instead, was a blood feud among insurance royalty.
Jeffrey Greenberg, his son, a graduate of Brown and Georgetown Law, had been groomed to succeed Hank. But in 1995, after a series of clashes with his father, Jeffrey left AIG, where he had worked for seventeen years. Two weeks earlier, his younger brother, Evan, had been promoted to executive vice president, his third promotion in less than sixteen months, establishing him as a rival to Jeffrey. With the departure of his brother, Evan, a former hippie who for many years had shown no interest in following his father into the business, was clearly the heir apparent. Yet Evan soon ran afoul of a patriarch who could not surrender any power and, like Jeffrey before him, bolted the company. Jeffrey would go on to become chief executive of Marsh & McLennan, the biggest insurance broker in the world, while Evan became CEO of Ace Ltd., one of the world’s largest reinsurers.
Ultimately it was clashes with regulators, not family members, that led to the downfall of Hank Greenberg. Headstrong and combative as ever, Greenberg simply picked the wrong time to take a stand against the feds. After the collapse of Enron and a procession of corporate scandals that dominated the front pages at the start of the new century, regulators and prosecutors became emboldened to come down hard on companies that were proving to be uncooperative. In 2003, AIG agreed to pay $10 million to settle a lawsuit brought by the Securities and Exchange Commission that accused the company of helping an Indiana cell phone distributor hide $11.9 million in losses. The settlement figure was relatively high, as the SEC acknowledged at the time, because AIG had attempted to withhold key documents and initially gave investigators an explanation that was later contradicted by those documents.
The following year, after yet another long tussle with federal investigators, AIG agreed to pay $126 million to settle criminal and civil charges that it had allowed PNC Financial Services to shift $762 million in bad loans off its books. As part of that settlement, a unit of AIG was placed under a deferred prosecution agreement, meaning that the Justice Department would drop the criminal charges after thirteen months if the company abided by the terms of the settlement. (After the indictment of the giant accounting firm Arthur Andersen had led to its collapse, the government preferred the softer cudgel of deferred prosecution agreements as a kind of probation—an approach that had previously been more common in narcotics cases.)
It was the AIG unit that had been placed on probation for thirteen months—AIG Financial Products Corp., or FP for short—that became Ground Zero for the financial shenanigans that would nearly destroy the company.
FP had been created in 1987, the product of a remarkable deal between Greenberg and Howard Sosin, a finance scholar from Bell Labs who became known as the “Dr. Strangelove of Derivatives.” A great deal of money can be made from derivatives, which are, in simplest terms, financial instruments that are based on some underlying asset, such as residential mortgages, to weather conditions. Like the bomb that ended the film
Sosin had been at Drexel Burnham Lambert, Michael Milken’s ill-fated junk bond operation, but left before that Beverly Hills-based powerhouse folded amid an epoch-defining scandal that drove it into bankruptcy in 1990. Seeking a partner with deeper pockets and a higher credit rating, Sosin fled to AIG in 1987 with a team of thirteen Drexel employees, including a thirty-two-year-old named Joseph Cassano.
Working from a windowless room on Third Avenue in Manhattan, Sosin’s small, highly leveraged unit operated almost like a hedge fund. The early days at the firm were awkward: The wrong rental furniture arrived at the office, and employees had to make do for a while sitting on children’s chairs and working on tiny tables—generating almost immediately, nevertheless, the same immensely profitable returns as they had at Drexel. As was the practice with some hedge funds, the traders got to keep some 38 percent of the profits, with the parent company getting the rest.
The key to the success of the business was AIG’s triple-A credit rating from Standard & Poor’s. With it the fund’s cost of capital was significantly lower than that of just about any other firm, enabling it to take more risk at a lower cost. Greenberg had always recognized how valuable the triple-A rating had been to him and guarded it carefully. “You guys up at FP ever do anything to my Triple-A rating, and I’m coming after you with a pitchfork,” he warned them.
But Sosin chafed under the short management leash that had been placed on the unit and in 1994 left along with the other founders after a falling-out with Greenberg.
(Long before Sosin’s departure, however, Greenberg, infatuated with the profit machine that FP had become, had formed a “shadow group” to study Sosin’s business model in case he ever decided to leave. Greenberg had PricewaterhouseCoopers build a covert computer system to track Sosin’s trades, so they could later be reverse engineered.) After much persuasion from Greenberg, Cassano agreed to stay on and was promoted to chief operating officer.
A Brooklyn native and the son of a police officer, Cassano was known for his organizational skills, not his acumen in finance, unlike most of the talent Sosin had brought with him—“quants,” quantitative analysts, with PhDs who created the complex trading programs that defined the unit.
In late 1997, the so-called Asian flu became a pandemic, and after Thailand’s currency crashed, setting off a financial chain reaction, Cassano began looking for some safe-haven investments. It was during that search that he met with some bankers from JP Morgan who were pitching a new kind of credit derivative product called the broad index secured trust offering—an unwieldy name—that was known by its more felicitous acronym, BISTRO. With banks and the rest of the world economy taking hits in the Asian financial crisis, JP Morgan was looking for a way to reduce its risk from bad loans.
With BISTROs, a bank took a basket of hundreds of corporate loans on its books, calculated the risk of the loans defaulting, and then tried to minimize its exposure by creating a special-purpose vehicle and selling slices of it to investors. It was a seamless, if ominous, strategy. These bond-like investments were called insurance: JP Morgan was protected from the risk of the loans going bad, and investors were paid premiums for taking on the risk.
Ultimately, Cassano passed on buying BISTROs from JP Morgan, but he was intrigued enough that he ordered his own quants to dissect it. Building computer models based on years of historical data on corporate bonds, they concluded that this new device—a credit default swap—seemed foolproof. The odds of a wave of defaults occurring simultaneously were remote, short of another Great Depression. So, absent a catastrophe of that magnitude, the holders of the swap could expect to receive millions of dollars in premiums a year. It was like free money.
Cassano, who became head of the unit in 2001, pushed AIG into the business of writing credit default swaps. By early 2005, it was such a big player in the area that even Cassano had begun to wonder how it had happened so quickly. “How could we possibly be doing so many deals?” he asked his top marketing executive, Alan Frost, during a conference call with the unit’s office in Wilton, Connecticut.
“Dealers know we can close and close quickly,” Frost answered. “That’s why we’re the go-to.”
Even as the bubble was inflating, Cassano and others at AIG expressed little concern. When in August of 2007 credit markets began seizing up, Cassano was telling investors, “It is hard for us, without being flippant, to even
