So did you catch the Michael Lewis AIG Vanity Fair takedown over bonus day? Ha ha ha kidding, here, look: I am going to let you in on a little “inside information.” I was talking to this Very Super Important Former Financial Regulator, seriously, a guy who is so important I was dumbfounded as to why he actually called me back, but since he did I thought I’d ask something about the latest incomprehensible development in the government’s recentest incomprehensible Free Money For People Who Have All The Money program. And he just sort of groaned, and I quote:
“To be honest, Moe? I stopped reading any of this stuff the day taxpayers pledged another $35 billion to prop up Citigroup. I actually cried that day, it was just such a crime. You can ask me about anything up till then, but at some point it just got too depressing.”
Which underscores a serious* problem: if the brilliant minds who actually understand this stuff can’t actually bear reading about it anymore, where does that leave the General Reading Public on the eve of the ten-month anniversary of its first concerted efforts to slog through jargony updates on credit derivatives and jumbo option ARMs? (Bitchy.) What to do when there is still so much unbelievable arrogance, unconscionable obliviousness layered atop epic criminality to be lavished over and yet you just can’t summon the outrage anymore?
Here is where I am going to experiment with summarizing what the financial blogs call the crisis “must reads.” The joke is that no one actually reads “must reads” except me because…I don’t know, a mild stroke or something. Anyway, without further ado, AIG.
You probably know roughly how the once-”respected” but historically shady insurance giant American International Group became the most treacherous black hole in the Wall Street money vortex: they “insured” a trillion dollars “worth” of “sophisticated” bond-type-things (CDOs) made up of bad mortgages, bad clones of bad mortgages known as “synthetics” and billions and billions of dollars in fees mortgage brokers, mortgage whoresalers, and assorted layers of Wall Street underwriters, lawyers, consultants and corrupt placement agents got paid to pool, slice, re-pool, re-slice and finally offload on some public school teachers’ pension fund. AIG “insured” these bond-type things against the risk that some of the proud homeowners, duped illiterates, schmuck condo flippers home equity loan-financed addition builders whose names were (knownst or unbeknownst to them) written on those mortgages ran out of cash. AIG sold this “insurance” dirt cheap because the only people who actually knew such insurance existed were the pooler-slicer guys who, realizing how unsustainably stratospheric the existence of said insurance had enabled housing prices to become, paid off credit rating agencies to rate their fancy exotic toxic bonds Triple-A and keep quiet about the whole thing.
Until! About March 2005, when some AIG employee named Gene Park — and this is where the Lewis story gives us helpful new detail — was fiddling around at work with his online trading account after reading about this wonderful new stock called New Century Financial with a terrific dividend yield.** So Gene Park looked at New Century’s financial statements, and noticed something “scary” according to Lewis, who does not elaborate, so I looked at the bank’s 2004 10K, which came out around that time. Wow, the average homeowner you are counting on to feed the interest on your “A+” tranche of New Century mortgage-backed CDO is… 598! With a 4.28% likelihood of being 60 days or more late on payment! But with standards like this…
Under the full documentation program, we generally require applicants to submit two written forms of verification of stable income for at least 12 months. Under the limited documentation program, we generally require applicants to submit 12 consecutive monthly bank statements on their individual bank accounts. Under the stated income documentation program, an applicant may be qualified based upon monthly income as stated on the mortgage loan application if the applicant meets certain criteria.
But hey, this was 2005, housing prices were still going up, that is what “home equity” is for. Which is exactly what AIG villain Joe Cassano’s #2 Al Frost said when Gene Park went him and said something along the lines of, ha ha ha this isn’t the sort of thing you are writing all that synthetic bond “insurance” on, is it?
And Al Frost’s retort was something like “fuck you,” until Gene started asking around the AIG Financial Products Bloomberg terminals to see what percentage of the new debt they were insuring fell into this new New Century style of crap mortgage. Some Yale rocket scientist estimated ten percent, a “risk analyst” said twenty, and Frost told Gene he was there to sell swaps, not manage risks, and the question was above his (eight or nine figure, it is helpful to remember) pay grade. Anyway, by now I am sure you have guessed the real answer to Gene Park’s question, that 95% of the credit default swaps the unit had been writing had been on some form of real, synthetic or omnivorous subprime mortgage bond.
“We were doing every single deal with every single Wall Street firm, except Citigroup,” says one trader. “Citigroup decided it liked the risk and kept it on their books. We took all the rest.”
