Cassano: the man with the trillion-dollar price on his head
This is Joseph Cassano. He is the multimillionaire trader accused of bringing
down the insurance giant AIG and with it the worlds economy.
So is he a criminal, an incompetent or a scapegoat?
Cassano leaves his Knightsbridge home
frightened for a long time, then suddenly they were angry. For millions
of Americans, anxiety about a jobless, debt-laden future turned to disbelief
when it emerged that AIG, the company at the centre of the worlds
financial crisis, was handing out £300m in bonuses. It was the superpowers
Sir Fred moment. Just as Britain reacted with fury to the disclosure that
Sir Fred Goodwins pension pot had been doubled as his bank neared
collapse, so the US was shocked. The death threats came soon after. I
want them dead! said one of a stream of messages that caused AIG staff
to travel in pairs, park in well-lit areas, and dial 911 if followed. I
want their spouses dead! I want their children dead! I want their childrens
children dead! I want the earth upon which they have walked salted so nothing
will ever grow again!
This was one
of the greatest bailouts in history, after the biggest corporate loss in
history, during the most serious challenge to world stability since the
1962 Cuban missile crisis. And here was AIG, the recipient of so much taxpayers
money that the cheques exceed the value of the gold reserves in Fort Knox,
paying bonuses to the very people who engineered the catastrophe.
toured the posh houses on Long Island Sound, an estuary northeast of New
York City, with letters for AIG executives describing the plight of homeowners.
But they were in the wrong place. Because the man who knows most about AIGs
troubles lives in a stucco-fronted house 3,000 miles away. Some call him
Patient Zero: the virus that infected the world financial system was transmitted
from a genteel square near Harrods. If you wait patiently in Knights-bridge
you will see him, and he appears not to be a risk-taking type. He puts on
his red crash helmet and cycles greenly off across the city, politely declining
to comment on global calamities. This does not look like a person waiting
at the curtains for the arrival of the FBI.
Can one man
in London really be to blame for the collapse of capitalism?
the economic crisis has been seen as a giant intellectual error, and AIGs
multimillionaire employees in England were simply the people who made the
biggest mistakes. The first to own up to misjudgment was Gordon Browns
friend Alan Greenspan once so revered in his role as Americas
central banker that to be photographed with him was as flattering as being
seen now with President Obama. I have found a flaw, said Greenspan,
referring to his free-market philosophy, after the banks started falling
over. I dont know how significant or permanent it is. But I
have been very distressed by that fact.
repeated this innocent-sounding explanation for the wrecking of so many
lives. There is no fail-safe way to offset this human tendency to
collective error, says Lord Turner, chairman of the Financial Services
Authority (FSA). And it is true, of course. Now and again, historical forces
come together in a way that is mutually reinforcing, and individual changes
that are powerful in themselves become so strong that their effects are
wrongly seen as permanent. If 150m people 2Å times the British
population stop tilling the land and start making things, as happened
in China between 1999 and 2005; if the Chinese recycle their export earnings
into cheap credit; if interest rates stay low for reasons that seem important
at the time (the millennium bug, the tech-stocks crash, 9/11); if new ideas
allow you to spread financial risk? well, by now you know the explanations.
It became easy to imagine that the world was growing rich because we understood
the universe better than our ancestors, until we didnt.
however, an alternative reading. This says that the furore over bonuses
is a convenient distraction from the real causes of the crisis, which go
to the heart of how the world is run. There is dishonesty in this collapse,
on a scale that is almost too vast to comprehend. There are conflicts of
interest in American finance and politics that make our own, dear House
of Lords look like beginners. There are frauds so large, and so long-standing,
that it can be hard to see them for what they are. And all these things
were allowed to thrive in an intellectual atmosphere that tolerated no dissent.
