All the Devils Are Here [118]
Cassano had learned the derivatives trade from the ground up, having begun his FP career in the back office. In the late 1990s, when the London office was floundering, Savage moved him there to fix the situation. He did, making London his home and traveling to the Connecticut office one week a month. When AIG-FP first began selling credit default swaps, Cassano ran the business. He may have lacked a degree in high finance, but nobody could say he didn’t know derivatives.
He also cared deeply about the business. His former employees all stress that as well. Whenever an executive said a deal couldn’t be done because of some deficiency with FP, Cassano would respond with fury. “He took that kind of thing personally,” says a former trader. “In his eyes, you were blaming his company for why you were ineffective.” In his mind, FP had no deficiencies. Cassano’s devotion to FP was also why his former colleagues all say that he would never, ever do anything that he thought might damage it. Which, in retrospect, was the most surprising thing about him. Joe Cassano was positively risk averse.
Ever since Howard Sosin’s departure in 1993, Greenberg had insisted that FP executives defer half their compensation to protect against deals later going sour. Cassano himself went much further. In 2007, for instance, he was paid $38 million, but pulled out only $1.25 million, keeping the rest in his deferred compensation pool. He had no incentive to take foolish risks. Whenever FP devised a new product, he took it to Greenberg to get the CEO’s blessing. He made traders pull back from positions he thought were becoming too risky. “The company took minimal risk,” says one former trader. When deals were brought to him, Cassano would pick them apart, looking for hidden risks. “He would say, ‘Be careful out there. Don’t take big positions,’” recalls the former trader. “He wasn’t a cowboy.”
“It was an extremely well-run business,” this trader continues. “But there was one blind spot.”
The blind spot was AIG-FP’s credit default swap business. Ever since that original BISTRO deal with J.P. Morgan, FP had created a profitable niche by taking on the risk of insuring the super-senior tranches of CDOs. These were the top-tier, triple-A tranches, the ones that got hit only if all the lower tranches got wiped out. Although it had been a sexy little business in the beginning, with innovative deals and healthy margins, it had become fairly humdrum. For the first four or five years, the credit default swap business was focused primarily on corporate credits—first writing protection against the possibility that a particular company’s debt might default, and then insuring the super-senior tranches of CDOs that were primarily made up of corporate loans. But as competitors entered the business, the spreads narrowed and the profits dwindled. Soon, FP’s traders were looking for new ways to use credit derivatives to make money.
FP found several things. It created a business aimed at helping banks—primarily European banks—evade their capital rules. AIG-FP sold credit default swaps to banks that held a variety of highly rated paper; the FP wrap, as it was called, allowed them to decrease their capital. There was nothing illegal about this; seeking “capital relief” had become widespread ever since the adoption of risk-based capital standards. Nor did FP hide what it was doing. It called the business—appropriately enough—“regulatory capital.” By the time of the financial crisis, AIG-FP had insured around $200 billion of highly rated bank assets.
And in 2004, AIG-FP began selling credit protection on triple-A tranches of a new kind of CDO, called a multisector CDO. In this, AIG-FP was following the evolution of the CDO business itself, which had gone from BISTRO—a CDO made up of one bank’s corporate loan portfolio—to CDOs that consisted of disparate corporate credits, to this new multisector CDO. Multisector CDOs were “highly diversified kitchen sinks,” as one FP trader put it, that included everything from student loans to credit card debt to prime commercial real