The Financial Crisis Inquiry Commission is having a hearing today, and while the spotlight in advance has been on Goldman Sachs President Gary Cohn, the prepared testimony of Joseph Cassano, the former CEO of AIG Financial Products, is pretty interesting, you might even say, surprising.
Among the highlights of Mr. Cassano's claims: AIG saw the sub-prime problems coming early and got out. "When we recognized — well before many others — that changes in the mortgage market likely presented increased risk for future deals, we decided to exit the subprime business. We thought the decision was appropriate, despite the lost profits at the time. With hindsight, the decision looks even more prudent....we made a decision at the end of 2005 to stop writing new deals that contained subprime collateral. Although we completed deals already in the pipeline, the portfolio grew comparatively little after 2006."
And, he claims, the pre-2006 stuff would have eventually recovered fine -- there would have been mark-to-market accounting losses, but no long-term economic losses -- if not for the decision in the midst of the crisis to unwind them: "When AIG-FP exited the business, we wondered whether there was a risk in our existing portfolio for which a hedge might be appropriate. After internal discussion, we believed that the
existing vintages were not tainted by any slippage in underwriting standards. We remained confident in our risk analysis for the existing deals. The decision was based on our firm view that the portfolio would not experience realized losses (as opposed to short-term accounting
losses). 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. But, as you know, a decision was taken after my departure from AIG-FP to unwind the CDS contracts."
He described a compensation structure that is far from the caricature of short-termism that the press and politicians have promoted. "We designed AIG-FP's compensation system to make sure that highly compensated employees had a large percentage of their compensation deferred and tied to the company's long-term performance. We adopted this plan approximately 15 years ago and changed it little after that. The plan generally required highly compensated employees to defer up to 45% of their compensation, through the purchase of AIG-FP subordinated debt, which was not guaranteed and was at risk to the business's performance. The deferred compensation was paid out annually during an average-life window (usually between four and six years)."