This reading is optimistic for those who believe in free markets, even if
it is pessimistic for the US. Capitalism has not failed, says
Bernard-Henri Lévy, the French philo-sopher. We have failed
capitalism. The thesis can be tested through Patient Zero.
version is that Joseph Cassano, who occupies the stucco-fronted house near
Harrods, brought down a safe and stable company and by extension,
the world with incompetent gambles. Youve got a company,
AIG, which used to be just a regular old insurance company, Obama
explained during a recent TV appearance. Then they decided
some smart person decided lets put a hedge fund on top of the
insurance comp-any, and lets sell these derivative products to banks
all around the world. Ben Bernanke, the chairman of the Federal Reserve,
adds: This was a hedge fund, basically, that was attached to a large
and stable insurance company.
ran AIGs financial-products division in London, almost single-handedly
is responsible for bringing AIG down and by reference the economy of this
country, says Jackie Speier, a US representative. They basically
took peoples hard-earned money, gambled it and lost everything. And
he must be held accountable for the dereliction of his duty, and for the
havoc hes wrought on America. I dont think the American people
will be content, nor will I, until we hear the click of the handcuffs on
is as satisfying as it is easy to understand. It treats the blowing up of
the world financial system like a global version of Barings, the bank that
collapsed in 1995, with Cassano in the role of Nick Leeson. Operating from
the fifth floor of a polished white stone building in Mayfair, Cassanos
unit sold billions of pounds of derivatives called credit-default swaps
(CDS), allowing banks to buy risky debt without attracting the attention
of regulators. AIG took the fees, but did not have the money to pay up if
the loans went bad. By the time the music stopped, European banks had protected
more than $300 billion of debt with this bogus insurance. And
that is just one corner of a web of risk extending to over 1,500 big corporations,
banks and hedge funds. In a 21-page paper known as the Mutually Assured
Destruction memo, AIG claims that if the bailouts stop and the company is
allowed to go bust, it will take the world with it. Cassano must have played
with handcuffs as a child: he is the son of a Brooklyn cop. Now he waits
for the fallout.
But the official
version overlooks many things, including episodes of fraud at AIG that go
back at least 15 years. It fails to explain why Public Enemy No 1 was allowed
to leave the company on generous terms, with a retainer of $1m a month and
up to $34m (£23m) in bonuses. And it does nothing to tell us why other
big companies, whose profits looked as smooth and certain as AIGs
in the good times, are also fighting for survival.
published its first list of the worlds biggest companies in 2004,
AIG ranked third, after Citigroup, the dying bank, and General Electric,
the industrial giant now drowning in its own debt. If you can think of a
risk to insure, AIG was there: the company even made plans to survive a
nuclear holocaust. It was built into a behemoth by one of the 20th centurys
corporate titans, Hank Greenberg. Less famous than the other insurance legend,
Warren Buffett, Greenberg gave shareholders a return of 14% a year, and
was equally loved. I just think you are the most stupendous, unbelievable
person in the entire industry, the entire world, one investor told
an annual meeting, without irony.
faced a problem. Insurance is not like iPods, where if you invent the market,
growth comes fast. Over time, it performs in line with the economy. In 1987
he found an answer: AIG would enter a joint venture with Howard Sosin, a
pioneer in the new Frankenfinance of derivatives trading. You
can thank Sir Isaac Newton for Frankenfinance. By showing in the 17th century
that the universe conforms to natural laws, he encouraged our age to see
money as a branch of physics. Starting in 1952, two generations of economists
worked to show that people are like molecules, whose behaviour can be predicted
in ways that are stable over time. Science then infected everything, from
how much capital banks need to protect themselves against insolvency, to
the risk in credit-default swaps. But there was a flaw: the Citys
faux physicists never go back far enough in their analysis, because the
data on the Bloomberg terminal cover a tiny period of history. Real
scientists tend to be much more sceptical about their data and their models,
says William Janeway, an MD of the private-equity firm Warburg Pincus and
a Cambridge University lecturer. They had all of the maths, but none
of the instincts of good scientists. There is also the 4x4 effect:
if you give people a safer car (read, a safer world through financial innovation),
they tend to drive faster. But we are getting ahead of ourselves.
To start with,
AIG trod carefully in the new, scientific universe. Sosins idea was
to buy financial risk from people who did not want it, then sell the risk
to others in a series of hedges so that AIG kept the fees but
not the risk. If a big organisation wanted to lock in an interest rate,
for example, AIG would promise to pay the difference in costs if rates rose,
then pass the risk to other parties in separate contracts. Sosin supplied
the nerds and the models, AIG supplied the reassurance of its AAA rating,
and for a long time the alchemy worked. AIG Financial Products (AIGFP),
a unit with 0.3% of AIGs 116,000 employees, made over $1 billion in
profits between 1987 and 1992, a vast sum at the time. But Sosin left. And
so did his successor, a mathematician named Tom Savage. When Savage departed
in 2001, Greenberg put in charge a man he saw as smart, tough and
aggressive: the units chief operating officer, Joseph Cassano.
