Joseph Cassano spent his entire career on Wall Street and worked with Drexel Burnham in the 1980s. In the same way that Drexel would collapse in spectacular fashion, so would another firm Cassano worked for, AIG. Unlike the collapse of Drexel – which Cassano had no role in – Cassano would labor long and hard to bring down AIG.
Cassano was the head of AIG’s Financial Products (FP) division headquartered in London. It was AIG FP that ran all of AIG’s trades in mortgage credit default swaps (CDS) or “insurance” on mortgage bonds. See Gary Gorton (#27) for more information on how AIG provided “insurance” to mortgage bonds investors through highly leveraged financial derivatives. Some idea of the enormous leverage in the trades made by AIG FP can be gleaned by this sobering fact; AIG FP never employed more than a few hundred people in London and this mere handful of educated fools was able to run up at least $60-billion in losses!
Cassano and AIG FP had several opportunities to get themselves out of the trade in mortgage bond insurance. In late 2005, Greg Lippmann of Deutsche Bank flew to London to meet with AIG FP and tried to convince AIG to stop selling insurance via credit default swaps. (This was not altruism on Lippmann’s part; if AIG FP stopped selling the insurance, then Lippmann had a trade that would increase in value.) A few months later, in early 2006, an AIG employee named Gene Park actually convinced Cassano to stop issuing new mortgage bond insurance policies. However, Cassano did not make any attempt to reduce AIGs exposure to the bonds they were already insuring. The most likely reason Cassano didn’t reduce AIG’s enormous exposure to mortgage bond risk was the enormous confidence Cassano had in models developed by Gorton, a Wharton finance professor. The misplaced confidence in Gorton’s models would cause tens of billions of dollars in losses and AIG’s bankruptcy.
See Tim Geithner (#24) for more information on the losses incurred by AIG FP in its mortgage trades. See Gary Gorton (#27) for the tremendous amount of confidence AIG management had in Gorton’s models. See Martin Sullivan (#44) for more information on AIG’s leadership.