So by the middle of 2005 Park had convinced his fellow Financial Producers to hold meetings with all the big bulge bracket banks informing them they were shutting down the subprime business and the rest has been pretty much reported before, aside from the Requisite Lying Scumbag Goldman Trader Anecdote in which a Lying Scumbag Goldman Trader tells the truth to an AIG trader two months after the meeting in a pure Goldman “between you and me, these things are gonna blow up” show of sinister cartoonishness too cartoonish not to have happened pretty much exactly as described. And everyone was sure Park had saved the company! But no.
Because during those crucial frenzied months of crazy business, evil Goldman (and also, every other firm on Wall Street) had convinced Cassano to add a clause to their “insurance” contracts whereby AIG would be forced to post collateral if AIG lost its own Triple-A rating, which everyone knew was inevitable once everyone woke up to the fact that seriously anything could get a Triple-A rating, and suddenly everyone (led of course by Goldman) was calling up demanding collateral and a “run on the bank” of sorts ensued, which is to say that it would have ensued and been calmly seized by the FDIC had AIG been a bank and therefore subject to regulations also known as “the law”, but the rule for firms that broker in unregulated derivatives contracts like credit default swaps and other such “insurance” is apparently that pure mayhem ensues, with every counterparty entitled to loot whatever the fuck they out of the company’s coffers because for some reason they are not subject to normal bankruptcy laws, that is just the way it has always been, according to page 189 of When Genius Failed anyway, although why that is is not explained in the story.
Some other things not explained in the story: why Lewis seems to subscribe to former AIG CEO Hank Greenberg’s contention that none of this would have happened had he been around to “control” Joe Cassano. Now certainly there seems to have been a sudden massive uptick in the subprime CDS business in 2005, but Greenberg didn’t leave until July 2005, and Gene Park got them out of the business no later than December of 2005, and anyway it is not as if Cassano’s division wasn’t up to shit so patently illegal the SEC didn’t catch onto it well before Greenberg left. The more I hear this “everything would have been okay if only Hank Greenberg hadn’t been chased out of the company” line of argument the more I think, for that to be true Hank Greenberg would have had to sabotage his own company merely to spite Eliot Spitzer, good thing that doesn’t sound like something Hank would ever do, no way…
Beyond that, plenty of even crappier CDOs were underwritten after AIG stopped insuring them. Lewis is right that some banks, namely Merrill and Lehman, simply kept the risk on their books — imagine that that is how it used to work in the olden days when a bank loaned money! — and then there was also a big effort to unload the riskiest tranches of loans on the pension funds of teachers and firefighters and such. But also, there were the “monoline” bond insurers like MBIA and Ambac, which were never taken that seriously because all they had ever had to “insure” was municipal bonds, which really never defaulted,*** but which sometime mid-decade, bored by their riskless business, followed AIG FP straight into the subprime abyss. What happened to their counterparties?
Glad you asked! For some reason the monolines were regulated by the New York insurance commissioner, who split MBIA into two parts after the housing market began to collapse, because the monolines also insured all sorts of municipal interest rate swaps deals, and a downgrade in the monolines’ credit ratings would (perversely) mean all manner of cities and towns and public works programs would have to cough up billions of dollars in collateral calls to Wall Street investment banks, which ended up happening anyway, but perhaps not on the apocalyptic scale Wall Street would have liked to have seen, and also no way are they getting 100 cents on the dollar on those subprime CDS, so Wall Street is suing them in hopes they can pillage the public sector, even more than they already have!
And the banks have a pretty good case for themselves if you look to the awe-inspiring precedent of AIG, wherein the unwind of the firm’s subprime credit derivatives portfolio not only paid investment banks 100 cents on the dollar, it was essentially outsourced by pissed-off employees to Wall Street derivatives desks in hysterically profitable trades that netted the big banks an extra ten or twenty billion dollars [don't mention it! --Taxpayer] on top of their hundred billionish payout.
And of course, the biggest mystery this story leaves unsolved is “uh…why, again?”
**I like this detail because back in the Nasdaq 5000 days sending your shareholders “dividends” (much less good ones) was about the quaintest most old-school way to get your stock laughed off CNBC because shareholders are for stealing from, silly! But no, New Century had so much cash they actually found some left over to send back to their shareholders, and Gene Park wanted to know if it was going to last, because as the venerable Jim Cramer once told me, “I like big yields, but they sometimes lie,” which any casual Mad Money viewer will recall has a “Shakira corollary” that goes “unlike hips, dividends…dissemble.” Your brain on AIG, folks.
***Although, financial sector innovations would soon change that too!