The new leader had no background in Frankenfinance; his degree, from Brooklyn
College, was in political science. The cops kid had ascended through
what is called the back office: his expertise was in supervising
the contracts and running the lawyers and accountants. This did not matter,
Greenberg thought. Underlings had the right maths, and besides, Greenbergs
AIG held everyone, Cassano included, to account. The London team would be
scrutinised. Which was just as well, as the huge intellectual error meant
nobody else was in charge. Why did no-one see it coming? asked
the Queen last November, on a visit to the London School of Economics. Well,
they did, maam. Charles Bowsher, head of the US governments
General Accounting Office, testified as long ago as 1994 that the
sudden failure or abrupt withdrawal from trading of large dealers
in derivatives could cause liquidity problems in the markets and could
also pose risks to others, including? the financial system as a whole.
It took another 13 years, but that is exactly what happened.
tried to act on Bowshers warning, but she was silenced. Brooksley
Born, who monitored the futures markets, tried to extend her remit to unregulated
derivatives. Alan Greenspan and Robert Rubin, the then Treasury secretary,
persuaded Congress to freeze her already limited power, forcing her departure.
Rubin had come into government from Goldman Sachs; when he left he went
back to banking, and pushed for Citigroup to step up its trading of risky,
mortgage-related investments. For his advice, he earned over $126m (£84m)
and then, as Citigroup collapsed, became an adviser to Barack Obama. After
Greenspan stepped down from the US central bank in 2006, he became a consultant
to Pimco, the worlds biggest bond fund, where his insights have been
praised by his boss. Hes made and saved billions of dollars
for Pimco already, said Bill Gross last year. Greenspan is also an
adviser to Paulson & Co, a hedge-fund group that has made billions from
the collapse in American housing.
of touch reached a level that defies belief. America has an Office of Risk
Assessment, set up in 2004 to co-ordinate risk management for the main regulator,
the Securities and Exchange Commission (SEC). Jonathan Sokobin, its director,
says it is charged with understanding how financial markets are changing,
to identify potential and existing risks at regulated and unregulated entities.
According to its website, it also helps to anticipate, identify and
manage risks, focusing on early identification of new or resurgent forms
of fraud and illegal or questionable activities? across the corporate and
financial sector. By early 2008, this office was reduced to a staff
of one. When that gentleman would go home at night, says Lynn
Turner, the SECs former chief accountant, he could turn the
lights out. We had gotten down to just one person at the SEC responsible
for identifying the risk at all the institutions. The $596-trillion
market in unregulated derivatives, including $58 trillion in credit-default
swaps, was being watched by one person. Thats when he wasnt
looking at the rest of the corporate world, of course.
We are in
a hotel in London, sitting on cracked red leather sofas. The interview is
with one of the finest analysts of financial statements on the planet. Where
you or I see pages of numbers, he sees a narrative. Sometimes the theme
is a companys potential for growth. Sometimes it is the prospect of
self-destruction. And at times the story does not make sense, because the
figures are hiding a fraud. Charles Ortel, managing director of Newport
Value Partners a firm that provides research to professional investors
is explaining the potential for fraud in insurance. Insurers share
their big risks with others. Imagine it is September 12, 2001, and you get
a report on the previous days terrorist attacks. You dont know
your loss, because it takes time for victims to come forward and costs to
be calculated. You decide its $12 billion and do a deal with another
insurer: I will write you a cheque now for $9 billion, and we agree my liability
is capped at $12 billion. If the eventual losses are higher, the second
insurer will pay. In the meantime, it is free to invest the $9 billion.
