Guest Post: Deciphering Joe Cassno's Lies Before The Financial Crisis Inquiry Commission
Submitted by David Fiderer
Deciphering Joe Cassno's Lies Before The Financial Crisis Inquiry Commission
Joe Cassano is a very good liar, which is why it would be so hard to
prosecute him for perjury. When testifying before The Financial Crisis
Inquiry Commission, the former head of AIG Financial Products kept
blending in half-truths with his audaciously dishonest claims, so that
the overall effect was nonsensical. For instance, to justify his
outrageous claim that, "the books were generally considered fully
hedged," he explained that "we were using it basically in actuarial
basis ...[so] it's not hedged in the conventional sense." (Translation:
The book was never hedged in any sense. Nor was there any actuarial
analysis, only a reliance on triple-A credit ratings.) These rhetorical
tricks were designed to throw sand in everyone's face. But his tactics
seem to have worked. The staunchly unregenerate Cassano framed a media
narrative that deflected away from his dishonesty and gross
Here's a reality check on some of his more ridiculous claims, in
order of appearance:
1. Cassanos's Claim: AIGFP never compromised its high
The Truth: AIGFP had no underwriting standards pertaining to the most
important risk, which affected AIG's liquidity.
Commission Chairman Phil Angelides asked Cassano if he understood the
subprime risks he insured. Cassano stonewalled with a lot of
Angelides: I want to talk to you about this, that these were
represented as multisector CDOs. But if you look at -- we did a sample
of some of these in 2004, 2005, 2006, they were almost overwhelmingly
residential-backed and very substantially subprime. For example, in the
survey we did of some of these CDOs that you issued protection on, 84
percent were backed by RMBS residential mortgages in '05, 89 percent in
'06. And just as an example, while you indicated you decided to stop
writing on subprime instruments in January of '06, for example, you
backed an instrument called RFC III where that CDO was 93 percent
subprime and seven percent HELOC home equity loans.
My question for you, Mr. Cassano, is was there -- you said you did
thorough due diligence. Were you aware of the quality of the mortgages?
Do you do direct analysis of the loan data? Were you confident that you
had a full understanding of the nature of what you were backing?
Cassano: Chairman Angelides, the numbers that you are referencing in
these portfolios, I don't know specifically. I'm happy to look at them
again and go through that with you.
Reality Check: Cassano insults everyone's
intelligence by refusing to admit that he insured tens of billions of
dollars of toxic investments that were primarily comprised of
subordinated tranches of subprime mortgage securities. The CDOs that
caused the collapse of AIG were no more "multi-sector" than the
government of Iceland is multiracial. His unwillingness to acknowledge
the obvious truth is a rhetorical device intended to cast doubt and
cause confusion among listeners and the media.
Cassano: But I think to answer your question more directly,
we never diluted our underwriting standards at any point in time. We had
rigorous standards, standards set by the AIG credit risk management
that we then employed in underwriting these transactions.
Reality Check: Cassano said he would answer
the question "directly" and then didn't. The question asked whether he
personally understood the risks associated with the subprime mortgages
embedded within the CDOs. It wasn't about what "we" did, and it wasn't
about some dilution or non-dilution of some undefined underwriting
standards that may have had nothing to do with subprime risk.
What remains indisputable is that there were no standards for
protecting AIG's liquidity. AIGFP was in the business of trading
derivatives. The liquidity risk, pertaining to collateral postings, was
never even considered when these deals were approved. It sold $78
billion worth of long-term credit default swaps that were unhedged. As
part of those swap agreements, AIGFP agreed to post margin, or cash
collateral, without ever attempting to define the basis by which those
collateral postings would be calculated. The stupidity of Cassano and
other top managers at AIG cannot be overstated. They operated like an
11-year-old driving a motorcycle. The current chief risk
officer at AIG explained:
Angelides: Mr. [Robert E.] Lewis, you are the chief risk
officer. Anything you want to add to this?
Lewis: I would state that the risk issues that were the focus of the
attention at AIG were around the actual credit risks in the underlying
portfolios. And our -- the rigorous work that we did together with FP
was to determine what the likelihood was of suffering credit losses
through defaults and losses in the underlying mortgages.
