The former head of the AIG derivatives unit accused of exacerbating the global financial crisis blamed the firm's auditors -- rather than his unit -- on Wednesday for the billions in losses the firm sustained, leading to its $182 billion taxpayer-financed government rescue.
Joseph J. Cassano, who led AIG's Financial Products division from 2002 to 2008, was unapologetic in the written testimony he submitted to the Financial Crisis Inquiry Commission, the panel created by Congress to investigate the roots of the worst financial crisis since the Great Depression.
Cassano's unit underwrote insurance on bonds, securities based on bonds (known as collateralized debt obligations), and securities based on securities that were based on bonds (known as synthetic collateralized debt obligations). That insurance, a type of derivative, is called a "credit default swap." As the housing market soured, leading to a worsening economy, financial firms that bought that insurance to either hedge their risk or to speculate demanded more and more collateral from AIG. This run on AIG, and its burgeoning accounting losses based on how they valued these securities, led to the government takeover and eventual bailout.
"I was truthful at all times about the unrealized accounting losses and did my very best to estimate them accurately," Cassano said in prepared remarks.
But Cassano didn't think his firm would actually experience any losses on those securities. Rather, the firm was forced to take accounting losses by its auditors -- a move Cassano disagreed with, according to his testimony.
"I did not expect actual, economic losses on the portfolio," Cassano said in his written remarks. "As I look at the performance of some of these same CDOs in Maiden Lane III, I think there would have been few, if any, realized losses on the CDS contracts had they not been unwound in the bailout."
CDOs are shorthand for collateralized debt obligations; Maiden Lane III is one of the financial vehicles created by the Federal Reserve Bank of New York to purchase the various instruments AIG insured. AIG's counterparties were paid 100 cents on the dollar. Unlike Wall Street firms like Goldman Sachs, it's unclear whether taxpayers will ever be made whole on the transactions.
Cassano, noting that the bailout occurred after he left his position as head of AIG-FP, said that his unit was able to negotiate with its counterparties as they stepped up their demands for increased collateral.
"[W]e got steep reductions in the called-for amounts from all counterparties who made the largest calls," he said in his prepared remarks. "During my tenure, no counterparty declared us in breach or threatened litigation, which shows our strategy was effective. I believe this strategy was appropriate and in the best interests of the company and its shareholders."
In discussing the losses AIG sustained, which led in part to the increased collateral calls, Cassano said that he disagreed with the firm's auditors' move to disallow an accounting adjustment that forced the firm to record several billions of dollars in losses.
"We believed then, and I still believe now, that it was a wholly appropriate adjustment," Cassano said.
He notes that "no one raised concerns about the negative-basis adjustment until mid-January 2008.
"Ultimately, in February 2008, the auditors decided that we did not have sufficient audit-quality evidence for the adjustment. As a result, they disallowed it. I disagreed with that decision, as did several others at AIG. It was, however, the auditors' final decision and we had to abide it," Cassano said.
"Regardless, the auditors' decision about the quantum of evidence supporting the adjustment had a huge impact on the company: it increased our unrealized accounting loss substantially," he said.
For example, in 2007, in the fourth quarter alone, AIG recorded $11.12 billion in pretax losses, according to a Feb. 28, 2008, filing with the Securities and Exchange Commission.
The "unrealized" loss was related to Cassano's unit.
"AIG continues to believe that the unrealized market valuation losses on this super senior credit default swap portfolio are not indicative of the losses AIGFP may realize over time," the firm noted at the time. "Under the terms of these credit derivatives, losses to AIG would result from the credit impairment of any bonds AIG would acquire in satisfying its swap obligations. Based upon its most current analyses, AIG believes that any credit impairment losses realized over time by AIGFP will not be material to AIG's consolidated financial condition, although it is possible that realized losses could be material to AIG's consolidated results of operations for an individual reporting period.
"Except to the extent of any such realized credit impairment losses, AIG expects AIGFP's unrealized market valuation losses to reverse over the remaining life of the super senior credit default swap portfolio," the firm said in its filing.
In other words, AIG expected the accounting losses to reverse over time.
The firm's auditors also said the firm wasn't properly valuing these securities, which it denoted through a "material-weakness finding." Cassano found this all "surprising."
"The auditors also made a material-weakness finding, which I first learned about in February 2008," he said in his prepared remarks. "In light of the auditors' heavy involvement in the fair-market-model evolution generally, and their prior knowledge of the existence and magnitude of the negative-basis adjustment in particular, I also found the material-weakness finding surprising, to say the least. I know AIG senior management argued strenuously against it."
AIG ultimately came to symbolize the worst excesses associated with Wall Street and the reckless risks it took in the run-up to and during the crisis. Taxpayers continue to own 79.9 percent of the firm.
READ Cassano's full remarks: