception for CDSs, they were able operate with no capital requirements for that business. None.
The article does a very nice job of explaining why there was no internal oversight, but the company also actively skirted any external oversight. As a result not only were they operating in stealth mode, nothing they did was technically illegal. So justice is just another snowball in hell on this one.
Because AIG was able to get a regulatory exception for CDSs, they were able operate with no capital requirements for that business. None.
The article does a very nice job of explaining why there was no internal oversight, but the company also actively skirted any external oversight. As a result not only were they operating in stealth mode, nothing they did was technically illegal. So justice is just another snowball in hell on this one.
Wendy, you are completely delusional. Banks were leveraging at 35 to 1, but you want to blame mark-to-market policy for this. The private sector merely innocent victims. Keep trying to sell that, Wendy. Tick tock.
Wendy, you are completely delusional. Banks were leveraging at 35 to 1, but you want to blame mark-to-market policy for this. The private sector merely innocent victims. Keep trying to sell that, Wendy. Tick tock.
The mark-to-market rule had nothing to do with AIG's collapse. The downgrades by the ratings agencies triggered requirements built into AIG's credit default swap agreeements to post additional assets as collateral. AIG didn't have enough liquid assets to meet the collateral calls. This was purely a matter of commitments made in private contracts that AIG couldn't honor. The government had nothing to do with this, except by failing to provide adequate oversight and regulatation of the financial markets.
The mark-to-market rule had nothing to do with AIG's collapse. The downgrades by the ratings agencies triggered requirements built into AIG's credit default swap agreeements to post additional assets as collateral. AIG didn't have enough liquid assets to meet the collateral calls. This was purely a matter of commitments made in private contracts that AIG couldn't honor. The government had nothing to do with this, except by failing to provide adequate oversight and regulatation of the financial markets.
I am pondering here as to whether all recessions are caused by a bubble bursting, and what follow that bursting is a correction in the relative values of all things. The oil bubble bursts, and a Prius is worth a lot less. My point is that a market correction is usually a lowering of values.
CDS is different than most insurance. If I buy flood insurance, the only way insurance pays is if my house floods. The way AIG, and others, wrote CDS is that AIG would have to pay if there was the THREAT of a default. As the head of OTS said the other day, none of these super senior traunches has failed or actually gone into default. They have been devalued, so (because of the nature of the contract) AIG ... view full comment
I am pondering here as to whether all recessions are caused by a bubble bursting, and what follow that bursting is a correction in the relative values of all things. The oil bubble bursts, and a Prius is worth a lot less. My point is that a market correction is usually a lowering of values.
CDS is different than most insurance. If I buy flood insurance, the only way insurance pays is if my house floods. The way AIG, and others, wrote CDS is that AIG would have to pay if there was the THREAT of a default. As the head of OTS said the other day, none of these super senior traunches has failed or actually gone into default. They have been devalued, so (because of the nature of the contract) AIG has to pay. But what if AIG only had to put money in an escrow account? The French and German banks using the CDO for capital purposes could still say their capital positions have not changed.
If my neighbors down the hill flood every 5 years, maybe that lowers the market value of my house if I want to sell it, but my insurace company does not pay up.
The whole idea that you can eliminate risk is foolish. All you can do is disperse it, or foresee the risk and build your house further up the hill.
Mark to market is more honest pricing of an asset than mark to model, but is it accurate? Maybe honesty was introduced too abruptly, maybe we should have eased into mark to market, and the bubble would have slowly deflated without all the collateral damage.
As for Obama "firing" Rick Wagoner, he had no authority to do that. He had every authority to have one of his people ask Wagoner to resign, and if Wagoner refused, go to the GM board and say, we have no faith that Rick Wagoner will turn this around. Your company was given until March 31 to present a viable plan for turnaround. You were told that absent that viable plan, we would stop federal financial support. Your plan, according to industry experts, is not even close to viable. Keep Rick Wagoner if you want, but we would be foolish to continue federal support when we have no faith in him or the board.
So, when presented with a request to resign, Wagoner could have said no. If he did that, either the board was going to fire him, or GM was going Chapter 11. In any of those cases, he would have lost his job shortly.
Wendy,
So how does mark-to-make-believe make their bad bets any less stupid?
Wendy,
So how does mark-to-make-believe make their bad bets any less stupid?
The "focus de jour" seems to be "greedy", or "aggressive" management. Yet that temperment exists in all corporations as a matter of fact, to some degree or another. I think that we have exhausted the "greedy capitalist" theory. Rather, some common sense needs to be injected here. Credit swaps have been in existence for some time now. I remember pricing some when I worked for Kidder Peabody in the early 90's. there is nothing extraodinary about it...risk is evaluated and the hedging of that risk is priced. This goes on daily in our active markets (e.g. listed options, futures, etc.). So Why did THIS situation blow up? Could it be that the data passed on to AIG was invalid, and inaccur ... view full comment
The "focus de jour" seems to be "greedy", or "aggressive" management. Yet that temperment exists in all corporations as a matter of fact, to some degree or another. I think that we have exhausted the "greedy capitalist" theory. Rather, some common sense needs to be injected here. Credit swaps have been in existence for some time now. I remember pricing some when I worked for Kidder Peabody in the early 90's. there is nothing extraodinary about it...risk is evaluated and the hedging of that risk is priced. This goes on daily in our active markets (e.g. listed options, futures, etc.). So Why did THIS situation blow up? Could it be that the data passed on to AIG was invalid, and inaccurate? I posed this question to a friend of mine in the bowels of AIG. While he was not involved in the pricing, he saw no reason that such a problem could not have existed. I have also contacted a professor who posted a column in the Wall Street journal about derivatives, and she did not see why that could not have contributed. She did say that the aggragation was the main factor in the collapse, but if you belive the data that the Government was passing on to be true, why should there NOT be aggregation? I maintain that the bogus books generated by FANNIE MAE and Freddie Mac were the source of the bad pricing of the swaps. Otherwise, if it was purely greed, this would have been evident across all swaps issued. And to the best of my knowlege that is not the case. No, the same greed that got Mr. Raines thrown out of FNM and fined $400MM contributed to the bad numbers that AIG used to price and issue the CDOs and swaps. As of yet, the only greed anyone wants to discuss is corporate greed, not "municipal greed". Until we get our heads out of the sand, we are cursed to repeat our mistakes; or at least allow the crooks in the House and Senate to repeat their mistakes.