Confidence Game - Christine Richard [104]
Mahoney wasn’t the only one fielding questions about triple-A-rated securities. American International Group (AIG), the world’s biggest insurance company, was also faced with questions about its massive amounts of guarantees on super-senior CDOs during its second-quarter conference call on August 9. Investors and analysts were concerned about a unit called AIG Financial Products (AIGFP), a small operation headquartered in London, which specialized in guaranteeing CDOs using credit-default swaps. AIG, like the bond insurers, guaranteed these securities at the super-senior level and, also like the bond insurers, it insisted that it did not foresee making any payments on these exposures.
On the call, Goldman Sachs analyst Thomas Cholnoky asked just how bad things would have to get before AIG would take losses on these super-senior exposures. “It is hard for us, without being flippant, to even see a scenario within any kind of realm or reason that would see us losing $1 in any of those transactions,” answered Joseph Cassano, who ran AIG Financial Products.
“That’s okay,” Cholnoky replied.
“Just okay?” AIG’s Cassano shot back.
“I agree with you,” Cholnoky said. “I tend to think that this market is overreacting.”
But was it?
In testimony before Congress a year later, Joseph St. Denis, a former SEC enforcement officer and the vice president of accounting policy at AIG Financial Products, reported that the process of valuing super-senior CDOs turned contentious in the summer of 2007. The problems intensified over an off-balance-sheet entity called Nightingale, St. Denis said. Nightingale was a structured-investment vehicle (SIV) created by AIG Financial Products. SIVs are intended as stand-alone entities, much like asset-backed commercial-paper programs such as Rhineland Funding. They finance themselves by selling short-term debt and using the proceeds to purchase securities with longer maturities such as super-senior CDOs.
St. Denis was vacationing in Puerto Rico in the summer of 2007 when he began receiving e-mails from the credit traders in London wanting to know if AIGFP would have to shift Nightingale onto AIG’s balance sheet if AIG Financial Products purchased all of its outstanding debt. That might become necessary, the traders told him, because the market was rejecting the commercial paper. When St. Denis returned from vacation, he discovered that the group had already bought the debt. He immediately scheduled a call with the firm’s Office of Accounting Policy (OAP) in London to discuss the problem of the company’s massive super-senior exposure. The instant the call was over, Cassano burst into the conference room. “He appeared to be highly agitated,” St. Denis later told Congress. His statement was cleaned up to remove objectionable language before being released to the public.
“What the [expletive deleted] is going on here?” Cassano asked.
“We’ve just finished a call with OAP,” St. Denis replied. “They agree with our approach . . . ”
Cassano let loose with a string of expletives. Then Cassano said, “I have deliberately excluded you from the valuation of the super-seniors because I was concerned that you would pollute the process.”
St. Denis resigned from AIG shortly thereafter.
DURING THE SECOND WEEK of August 2007, three issuers of asset-backed commercial paper (ABCP)—American Home Mortgage Investment Corporation, Luminent Mortgage Capital, and Aladdin Capital Management—opted to extend the maturity of their commercial paper. Under the terms of the debt, the issuer was permitted to do this as an alternative to arranging a bank liquidity line. It was a clever idea, allowing holders of the commercial paper to earn a small additional yield by granting this option to the issuer. Unfortunately, when the option was exercised, it triggered a panic. Investors didn’t buy commercial paper to find out that they’d lent their money to an issuer undergoing a crisis of confidence. “The subprime tsunami has come to the beach, as it were, to the safest of the safe,” Lee Epstein, CEO of Money Market