Insurers make much of their money from investing premiums while they wait
for a claim.
insurer can book some of the $9 billion as income. It shouldnt, because
it is exposed to risk. But theres flexibility in how the numbers can
be treated. If the second insurer is not having a good year, the flexibility
creates the temptation to book phantom earnings, illegally supporting the
share price. In the past, AIG has admitted episodes of improper accounting.
has not been answered. Was Cassanos team simply the dumbest in the
room, betting on an ever-rising housing market against the likes of Goldman
Sachs? Or was the world financial system brought down by fraud a
fraud made possible by the gradual but relentless takeover of public life
by the insiders club of finance?
In 2001, with
AIG trading at $85 on the New York Stock Exchange, The Economist decided
to commission some research on the companys true value, and chose
the little-known firm Seabury Analytic to do it. This was deliberate. The
magazines New York bureau chief, Tom Easton, had been around long
enough to know that nobody on Wall Street ever says sell, except
perhaps when a market is about to go up, and that the big security firms
could not be trusted to give a candid view of AIG.
which took five months, was the work of a team led by Tim Freestone, who
is speaking here for the first time. Most analysts are upbeat: their colleagues
bonuses depend on fees from the company under scrutiny. But Freestones
firm (now called Crisis Economics) is independent. He judged that AIG was
highly overvalued, and he would later realise that its shares were supported
by an ability to stifle criticism. In his report for The Economist, however,
he was tactful. To justify the share price, he said, it would have
to grow about 63% faster than [its] peers for the next 25 years. If investors
believe that AIG can sustain this type of performance for that period of
time, then AIG is properly valued. Any investor who believed that
would need to be certified.
article came out, researchers from the big banks contacted him, incredulous
that he had dug deeper than the industry norm and dared to release the findings.
They seemed to be in awe, and at the same time jealous; nobody breaks the
rules like this not without paying a price. A delegation from AIG
arrived at his office and presented him with a letter that seemed to renounce
the story and to condemn its distortion of his research. He was intrigued
to see the authors name at the end of the letter why, it was
his name, and the AIG contingent was awaiting his signature. The company
also sent its executives on a private plane to The Economist headquarters
in London to demand a retraction. Legal threats followed.
AIG was attempting to railroad us out of business, says Freestone,
who did not sign.
was forceful when it came to his share price. He was often on the phone
to Richard Grasso, the head of the New York Stock Exchange, with expletive-laden
threats to move AIG to the Nasdaq unless the exchange did a better job.
Grasso would then be seen on the floor of the exchange, talking to the market-maker
for the stock. Grasso says he never asked the market-maker to bid the shares
higher, which is just as well: both men could have gone to jail.
all this have to do with Joseph Cassano? Seabury Analytics research
suggests that when Cassano took over the Frankenfinance unit, the parent
company was in trouble. Its distance to default was much
closer than anyone realised, says Freestone, whose models would later
identify AIG and three peers Lehman Brothers, Merrill Lynch and Bear
Stearns as insolvent when the markets saw everything as fine. He
is not alone in his view. Another authority believes that as the man in
Mayfair wrote his credit-default swaps, AIG was already doomed. AIGs
foray into CDS was really the grand finale, says Christopher Whalen,
managing director of Institutional Risk Analytics, an expert on banking
who has testified before Congress. Towards the end, it looked much like
a Ponzi scheme, yet the Obama administration still thinks of AIG as
a real company that simply took excessive risks. In other words, there
was never a chance AIG would honour its contracts: its income was nowhere
near enough to cover the payouts.
a reputation to protect: he is global risk editor of The International Economy
magazine, co-founder of the Herbert Gold Society, a group of current and
former employees of the US Treasury and the Federal Reserve, and regional
director of the Professional Risk Managers International Association.
His assertion is not an impulse. It comes from months of talking to forensic
specialists such as Freestone, insurance regulators and members of
the law-enforcement community focused on financial fraud. As
dishonesty, Whalen points to AIGs occasional habit of using secret
agreements to falsify financial statements either its own or those
of other companies. In 2005, a former senior executive at the insurer General
Re pleaded guilty to a conspiracy to misstate AIGs finances, after
General Re paid $500m in premiums for AIG to reinsure a nonexistent $500m
risk. The transaction was a sham; the only economic benefit to either party
was the $5.2m fee paid by AIG for Gen Res help.
When the $500m
in loss reserves were added to AIGs balance sheet in 2000 and 2001,
Greenberg was able to claim an increase in reserves, when in fact they had
declined. Theyll find ways to cook the books, wont they?