The liquidity aspects were something, quite frankly, just didn't
focus on to the extent that we now know we should have. The -- these
instruments up until the time of the crisis had traded in very narrow
bands, highly liquid AAA securities, until the crisis occurred when they
traded off quickly and then there was no market. So --
Angelides: But were you -- but you -- were you aware that there was a
liquidity provision, you weren't, were you?
Lewis: No, I was not until --
Angelides: All right.
Lewis: -- till the date I just testified. [i.e. July 2007, several
years many of the deals were booked]
Reality Check: Lewis, like Cassano, had no idea what
he was doing. Every trader, every junior risk analyst, every deputy
assistant treasurer with the most minimal level of competence knows the
dangers of selling an unhedged derivative. You can lose money when the
swap terminates, and you can lose liquidity before the swap terminates.
The longer the tenor of the swap, the bigger the risk. This isn't some
honest mistake, some detail that could ever be overlooked. A financial
company depends on liquidity the same way that a mammal relies on oxygen
to stay alive. Lewis acted like the traffic cop who looks at cars in
the left lane and ignores the vehicles in the right lane. The only
plausible explanation why Lewis still has his job is that the AIG does
not want to expose more dirty laundry.
Their stupidity was compounded further their willingness to post
collateral based on the "market value" of the CDOs. Lewis's claim that
"these instruments up until the time of the crisis had traded in very
narrow bands, highly liquid AAA securities, until the crisis occurred,"
is further demonstration of his cluelessness and/or dishonesty. The
triple-A tranches of these CDOs didn't trade. Why would they? AIG had
assumed virtually all the credit risk in the most senior tranches.
These CDOs never had an ascertainable market value based on comparable
sales or industry benchmarks, according to PriceWaterhouseCoopers, AIG's
auditor, and Deloitte & Touche, Maiden Lane III's auditor. Both
accounting firms designated the CDOs as Level 3 assets, explained here.
Another level of stupidity was their disregard how residential
mortgage-backed securities work. These mortgage bonds are valued
according to the credit losses that are expected in the future,
not according to the actual losses that have already been recognized.
It takes a long time, typically about a year, to recognize an actual
loss on a loan after the borrower first becomes delinquent. Usually, a
notice of foreclosure is first presented after the 90-day delinquenciy
period has passed, later, the lender commences a procedure whereby it
"buys" the residence, and then the property sits on the market until it
is sold to partially pay down the loan. Because of the time lag, you
need to be concerned about paying cash margin long before the final
tally of actual losses on a mortgage pool. Goldman had always understood
this; Cassano's people didn't. Cassano and his management team, who
were in the business of trading derivatives, didn't know squat about
Because AIG never understood the risks it was taking on, it agreed to
contract language that gave Goldman and other CDO banks the opportunity
to jerk the company's chain indefinitely. Since the valuation of the
CDOs could be debated endlessly, there was an ongoing risk that, at any
given moment, Goldman could declare its unmet demands for cash
collateral to be an event of default. One default can quickly trigger a
series of cross-defaults forcing a bankruptcy. This was why the rating
agencies told AIG and the New York Fed that the contingent liabilities
tied to these CDOs needed to be removed no later than November 10, 2008, or AIG would suffer further
2. Cassano's Claim: The CDOs held by Maiden Lane III
performed in line with his expectations.
The Truth: The CDOs performed in line with the $35 billion write-down
taken by AIG when Maiden Lane III was created.
Cassano: [M]any of these multi-sector CDOs that we did
now reside in Maiden Lane III...And to date that vehicle is performing. I
think, you know, I'm sure the commission knows the statistics, the
federal government lent that vehicle $24 billion. To date that vehicle
has repaid $8 billion through the performance of these transactions.
