Michael Lewis has a very interesting piece at Vanity Fair tracing the rise and fall of AIG's Financial Products division and its infamous boss, Joe Cassano. Lewis makes the argument that the major Wall Street banks used AIG as a sort of sacrificial lamb to hold all of the risk on their sub-prime loan securities (which we knew; that's what those derivatives were all about) but also that no one at AIG knew what was happening until it was way too late to do anything about it -- they were, in essence, bilked by the bankers.
That's when [Gene] Park decided to examine more closely the loans that A.I.G. F.P. had insured. He suspected Joe Cassano didn’t understand what he had done, but even so Park was shocked by the magnitude of the misunderstanding: these piles of consumer loans were now 95 percent U.S. subprime mortgages. Park then conducted a little survey, asking the people around A.I.G. F.P. most directly involved in insuring them how much subprime was in them. He asked Gary Gorton, a Yale professor who had helped build the model Cassano used to price the credit-default swaps. Gorton guessed that the piles were no more than 10 percent subprime. He asked a risk analyst in London, who guessed 20 percent. He asked Al Frost, who had no clue, but then, his job was to sell, not to trade. “None of them knew,” says one trader. Which sounds, in retrospect, incredible. But an entire financial system was premised on their not knowing—and paying them for their talent!
Of course, when Park took this news to his boss, Cassano told him that everything would be fine: Housing prices couldn't fall! Certainly not all over the country! Yipes.
-- Tim Fernholz