John Houldsworth, the former executive, said in a recorded phone conversation
with Elizabeth Monrad, his chief financial officer. She observed that these
deals are a little bit like morphine; its very hard to come off of
in 2003 AIG was fined $10m for helping a telecoms company, Brightpoint,
hide $11.9m in losses with a non-traditional insurance product
that AIG offered for income statement smoothing. Brightpoint
paid $15m in premiums, and AIG refunded $11.9m in fake insurance claims.
The ruse allowed Brightpoint to spread its loss over three years, overstating
its 1998 net income by 61%. And in 2005, AIG restated five years of financial
statements, admitting that they had exaggerated its income by $3.9 billion.
that at some point between 2002 and 2004, AIG concluded that the game was
up for secret agreements, and that other methods of enhancing revenue were
needed. The thing I havent satisfactorily answered, Whalen
adds, is whether AIG was so unstable coming out of 2000, 2001, that
Cassano was trying to cover up a wounded, dying beast. Was he doubling up,
to try and hit a home run and save the house? It looks like it, because
otherwise it was just greed on his part, and he was writing as much of this
crap as he could to inflate his bonus. If he is right, the implications
are profound. Any bank that thought it was protected by credit-default swaps
with AIG would have been exposed from the start, putting taxpayers at risk.
The banks credit traders would or should have realised
that AIG was never likely to pay out. The key point that neither the
public, the Fed nor the Treasury seems to understand, says Whalen,
is that the CDS contracts written by AIG were shams, with no correlation
between fees paid and the risk assumed. These were not valid contracts but
acts to manipulate the capital positions and earnings of financial companies
around the world.
into the General Re affair prompted AIG to oust Greenberg in 2005. He has
always denied wrongdoing. In fact, he is suing AIG, claiming his successors
abandoned risk controls and destroyed the firm. The old mans departure
meant the brakes were off for Cassano; the new CEO, Martin Sullivan, had
risen through the property and casualty side of the business.
As he is fond of pointing out, he is not an accountant. Who would scrutinise
the financial-products team now? The pace of CDS deals suddenly accelerated,
until Cassano halted them for ever, all in the space of a few months. He
had realised that sub-prime mortgages accounted for an increasing proportion
of his trades, and that the underwriting standards were shocking. No model,
however carefully constructed, can protect you from that. It was too late:
the bomb on AIGs books was ticking.
For the world
to go truly insane, leading to what the Bank of England has called possibly
the largest crisis of its kind in human history, two things are needed.
The first is the intellectual capture of the Establishment, so that everyone
politicians such as Gordon Brown, regulators such as the SEC and
the FSA, and academic and media commentators is persuaded that a
new way of thinking is in the public interest. The second step is when vested
interests exploit the intellectual capture and take it to extremes.
such as Cassano push at boundaries. You could say it is their evolutionary
purpose. That is one reason we need governments, to protect us when male
ambition reaches too far. But our governments were mesmerised by our bankers.
From 1973 to 1985, says Simon Johnson, a former chief economist
at the IMF, the financial sector never earned more than 16% of [US]
corporate profits. In the 1990s, it oscillated between 21% and 30%, higher
than it had ever been in the post-war period. This decade, it reached 41%.
The whole point of financial companies is to allocate your savings to those
who can use the money best. If they are taking 41% of the profit in an economy,
something is out of balance. These figures reveal an enormous transfer of
us back to bonuses. In August 2007, as the financial crisis broke, Cassano
claimed everything was fine. It is hard for us, and 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, he told investors,
as his CEO listened in on the call. But it seemed to be a different story
inside AIG. The company had hired Joseph St Denis, a former SEC official,
as part of an effort to improve its internal controls. Cassano shut him
out. I have deliberately excluded you from the valuation of the super
seniors [a type of debt] because I was concerned that you would pollute
the process, St Denis recalls Cassano saying. The auditor resigned
in protest, yet the minutes of AIGs audit committee show no sign of
In the final
three months of 2007, AIG lost over $5 billion. Under the terms of the bonus
scheme, top executives should have had their pay cut for poor performance.
