All the Devils Are Here [126]
Nor did the credit default swap deals slow down after Greenberg left. Although the business had its best quarter ever in late 2004, its second biggest quarter was in the spring of 2005, after Greenberg’s departure. From $50 billion in 2004, the business ballooned to $110 billion by the end of 2005, according to the Congressional Oversight Panel. (By September 2008, when AIG was bailed out by the government, the exposure had been reduced to $60 billion.) Though it was still a small portion of AIG’s $2.7 trillion derivatives book (in notional value), the run-up was startling nonetheless. And Frost wasn’t the only one putting the pedal to the metal now that Greenberg was gone. The securities lending program also went into overdrive, and the mortgage insurance unit threw caution to the wind. The whole company, it sometimes seemed, was doubling down on subprime mortgages.
At both FP’s and AIG’s headquarters, the increasing number of multisector CDO deals was not viewed with alarm. On the contrary, Frost was seen as a hero. The downgrade to double-A had hit AIG-FP hard—it had to unwind billions of dollars worth of complicated transactions that had been dependent on the triple-A rating. A large part of the FP staff spent 2005 either unwinding deals or dealing with the restatements. Neither activity put money in the till. Frost’s multisector CDO business was something everyone else at FP could be happy about.
Which is also why Cassano decided in the fall of 2005 that the time had come to give Al Frost a promotion. At the same time, he decided to put Gene Park in charge of the multisector wrap business.
Park, however, wanted nothing to do with multisector CDOs. By then, he had done a little experiment. He had asked some people involved in the FP business to guess the percentage of subprime mortgage-backed securities in some of the recent CDOs that FP had wrapped. Most of them had guessed it was around 10 percent. Then he asked one of them to look up a few recent deals. What he found was stunning. The percentage of subprime securities in the CDOs wasn’t 10 percent—it was 85 percent! Without anybody at FP noticing, the multisector CDOs had become almost entirely made up of risky subprime securities.
Seriously worried, Park took his concerns to Andrew Forster, one of Cassano’s chief deputies in London, who had begun to have thoughts along the same lines. The two men then made the rounds of the Wall Street underwriters to better understand the collateral. What they heard was not comforting. The firms all acknowledged that the credit histories were not very good—but they all insisted it was okay because historically, housing prices only went in one direction: up. As long as that was the case, homeowners would be able to refinance and repay the debt.
Park and Forster both knew this was a terrible rationale. The collateral, clearly, was unsound. The supposed diversification benefits of having a variety of credits in a multisector CDO had disappeared. They knew they needed to get out of the business.
And yet, how to break this news to Cassano without having him blow his stack? How to explain that this seemingly great business was exposing the firm to enormous risks that no one had been aware of? They couldn’t. Park himself never spoke to Cassano, but Forster decided that the best way to approach him was to say that the business had changed and the underwriting standards were deteriorating. “We’re comfortable with the portfolio today, but we’re not comfortable going forward,” Forster told Cassano, according to several former FP executives. “They were afraid to say they had made a mistake,” adds one of them. “They couldn’t admit to that.” After listening to Forster