AIG trail leads to London 'casino'
Since 1987 the American financier Joseph Cassano has divided his time between London and Connecticut, where AIG, the world’s largest insurance company, runs a subsidiary called AIG Financial Products.
For most of those 21 years life has been good for the bespectacled, intellectual-looking Cassano.
The Wall Street veteran rose to run his part of the insurer, AIG Financial Products. When in London he commuted from a company flat behind Harrods to his unit’s office at 1 Curzon Street in Mayfair’s hedge fund alley.
Cassano’s pay over the past eight years, according to US Congressional records, totalled $280m (£162m).
Then at the end of 2007 Cassano’s fortunes changed. The company’s accountants changed the basis on which they valued much of the collateral held by its units. Some half a trillion dollars worth of credit default swaps written by AIG Financial Products were marked down.
Credit default swaps, or CDSs, are quasi-insurance products bought by investors seeking protection against defaults on mortgage-backed securities and other credits.
In contrast to the remarkable profits it had tallied until 2007, the AIG subsidiary headed by Cassano began to report quarterly losses. The unit went from being star performer to vortex of a gathering nightmare.
On April 1 Cassano was nudged into retirement. In keeping with the bubble-time executive compensation practises established in the City and on Wall Street, however, the blow was softened. Cassano was allowed to continue using the company flat behind Harrods. He was given a consultancy and, according to former AIG chief executive Martin Sullivan, testifying to the US Congress, helped AIG unwind the rapidly devaluing CDSs held by AIG Financial Products. Cassano’s pay for this work was $1m a month for nine months.
On September 16 the American insurer suffered a liquidity crisis following the downgrade of its credit rating. AIG had to beg the Federal Reserve Bank for an $85bn credit facility in return for giving up 80 per cent of its equity to the US government. This poured fuel on the fire ignited by the bankruptcy of Wall Street investment bank Lehman Brothers a day earlier.
A Sunday Telegraph investigation has determined, however, that there is a row brewing between the scores of regulators responsible for AIG’s activities in 130 countries. In the forefront of this row stands Britain’s financial regulator, the Financial Services Authority.
The operations of Cassano and his colleagues at 1 Curzon Street are attracting the attention of government officials in Washington, New York and Paris as well as London. Bumbling by the FSA, according to regulators in other countries, may have played an instrumental role in sparking the credit crunch that brought the global financial system to the brink of collapse.
This is already making political waves. Distancing himself and his government from the bad news, the Prime Minister Gordon Brown has repeatedly contended the financial crisis was made in the USA – where poor Americans in Rust Belt cities like Cleveland and Detroit fell behind on mortgage payments.
The reality has always been more complex. A financial chain links American sub-prime mortgages to the packagers and sellers of those mortgages in the City, as well as on Wall Street.
Now the role of AIG’s London office, and the FSA in overseeing what went on inside it may change all that.
“We need an inquiry to establish what happened with the FSA’s regulation of AIG’s London operation,” Cable said.
Since AIG’s collapse in September, insurance regulators in various jurisdictions have played pass the parcel, each regulator seeking to distance itself from the CDS firm’s London business, according to politicians in Washington, such as the US Congress’s Waxman, as well as here.
The spectacle is reminiscent of the regulatory response to the collapse in the early 1990s of BCCI, a bank with operations in London, Luxembourg and the Middle East. BCCI regulators in its multiple jurisdictions, including London, dodged responsibility for not spotting BCCI’s $10bn fraud by blaming each other.
On Friday, Adair Turner, the FSA’s chairman, declined to answer questions about AIG’s London operation.
Meanwhile, people close to the City regulator explained that AIG Financial Products, the unit responsible for the insurer’s failure, fell outside its jurisdiction.
Under FSA rules, these people said, AIG Financial Products was deemed an “internal treasury operation” and, like the internal treasury operations of other companies, was not regulated.
But the FSA does have regulatory oversight responsibility for a number of AIG units in London, including a company called AIG FP Capital Management registered at 1 Curzon Street.
People close to the FSA said AIG FP Capital Management is a separate company from AIG Financial Products and is not involved in the business of creating credit default swaps.
There is little doubt, nevertheless, that US lawmakers consider London an epicentre of the AIG Financial Products disaster. During the hearing into the causes and effects of the AIG bail-out on October 7, the US House of Representatives Oversight Committee, led by Congressman Waxman, politicians pmentioned [sic] London a dozen times. California Congresswoman Jackie Speier referred to AIG’s Mayfair business as “the casino in London”.
Testimonies by former AIG chief executives Martin Sullivan and Robert Willumstad, along with a New York Times article on September 28, sketch the story of the AIG Financial Products unit in London.
It was originally staffed by executives, including Cassano, from defunct Wall Street investment bank Drexel Burnham Lambert. Drexel’s legendary junk bond king, Michael Milken, was investigated for insider trading in the 1980s and pleaded guilty to six charges.
In contrast to standard practice, however, AIG Financial Products did not hedge its exposure to a possible fall in the CDS market. In a footnote to AIG’s 2007 accounts spotted by Forbes magazine, the company declared: “In most cases AIGFP does not hedge its exposures to credit default swaps it has written.”
Last November, when AIG’s accountants asked the insurer to change the way it valued CDS’s, the comparatively small base of capital on which AIG Financial Products had built a mountain of business became visible. This began the unravelling that led to AIG’s central role in sparking the global financial crisis.
To date, no British authorities have said anything about AIG. In the US, in contrast, there are multiple investigations. In addition to the October 7 Congressional hearing into AIG, the insurer’s London business is now under scrutiny by the Office of Thrift Supervision in Washington and the New York State Department of Insurance in Manhattan.
Last week New York State Attorney General Andrew Cuomo sent a letter to AIG informing the company it was under investigation for “irresponsible and damaging” expenditures, among other things, for executive compensation packages that were not cut even as AIG drew down on the Federal Reserve’s $85bn credit facility to keep itself afloat.
Although the FSA will not comment on AIG Financial Products, there are indications from America that it is belatedly looking into the unit’s operations.
“There have been meetings and conversations” between Washington’s Office of Thrift Supervision and the FSA,” said Janet French, a spokeswoman for the Washington agency.
A person close to the New York State Department of Insurance said: “You can be certain there have been talks with the FSA.”
I did a little bit of reading on the FSA. They seem innocuous enough-- seemingly civic-minded government regulators. But I suspect they are like the US FEC-- overworked, understaffed, and likely subject to political pressure over which companies to investigate and which to avoid. Plus there is this legal gray area of jurisdiction that sleazy international companies take advantage of that made the situation worse.