And as far as I can see from where I sit when I look at the portfolio
residing in Maiden Lane III, I don't know -- I don't think any of the
transactions have pierced the attachment levels that we had set in our
underwriting standards... 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 it's not the credit risk here that eventually became the issue at
hand. These -- my point has been that the underwriting standards and the
credit risk within these transactions have, to date, been supported and
Reality Check: To recap simply, Cassano insured the
CDOs acquired by Maiden Lane III for $62 billion. AIG had paid out $35 billion in cash collateral to
the CDO banks before Treasury and the New York Fed began negotiating
with the banks. When Maiden Lane III paid the banks an additional $27
billion to acquire the CDOs and tear up the credit default swaps, AIG
recognized a loss of $35 billion. Deloitte & Touche valued the CDOs
at $27 billion on December 31, 2008, and that value more or less
held steady as of December 31, 2009. Cassano wants to make it sound
as if the CDOs' performance, after recognition of the $35 billion loss
created by him, somehow validates his own reckless performance.
When Cassano said, "the only thing I can do is look at the existing
portfolio and say that it is performing.." it became obvious that he was
lying. Cassano can't look at the performance of the CDO portfolio
because he no longer works at AIG and the performance reports on all CDO
portfolios are kept secret. The reports are only disclosed to actual
investors of CDOs, who are bound by nondisclosure agreements. (The
reports are still kept secret in order to protect the banks and rating
agencies from lawsuits.) Cassano was blowing smoke in everyone's face;
he has no idea whether these deals have "pierced the attachment levels,"
i.e. crossed the loss threshold when a credit default swap provider
must pay out. Again, any half-wit in finance understands the idea of
discounting future expected losses to present value.
3. Cassano's Claim: His books were fully hedged.
The Truth: They were never hedged.
Commissioner Brooksley Born: With respect to your portfolio
as a whole, did you hedge any parts of that portfolio?
Born: Which parts?
Cassano: Much of that...But we ran -- you know, nothing is 100
percent hedged, but the books were generally considered fully hedged.
Born: Well, let's look at your credit derivatives portfolio. I think
there was something like more than $560 billion in notional amount of
credit derivatives in your portfolio in 2007. Were you actually hedging
in the conventional sense or were you relying on tranching and the
level at which you were insuring? I want you to answer as to whether you
were hedging the way you were hedging your interest rates by taking
Cassano: Perhaps the best way to delineate this is that the super
senior credit derivative book, which is the book you're -- the super
senior credit derivative book globally, which is the book you're
referencing, had $560 billion. We were using it basically in actuarial
basis in order to secure that business. So it wasn't -- it's not hedged
in the conventional sense that you're talking about buying and selling
interest rate risk.
Reality Check: Cassano went Orwellian,
labeling his unhedged portfolio as "hedged" the in the same manner that
East Germany called itself the German Democratic Republic. Every hedge
has two offsetting positions. A single position is always unhedged,
period. The distinction between a hedged position and an unhedged
position that you deem to be low-risk is as big as the Grand Canyon. A
hedge protects you against a market shock, when the markets freeze or
act in an unexpected manner. A "low-risk" unhedged position has no such
protection. Of course, the "actuarial basis" that Cassano relied upon
was also bogus.
4. Cassano's Claim: The risk exposure on the credit default
swaps was managed on an actuarial basis.
The Truth: They took $78 billion worth of unhedged exposure based on the
CDOs' triple-A ratings.
The "actuarial basis" by which these CDOs were evaluated was AIG's
secret financial model developed by Professor Gary Gorton of Yale. It
was one of those "Monkey-See-Monkey-Do" models that regurgitated credit
ratings but tested nothing. The truth was revealed by Andrew Forster,
the former CFO of AIGFP, in testimony given on July 1, 2010. The
questioner was Commissioner Peter Wallison:
Wallison: So the Gorton model now evaluated the risk of loss
on super senior portions of these CDOs. Did the model evaluate the
assets or the composition of the assets in the CDOs?
Wallison: So it just -- let me go on a little bit further then and
ask -- so in your testimony you said that in the summer of 2005 you
began thinking more about the multisector CDOs, and you began to
question whether the modeling that was needed -- the additional analysis
of deals -- was sufficient, or were they sufficiently taking account of
interest-only loans? I think that's how you phrased it in your
Were you then beginning to ask whether the model was actually looking
at the underlying loans and how it was functioning at that point?
Forster: I think -- just to take a step back, if I may -- the --
through any business that we did, it always made sense to take a step
back at different times and question the assumptions that we were using
in any of it. And I think that's -- that's what we did in July 2005.
