Joseph J. Cassano, head of what was formerly an obscure 400 employee division of American International Group (AIG) with main offices in London, called AIG Financial Products (AIG-FP), testified today before the FCIC (Financial Crisis Inquiry Commission).
The inability of AIG-FP to meet collateral calls by CDS (Credit Default Swaps) partners was a major trigger to the collapse of the company and the purchase of majority ownership of AIG by the U.S. government to prevent bankruptcy.
An oversimplified summary of Cassano's testimony is as follows:
1. AIG-FP had a diverse portfolio, including CDSs on CDOs (collateralized debt obligations).
2. The underlying loans in the CDOs were diversified, and we insured only the super-senior tranche, which always had a AAA layer of loans below it.
3. In late 2005 we (AIG-FP) came to a decision to stop writing CDSs on CDOs backed by sub-prime mortgages and announced this decision in February, 2006.
4. We had a firm view that our portfolios would not suffer realized losses (as opposed to short-term accounting losses).
5. I depended on a network of risk analysis methods, outside management and auditing reviews and valuation models by authorities such as Moody's (MCO).
6. " I am not a CPA."
7. I could have negotiated terms of settlement with counterparties that would have made government rescue unnecessary.
The final point is one that I can not test. It may or may not be correct. It is possible that, if such fractional settlement of collateral had been effected, bank failures would have been more endemic. Or TARP would have been bigger to achieve the same result. There has been much discussion of whether the Treasury insistence of collateral settlement by AIG (in government receivership) with banks at 100% was part of a master plan to rescue the banks.
In the end the decision may have been to sacrifice AIG to save the banks. If that was in fact the case, Cassano may be a convenient scapegoat. An article today by Felix Salmon raises an issue that makes the question of sacrificing AIG to save the banks of more than passing interest. (In the case Felix mentions the bank was Goldman Sachs (GS)). But, putting that uncertainty in the Casano case aside, let's continue with the discussion to consider the question of compensation.
Cassano retired from AIG in early 2008, took a $1 million a month consultancy with the company and was fired in March, 2008, according to Michael Daly in the New York Daily News. Daly said that, when all was said and done, Cassano walked away with $315 million - quite a reward for one who brought down the world's largest insurance conglomerate.
This situation is an example of the capitalization of gains with the socialization of losses. There are many more examples (such as many top executives of banks and corporations such as General Motors), but Cassano serves well as the example of the day.
Why should Cassano be compensated for presiding over what turned out to be one of history's greatest financial collapses. By his own admission he did not know what he was doing: He depended on "experts". That is worth $315 million?
I'm sure these experts were all well compensated, as well, and this is another problem. If someone misjudges risk, why should they be well paid for that judgment without having to suffer economic loss for misjudgment?
This brings us to the bottom line of the problem with our socialist-capitalist hybrid system: A few are in the position to gain riches through risky and reckless action without any downside consequences. The many are left in a position to gain few riches but realize all the downside.
The ideal of capitalism is that many individual self interests collectively produce a public good. This breaks down when many of the most powerful interests operate on the credo of "take the money and run".
Until the compensation plans of corporations reflect long term performance and penalize short term failures we have a structural weakness in our business models. We have a system that rewards short term gains and, in effect, imposes little penalty for long term failure. Sure Cassano was fired, but he kept the millions he made while AIG essentially went into government receivership.
Disclosure: No positions