When the compensation committee met in March 2008 to award bonuses, however,
the Essex-born CEO urged it to ignore the losses. The board approved the
change, even though losses were growing by the month, and Sullivan pocketed
$5.4m. He was also awarded a golden parachute worth $15m. He was out of
the company three months later, with a severance package worth $47m (£31m).
That is $39,500 (£26,000) for every day he was in charge. Pension
funds and other savers holding AIG shares lost $58.4m (£39m) a day
during his tenure.
In seven years,
the 400 employees in Cassanos division were paid $3.5 billion. Cassano
received $280m. When the losses became public, AIG parted company with him
immediately. But he wasnt fired: he retired, with a contract
paying him $1m a month for nine months, and protecting his right to further
bonus payments. Joe has been a very valuable member of the AIGFP senior
management team for over 20 years, said Sullivan, who was soon to
leave the scene himself. He has had a great career with us, and we
wish him the very best in the future.
division then imploded. As house prices fell, credit ratings were cut and
bankers began to panic, AIG posted the biggest quarterly loss in corporate
history: $61.7 billion. This is equivalent to losing $28m (£19m) an
hour, every hour, for the final three months of 2008. But by now, the companys
problems were the property of the American taxpayer, creating extraordinary
new conflicts of interest. Hank Paulson, the Treasury secretary in the outgoing
Bush administration, was an ex-CEO of Goldman Sachs. He received tax benefits
of about $200m (£133m) for taking on a government role. When the US
decided to bail out AIG, the chief beneficiary of the rescue was? Goldman
Sachs, which received $12.9 billion of public funds via the insurer. The
new CEO, Edward Liddy, whose task is to wind down the company and to close
$1.6 trillion in trades that are still outstanding from the Cassano era,
is ex-Goldman Sachs. He even has $3.2m in the banks shares.
to keep secret its payments to Goldman Sachs and others, somehow imagining
you could have $182.5 billion of taxpayers money and not say how you
were using it. And so the task facing Obama is even greater than we imagine.
Intellectually, the president might see what is required, but execution
still depends on the very club that helped bring about the collapse in the
first place. It is not outright fraud that has caused the most damage
to the market, says Tim Freestone, the analyst first to see AIGs
troubles. It is the suppression of information, wittingly or unwittingly,
by most of the markets players. A rush to regulation is not
the answer, he adds: each new rule creates a minimum target for compliance,
with unintended results. The challenge is to confront the keiretsu, the
interlocking relationships that give insiders such an advantage.
politicians like to blame the catastrophe on this or that cause, which swelled
into a tsunami nobody could have foreseen. But as Simon Johnson points out,
each reason light regulation, cheap money, the promotion of homeownership
has something in common. Even though some are traditionally
associated with Democrats and some with Republicans, they all benefited
the financial sector.
early trades showed genuine brilliance; their later CDS deals, many of which
were not even hedged, were as foolish as can be. Was it fraud?
Yes, in the widest sense but it was fraud as wilful ignorance, in
which a whole industry is based on false assumptions, and each participant
has little reason to question the system as long as it continues to make
him rich. There is no need to have an overt conspiracy, or to be incompetent,
says a thoughtful internet poster called Anonymous Jones. Unfortunately,
those ultimately bearing the risk savers, taxpayers did not
have as strong a personal incentive to keep watch over the system, and those
in charge of the financial sector ran roughshod over the entire enterprise,
extracting profits far in excess of any value generated by their actions.
When there are enormous incentives for each participant to cheat, the efficiency
of any market breaks down.
weeks, Cassano has grown a beard and changed his crash helmet, which is
no longer red but silver. The disguise might not be enough; prosecutors
are said to be close to criminal charges. They think he misled investors,
an easier case to make than that of knowingly risking the financial system.
To date, neither AIG nor AIGFP is aware of any fraud or malfeasance
in connection with the underwriting and creation of the multi-sector CDS
portfolio, says AIG, referring to the trades under scrutiny, as
opposed to what, with hindsight, turned out to be bad business decisions.
If they were
bad decisions, they had a context. Once people who push boundaries
understand that the police dont want to issue tickets, says
Charles Ortel, they start pushing. If youre not going
to arrest me for going 10 miles over the speed limit, well, Ill try
20. If I can do 20, Ill try 30. And then Ill try flying a plane
on a road.