Authors: William D. Cohan
On December 5, still in denial, Martin Sullivan and Joseph Cassano gave an Oscar-worthy performance on the investor conference call related to AIGFP’s credit-default swap portfolio—and made no mention of Pricewaterhouse’s comment. “AIG has accurately identified all areas of exposure to the U.S. residential-housing market,” Sullivan said that day. “We are confident in our markets and the reasonableness of our valuation methods.” Added Cassano, in yet another moment of profane understatement: “It is very difficult to see how there can be any losses in these portfolios.” Cassano made no mention of the disputes AIGFP was having with Goldman, and presumably some of the other counterparties, about the posting of collateral. “We have, from time to time, gotten collateral calls from people,” Cassano said at the meeting, according to the transcript. “Then we say to them, ‘Well, we don’t agree with your numbers.’ And they go, ‘Oh.’ And they go away.”
A week later, after a collateral call that came from
Calyon, the big French bank, Tom Athan wrote to a colleague, “We are in uncharted waters for our firm. I realize that. I’ve been on [Wall Street] for 17 years, mostly in new derivatives businesses so I know how it goes. We’ll all get better together. Takes time unfortunately.”
On December 14, Forster again tried to get AIGFP’s money back from Goldman. He wrote
Neil Wright, at Goldman Sachs International, that “Given the significant amount of collateral in dispute that is held by Goldman, we expect either that you now return to us the amount of the
collateral that we have called for, or that you continue next week to engage actively and constructively with us in discussions with us toward resolving the dispute. It would not be appropriate to delay the discussions at this stage.” But the discussions were delayed further by the holidays. Before Christmas, Cassano wrote both Sherwood and Viniar, Goldman’s CFO, that he appreciated getting Goldman’s pricing information from the firm on the various securities but even on a preliminary look he could tell the Goldman prices were too low, compared to the rest of the Street. “[I]t’s already evident that your exposure calculations are significantly higher than is warranted by third party indications that you yourself have provided to us,” Cassano wrote, adding, “You currently hold $2 billion of collateral for these positions, which is demonstrably in excess of what is contractually required.” He told the Goldman executives he wanted to resolve the matter early in January.
Cassano was also continuing to feel pressure from Tim Ryan, at Pricewaterhouse, who wanted to get to the bottom of why Goldman’s marks were consistently lower than those of other dealers. Cassano told the FCIC that Ryan was “like a dog with a bone” and that he could never figure out why Ryan “held Goldman in such high esteem.” On December 18, Ryan visited Cassano in his London office. According to Cassano, Ryan told him that he wanted to go see Goldman himself to discuss the marks so that he could figure out how Goldman derived them. Cassano was incredulous. Not only was Pricewaterhouse also Goldman’s auditor—a potential conflict of interest—but also Cassano could not imagine his auditor going to see Goldman and essentially announcing that he did believe his client’s marks and wanting to see how Goldman had figured things out. “You will undermine my negotiations with them,” Cassano said he told Ryan. “You can’t do that.” Cassano said he suggested that Ryan simply talk to the Pricewaterhouse partner on the Goldman audit account to get the comfort he was seeking. But Ryan was insistent that he wanted to talk to Goldman directly. When Cassano asked him why, Ryan said simply, it’s “good audit procedure.” In the end, Cassano succeeded in keeping Ryan away from Goldman.
By early 2008, AIGFP executives were busy scrambling to make sure they had a response to Pricewaterhouse’s growing concerns. At the January 15, 2008, Audit Committee meeting, there was much discussion about whether proper controls existed to monitor independently the valuation of the AIGFP portfolio. According to minutes from the meeting: “Mr. Habayeb believes that he is limited in his ability to influence changes, and the super senior valuation process is not going as smoothly as it could. Mr. Ryan said that the control functions are not included in
the ongoing process and lose the ability to participate in discussions of the issues. He added that roles and responsibilities need to be clarified, and pointed out that collateral issues could have been escalated to the AIG level earlier in the process.”
The next day, Cassano again wrote Sherwood and Viniar. “We believe that your current exposure calculations are too high,” he wrote, not surprisingly.
