Felix Salmon

How AIG FP brought down the world

By Felix Salmon
July 2, 2009

Michael Lewis is back in Vanity Fair, with a really good article about Joseph Cassano and AIG Financial Products. Or half of a really good article, at any rate — the second half of the story is fantastic, and gives by far the best English-language account of what happened at FP and how Cassano, by commission and omission, enabled it. (The piece isn’t online, just a précis — I do hope VF gives up this annoying habit soon.)

There’s a bit too much irrelevant throat-clearing at the beginning of the piece, though, and there’s also this very peculiar passage:

The public explanation of AIG’s failure focused on the credit-default swaps sold by traders at AIG FP, when AIG’s problems were clearly broader. There was the mortgage-insurance unit in North Carolina, United Guaranty, that had taken on all sorts of silly risks in the past two years, lost several billion dollars, and replaced their CEO. There were the fund managers at AIG, the parent company, who had blown nearly $50 billion in trades in subprime mortgages — that is, they had lost more than AIG FP, whose losses stood at around $45 billion.

Later on in the piece, after it starts getting good, Lewis explains how “if it hadn’t been for AIG FP the subprime-mortgage machine might never have been built, and the financial crisis might never have happened”. So doesn’t it make perfect sense for the public explanation of AIG’s failure to focus on FP? After all, as Lewis shows, FP literally had no idea what it was doing. He tells the story of Gene Park, who examined FP’s business at the end of 2005 and found that it was insuring deals which were 95% subprime:

Park then conducted a little survey, asking the people around AIG FP most directly involved in insuring them how much subprime was in them. He asked Gary Gorton, a Yale professor who had helped build the model Cassano used to price the credit-default swaps. Gorton guessed the piles were no more than 10 percent subprime. He asked a risk analyst in London, who guessed 20 percent. He asked Al Frost [FP's main liaison to Wall Street], who had no clue.

Cassano simply trusted the models (which were built with a lot of Gorton’s help), even when the models weren’t designed for subprime in particular, or even really for mortgages.

I guess the message of Lewis’s piece is that FP caused the global financial crisis, even if it didn’t necessarily cause the complete downfall of AIG — that AIG ended up buying in to the bubble created by FP, just companies like Citigroup and Bear Stearns did. Or, to put it another way, FP brought down the financial markets, and the crashing financial markets brought down AIG. You can blame the end of the world on Cassano, but there were a lot of people inside AIG but outside Cassano’s little group who ended up buying into the markets he helped to create and inflate.

8 comments so far | RSS Comments RSS

Someone has posted a copy of the Vanity Fair article to Scribd at: http://www.scribd.com/doc/17017708/vf-ar ticle. Yves Smith linkeed to it.

Posted by AndrewBW | Report as abusive

I’m pushing this post on Bloomberg. It helped me:

http://www.bloomberg.com/apps/news?pid=2 0601170&sid=afDX3.N1Kdgw

“What brought the company down, Pasciucco says, was its exposure to fewer than 200 insurance contracts that were sensitive to AIG’s credit ratings and the value of the underlying CDOs.

Pasciucco’s job is to extricate AIG from tens of thousands of derivatives contracts, or trades, entered into by what amounted to a hedge fund within the insurance company — one whose managers worked independently and took home 30 percent of the profits. No winding down on this scale has ever been attempted. The effort that comes closest may be the dismantling of hedge fund Long-Term Capital Management LP, which in 1998 lost more than 90 percent of its value amid the Russian bond default. ”


“Some of the most treacherous deals are also the longest dated. In the first quarter, the number of trades lasting more than 50 years was cut to 11 from 67. Pasciucco notes that his predecessors didn’t shy away from complicated derivatives.

“They were often combining commodity risk with equity risk and with puts and calls,” he says. “They were very comfortable with complexity.”

Read it and see.


The confidence that these people placed in their statistical models was absurd. They forgot the wisdom expressed by Disraeli:

“There are three kinds of lies: lies, damned lies and statistics”

-Attributed to Benjamin Disraeli (1804-81), British statesman and Prime Minister (1868, 1874-80), in:

Mark Twain (Samuel Langhorne Clemens), U.S. writer and humorist (1835-1910), Autobiography, “Notes on Innocents Abroad”

Posted by Steve Numero Uno | Report as abusive

Grr. Works on scribd, but not in Acrobat. No Kindle DX love.


Mea culpa. Chrome can’t handle scribd well.


the unfortunate consequence of this delusional and destructive behavior has been to undermine the trust the global markets had in our economy// how long do we think the chinese and other countries are going to keep accepting our paper currency to pay for natural resources ie oil & value added products// these countries already have more of our currency than they can possibly spend//at some point china et al will want tangible assets instead of paper// we will see the emergence of bartering of physical goods

Posted by cgortiz | Report as abusive

we are witnessing the deathrattle of paper currency and the re emergence of bartering// how long will china and other countries accept paper money ie the us dollar in return for oil and value added goods // they already have more currency than they can possibly spend //soon they will demand tangible assets in return for any product we buy//thats when the real nightmare begins


Felix – Michael Lewis’ piece on AIG FP was good but it was far from original reporting. In fact the picture he put together has been out there for some time now in bits and pieces…he seems merely to have aggregated it all while also deeming it the “original story as told by insiders at AIGFP”.
For instance, the Washington Post ran a 3 part series late last year charting the evolution and denigration of AIG FP’s corporate culture from the time of Howard Sosin to the time of Joe Cassano.
Part 1 – http://www.washingtonpost.com/wp-dyn/con tent/article/2008/12/28/AR2008122801916_ pf.html; Part 2 – http://www.washingtonpost.com/wp-dyn/con tent/article/2008/12/29/AR2008122902670_ pf.html; Part 3 – http://www.washingtonpost.com/wp-dyn/con tent/article/2008/12/30/AR2008123003431_ pf.html
Carole Loomis took great pains to detail how AIG thought there was no default risk but did not even contemplate market risk (fall in the value of these securities would expose it to massive collateral calls); others have made this point too; Carol also pointed out how AIG’s securities lending ops and other insurance units also made stupid bets on subprime mortgage bonds – http://money.cnn.com/2008/12/23/news/com panies/AIG_150bailout_Loomis.fortune/ind ex4.htm
And finally, you explained in your regional broker dealer conference speech how a whole lot of risky subprime mortgage bonds got crammed into these CDOs that through a faith-in-models approach adopted by everybody got rated AAA and how AIG was the main counterparty that helped make the market for these trades
I generally admire Lewis’ work – his Iceland piece and his take on the whole subprime debacle in Portfolio were excellent. This article though, despite all the hype around it, is really not that original – it’s as you said a lot of throat clearing and beyond that simply a summary of all the various issues underlying the collapse of AIGFP that have already been reported.

Posted by Kamran | Report as abusive

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