Too Big to Fail [89]
But Sosin chafed under the short management leash that had been placed on the unit and in 1994 left along with the other founders after a falling out with Greenberg.
(Long before Sosin’s departure, however, Greenberg, infatuated with the profit machine that FP had become, had formed a “shadow group” to study Sosin’s business model in case he ever decided to leave. Greenberg had PricewaterhouseCoopers build a covert computer system to track Sosin’s trades, so they could later be reverse engineered.) After much persuasion from Greenberg, Cassano agreed to stay on and was promoted to chief operating officer.
A Brooklyn native and the son of a police officer, Cassano was known for his organizational skills, not his acumen in finance, unlike most of the talent Sosin had brought with him—“quants,” quantitative analysts, with PhDs who created the complex trading programs that defined the unit.
In late 1997, the so-called Asian flu became a pandemic, and after Thailand’s currency crashed, setting off a financial chain reaction, Cassano began looking for some safe-haven investments. It was during that search that he met with some bankers from JP Morgan who were pitching a new kind of credit derivative product called the broad index secured trust offering—an unwieldy name—that was known by its more felicitous acronym, BISTRO. With banks and the rest of the world economy taking hits in the Asian financial crisis, JP Morgan was looking for a way to reduce its risk from bad loans.
With BISTROs, a bank took a basket of hundreds of corporate loans on its books, calculated the risk of the loans defaulting, and then tried to minimize its exposure by creating a special-purpose vehicle and selling slices of it to investors. It was a seamless, if ominous, strategy. These bond-like investments were called insurance: JP Morgan was protected from the risk of the loans going bad, and investors were paid premiums for taking on the risk.
Ultimately, Cassano passed on buying BISTROs from JP Morgan, but he was intrigued enough that he ordered his own quants to dissect it. Building computer models based on years of historical data on corporate bonds, they concluded that this new device—a credit default swap—seemed foolproof. The odds of a wave of defaults occurring simultaneously were remote, short of another Great Depression. So, absent a catastrophe of that magnitude, the holders of the swap could expect to receive millions of dollars in premiums a year. It was like free money.
Cassano, who became head of the unit in 2001, pushed AIG into the business of writing credit default swaps. By early 2005, it was such a big player in the area that even Cassano had begun to wonder how it had happened so quickly. “How could we possibly be doing so many deals?” he asked his top marketing executive, Alan Frost, during a conference call with the unit’s office in Wilton, Connecticut.
“Dealers know we can close and close quickly,” Frost answered. “That’s why we’re the go-to.”
Even as the bubble was inflating, Cassano and others at AIG expressed little concern. When in August of 2007 credit markets began seizing up, Cassano was telling investors, “It is hard for us, without being flippant, to even see a scenario within any kind of realm of reason that would see us losing $1 in any of those transactions.” His boss, Martin Sullivan, concurred. “That’s why I am sleeping a little bit easier at night.”
The pyramidlike structure of a collateralized debt obligation is a beautiful thing—if you are fascinated by the intricacies of financial engineering. A banker creates a CDO by assembling pieces of debt according to their credit ratings and their yields. The mistake made by AIG and others who were lured by them was believing that the ones with the higher credit ratings were such a sure bet that the companies did not bother to set aside much capital against them in the unlikely event that the CDO would generate losses.
Buoyed by their earnings, AIG executives stubbornly