On February 4, at a meeting between the Pricewaterhouse auditors and AIG executives, including Cassano, PWC again broached the idea that there could be a “material weakness” at AIGFP. Cassano told the FCIC that Sullivan and the other senior AIG executives were “gobsmacked and stunned” by the news, although this was clearly not the first time the matter had been discussed. On February 6, the “case” Tim Ryan had made to the Audit Committee about the potential for a “material weakness” at AIG caused Cassano to inform his AIGFP colleagues of a potential problem. “[T]he [AIG] team is now trying to determine whether they have been officially served the notice such [that] they need to file an 8K,” Cassano wrote to the AIGFP team, referring to a document filed with the SEC that releases important corporate news publicly in between quarterly filings. He wrote, “Apparently a material weakness finding creates a need for an immediate 8K,” seemingly oblivious to the fact that the original warning had come on November 29. He then went on to write about other concerns with the monitoring. “Quite a mess,” Cassano concluded. Five days later, AIG announced that as of December 31, 2007, Pricewaterhouse believed AIG “had a material weakness in its internal control over financial reporting and oversight relating to the fair value valuation of the AIGFP super senior credit-default swap portfolio.” That announcement, naturally, increased the pressure from counterparties and justified, according to Cassano, “new calls from our counterpart[ie]s stating that they can no longer accept our pricing methodology,” which had “weakened our negotiation position as to collateral calls.”
On February 28, AIG released its full-year 2007 financial results and announced that those numbers included a charge of $11.47 billion related to unrealized losses from the AIGFP swap portfolio. On March 1, Sullivan announced Cassano’s departure from the firm “with our concurrence.” In the preceding eight years, Cassano had received more than $280 million, according to Representative
Henry Waxman, and was allowed to keep “up to $34 million in unvested bonuses” after his departure. He remained a consultant to AIG for six months thereafter, at a cost of $1 million per month.
On August 18, a week or so after AIG announced more bad earnings,
Goldman’s well-regarded research analyst on AIG,
Thomas Cholnoky, issued a report with the advice “Don’t Buy AIG,” citing the risks to shareholders from “likely” further rating agency downgrades and capital-raising activities that would dilute shareholders. Among the reasons Cholnoky cited for his report was the potential for an increase in collateral calls. He made no mention of the fact that Goldman itself was leading this charge and had been for about a year. (In an interview, he said he did not know about Goldman’s ongoing collateral calls to AIG.)
The final nail in AIG’s coffin came from another questionable decision made under Sullivan’s leadership: taking the cash generated when institutional investors, seeking to sell securities short, borrowed stock from AIG’s massive $800 billion investment portfolio and invested it in what turned out to be high-risk mortgage securities. “There’s no sense lending [the securities] to [other dealers] unless you’re going to take the cash and invest it someplace and earn a spread,” explained one AIG former executive. “That’s what a AAA rating is for.”
But what should have been invested in liquid, low-risk securities like Treasury bonds went instead into the illiquid mortgage market. At one point, AIG had converted some $60 billion of the cash it had received from other dealers into mortgage-related securities. “It scared the shit out of me,” said one AIG executive. “My first reaction was, ‘What happens if all those guys come back and say, “We want our money back. Here’s your damn securities, give us our cash back.” ’ All the cash had been put into securities that are now twenty-five, thirty percent underwater. If they were
government securities, we could turn around, sell them tomorrow, and give them their money back. Well, we had securities that you couldn’t sell to anybody.” By the late summer and early fall of 2008, borrowed stock was flooding back to AIG and investors were asking for their cash back, further exacerbating AIG’s cash crunch. Buried on the last page of Cholnoky’s August 2008 report was his concern about AIG’s securities lending business. “[D]ue to AIG’s aggressive investment strategy into riskier classes, the current market value of the assets stood at $59.5 billion as compared with liabilities of $75.1 billion,” he wrote, noting that AIG had agreed to post collateral to make up for these losses.