Some of the questions that I posed at that time, we probably knew the
answers to. Others of it was just reinforcing the assumptions that we
At the time, what we wanted to do was -- the model is obviously only
as good as the inputs that you put into it -- we wanted to make sure
that the underlying loans, underlying reference obligations, we were
still comfortable with those and we still felt they -- you know, the
ratings and things like that reflected the risk that was inherent in it.
Wallison: Let me see if I understand correctly. The model did look at
the underlying loans, the kinds of loans that were being made. And when
you were talking about interest-only loans, for example, those were
taken account of in some way in the model, so that if the model was made
up of 95 percent interest-only loans, the model would have reflected
the risk associated with that? Is that correct?
Forster: It's not quite correct, I think --
Wallison: Good. Please correct me.
Forster: Sorry. The underlying ratings of the obligations -- if you
had the subprime obligation -- if it was all interest-only or heavily
concentrated in certain areas, then the rating of that obligation would
reflect that. So if it was all interest-only, the rating agencies would
see that as more risky. It would likely then get a lower rating. The
model would just take the rating of the instrument.
Wallison: Oh, so the model relied on the rating agencies?
Forster: Yes, the model -- I mean, to a large extent. We made
additional changes to it and we stressed the rating agency's assumptions
and we checked that we we were comfortable with the rating agency
ratings. But the model basically uses the ratings of the underlying
To clarify further, if you let the bogus triple-A ratings define the
range of possible outcomes, a "stressed" scenario is meaningless.
5. Cassano's Claim: His people did not rely on the rating
agencies to evaluate the risk.
The Truth: They sure did.
Cassano: We did a fundamental analysis of the transactions.
My team reviewed the underlying portfolios and the underlying assets
within the portfolios directly. So we were not reliant on the rating
agencies to tell us what was good or bad in these portfolios.
Reality Check: See 4 above. This is how a liar defends his
lies with more lies.
6. Cassano's Claim: He arranged the CDOs to benefit from
The truth: The opposite is true. Cassano insured the senior tranches of
CDOs compiled of deeply subordinated claims of risky subprime mortgage
Cassano: I think what you need to look at within these
transactions is the underwriting standards that we committed to, to do
these transactions. I've heard this phrase that it's a one-sided bet.
But when you think about the protections that we built into the
contracts through the subordination levels, through the structural
supports that we built into the contracts and then through this very,
very strict underwriting standards we performed, it -- this was
extremely remote risk business.
Reality Check: Any residential mortgage asset that
was not initially rated triple-A is deeply subordinated, at the bottom
20% of the capital structure. The deeply subordinated tranches of subprime mortgages were
packaged into CDOs, with senior tranches that were rated triple-A
and insured by AIGFP. Structural seniority in a CDO only indicates that
you're better off than the suckers beneath you. It's like having the
top bunk in steerage on the Titanic.
7. Cassano's Claim: The New York Fed handed over $40 billion
to the CDO counterparties.
The Truth: He inflated the number by 50% to give the false impression
that most of the cash had been paid out at the initiative of the New
Cassano: For the credit default portfolio the federal
government paid $40 billion. But one of the things I wonder about when I
look at that is I've never understood why the $40 billion was
accelerated to the counterparts. Now, I haven't been involved in that
and I'm only looking at it from afar. But when I think about the
contractual defenses and the contractual rights we had in the contracts,
it has caused me to scratch my head and ask why was it that $40 billion
was accelerated to the counterparts.
Reality Check: A lying liar lied about the
dollar amount paid by the New York Fed, and about the criteria that
drove negotiations. The CDO counterparties received $35 billion, paid out by AIG before it allowed the New York Fed
to take the lead in negotiations, on Thursday November 6, 2008, well
past the point when there was time to negotiate anything. There were no
clear-cut contractual defenses because there were no clear standards for
calculating collateral. The rating agencies told AIG, Treasury and the
Fed that AIG's failure to remove the contingent cash calls from the CDOs
by Monday November 10, 2008 would cause them to
further downgrade the company, and thereby precipitate a bigger
liquidity crisis from collateral calls imposed by AIG's ratings
triggers. Cassano acts like Heinrich Himmler critiquing the Marshall
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