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HOLNOKY’S REPORT BROKE
the camel’s back once and for all. On September 16, 2008, the federal government poured $85 billion of taxpayer money into AIG to keep it from falling into bankruptcy as Lehman Brothers had only hours earlier, and in effect took over the company. AIG eventually turned around and paid out $62.1 billion to sixteen counterparties to fulfill its collateral obligations related to credit-default swaps
AIGFP had sold. Second on the list, according to TARP special inspector general
Neil Barofsky’s November 17, 2009, report about AIG’s counterparties, was Goldman Sachs, which received $14 billion, or everything AIG owed it at 100 cents on the dollar (
Société Générale, a French bank, came in first with $16.5 billion, some of which was then paid over to Goldman, according to the
New York Times
.) There has never been a good explanation of why the money was paid out or why the Fed paid the counterparties 100 cents on the dollar when they surely would have received much less, if anything, had AIG filed for bankruptcy. Indeed, the
Federal Reserve Bank of New York unsuccessfully tried to negotiate discounts, known as haircuts, with the counterparties. “Seven of the eight counterparties told [the New York Fed] that they would not voluntarily agree to a haircut,” Barofsky wrote in his November 2009 report. “The eighth counterparty,
UBS, said it would accept a haircut of 2 percent as long as other counterparties also granted a similar concession to [the New York Fed].” For his part, Cassano told the FCIC that taxpayers would have been far better off if the counterparties had not been paid off at all and if the Fed just held on to the original credit-default swaps. “What I look to is the performance,” Cassano testified in 2010, “and to see if anything has been pierced. Now we’ve gone through obviously one of the worst financial crises in anybody’s lifetime. And as we move through this and we come through the financial crisis, the only thing I can do is look at the existing portfolio and say that it is performing through this crisis, and it is meeting the standards that we set. And I think our reviews were rigorous. I think the portfolios are withstanding the test of time in extremely difficult circumstances.”
Furthermore, according to a September 2009 report from the U.S. Government Accountability Office, “AIG’s securities lending program continued to be one of the greatest ongoing demands on its liquidity” even after the September 16 bailout. As a result, the Fed created a vehicle dubbed
Maiden Lane II and funded it with $24 billion to purchase from AIG the most troubled residential mortgage-backed securities it had bought with the cash received from the securities lending program. As of June 2010, AIG owed $16 billion on this credit facility, which Cassano at least took as a sign that AIGFP’s underwriting standards had held up. Not everyone, though, agreed with Cassano’s self-congratulatory stance. “Of all the events and all of the things we’ve done in the last eighteen months, the single one that makes me the angriest, that gives me the most angst, is the intervention with AIG,” Bernanke said in March 2010 on the television program
60 Minutes.
“Here was a company that made all kinds of unconscionable bets. Then, when those bets went wrong …
we had a situation where the failure of that company would have brought down the financial system.”
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CCORDING TO ONE
internal Goldman report, Birnbaum’s desk made $947 million in the fourth quarter and $3.738 billion for the fiscal year 2007. Birnbaum said his trading made Goldman $4 billion in profit it otherwise would not have had. And had the VAR police been less demanding, he said he believes he could have made two to three times more profit, or $8 billion to $12 billion instead of $4 billion. “More Paulson-like,” he said. “He didn’t cut back. He went for it.” Birnbaum said the losses Goldman suffered in 2007 from writing down its long mortgage positions was more than $1 billion, but significantly less than the $4 billion his desk made. “The net result for the mortgage department in 2007 was a record year,” he said. “Think about that statement: making a record amount of money in a year when everyone else was losing their shirts.” The firm could also boast of its trading and risk-management prowess—which it certainly did—and then was able, in September 2008, to attract a $5 billion preferred stock investment from
Warren Buffett.
Months later—as the spotlight began to focus on Goldman in the wake of the AIG counterparty payments—the senior brass at Goldman preferred to spin Birnbaum’s success differently. Viniar said the decisions to occasionally reduce Birnbaum’s short positions in 2007 cost the firm only around $200 million, not the billions of dollars in lost profits suggested by Birnbaum. But he did concede, “
They were one hundred percent right. I was one hundred percent wrong.” The Goldman perspective was, essentially, that the firm provided Birnbaum the capital he used to execute “the big short” and that he was good at executing the directive. But the opportunity Birnbaum seized at Goldman existed, in large part, because of the emphasis the firm placed on marking to market and because of the existence of Goldman’s long positions in mortgage-related securities the firm wanted either to sell or hedge. Without that preexisting condition, Birnbaum would not have found a receptive audience at the executive levels of the firm.