There were also concerns raised about AIGFP’s ability to provide the necessary collateral from inside AIGFP itself. Joseph W. St. Denis, AIGFP’s vice president for accounting policy from June 2006 and a former assistant chief accountant at the SEC’s division of enforcement, got worried when he came back from vacation in early September 2007 and heard about “a multi-billion-dollar margin call on certain” super-senior credit-default swaps that AIG had written. “I was gravely concerned about this, as the mantra at AIGFP had always been (in my experience) that there could never be losses on the” super-senior credit-default swaps. He later told the FCIC that when he first heard about Goldman’s collateral call, he was so upset that he “had to sit down.” He worried that AIGFP could be in “potentially material liability position” as a result of the increasing collateral demands. Before the month was out, after several profanity-laced tirades delivered by Cassano to St. Denis, Cassano told him, “I have deliberately excluded you from the valuation of the Super Seniors because I was concerned that you would pollute the process” by questioning too closely the accounting for the swaps. (Cassano denied to the FCIC having said this to St. Denis.) When St. Denis resigned on October 1, he told AIGFP’s general counsel that he “had lost faith in the senior-most management of AIGFP and could not accept the risk to AIG and myself of being isolated from corporate accounting policy personnel, especially given the situation with the” super-senior credit-default swaps.
Much to Cassano’s further consternation, Goldman wasn’t going away, either. “For 14 months [from July 2007], Goldman pressed its case,” the FCIC reported, “and sent AIG a formal demand letter [for collateral] every single business day. It would pursue AIG relentlessly with demands for collateral based on marks that were initially well below those of other firms—while AIG and its management struggled to come to grips with the burgeoning crisis.” Not surprisingly, Goldman was becoming increasingly frustrated by AIG’s failure to own up to its agreements to make good on the insurance it had issued on the mortgage securities. “We couldn’t get AIG to give us their line by line prices [on the securities],” one Goldman trader recalled. “We couldn’t get them to commit to getting on the phone within a reasonable period of time even to discuss it.” Despite the tough early August conversation between Sundaram and Forster, Goldman reduced the collateral call to $1.6 billion, then to $1.2 billion and then to $600 million. “That told me something was up with their numbers,” Cassano said. “This market is so difficult, the markets are roiling to say the least. Even Goldman Sachs—a pretty good outfit—was having a hard time getting the numbers themselves.” Before Cassano left for a late August cycling vacation in Germany and Austria, he suggested paying Goldman a “good faith” $300 million deposit. Goldman countered with a demand for a $450 million deposit, which Cassano agreed to provide on August 10. In a side letter that same day, AIGFP and Goldman further stipulated that the $450 million did not resolve the collateral dispute between the two firms. “The idea was to get everyone to chill out,” Frost wrote to Forster, explaining why AIGFP had decided to give the money to Goldman. “[B]ut we were to start thinking about how to deal with this on a more permanent basis.” Soon thereafter, Cassano was off on his bicycling vacation.
On August 15, Alan Frost went to 85 Broad Street to meet with Goldman executives “to show good faith,” he wrote Andrew Forster the next day, and “at least start the dialog.” He reported that the conversation “was fine. Everybody wants this to go away, but the primary focus is to think if we can establish a better way of dealing with it if we need to again.” Frost was especially concerned with trying to figure out how the two firms would come to an agreement about the underlying value of the securities that AIGFP had insured. The obvious gulf between the two firms was causing much consternation.
Before he left on vacation, Cassano had spoken by telephone to Michael “Woody” Sherwood, a co-CEO of Goldman Sachs International, and other Goldman executives seemed to think the two men had agreed that the matter of valuation would be best resolved by going to the market and getting a bid on $10 million worth of mortgage-backed securities. Frost was concerned that this might not have been what Cassano agreed to with Sherwood, especially since “[w]e run the risk that the market interprets it more [a]long the lines of the way Goldman thinks than the way we think.” He was also nervous that Goldman was not “happy about the notion of zero progress until labor day”—“one of the reasons I went in for a face to face,” he wrote—but that he “made it unambiguously clear” to Goldman “that I was not going to disturb him”—Cassano—“on his holiday for this.” Concluded Frost: “[W]e should be thinking of how we are going to deal with this, because, trust me, this is not the last margin call that we are going to debate.”
In response, Forster wrote to Frost that although he had “no colour” on the conversation between Cassano and Sherwood and that the “whole idea was to leave it for a few weeks” until after Labor Day. “I have heard several rumours now that [GS] is aggressively marking down asset types that they don’t own so as to cause maximum pain to their competitors. It may be rubbish but it’s the sort of thing [GS] would do.”
Things quieted down in the markets and between Goldman and AIGFP until September 11 when Goldman asked for another $1.5 billion in collateral based on its marks. By then, AIGFP executives had also become convinced that Goldman’s marks were influencing the marks—and resulting collateral calls—of other banks. Cassano was telling his colleagues that one collateral call, by French bank Société Générale, “had been spurred by Goldman.” In his subsequent testimony before the FCIC, Cassano said that Sherwood had told him—in their August 2007 conversation—that Goldman’s marks may have been too low initially “but that the market’s starting to come our way.” Still, Cassano said Sherwood told him, Goldman “didn’t cover [them]selves in glory during this period.”
Regardless, Goldman ratcheted up the amount of insurance it bought against the possibility that AIG itself would not make good on what it owed Goldman. On September 13, Goldman bought another $700 million in CDS protection against AIG, bringing the amount of its insurance against the company at that time to $1.449 billion.
On November 1, Cassano wrote to Habayeb that it was clear that AIGFP and Goldman “have a bona fide dispute” and added, “It is not unusual even in the best of times with normal liquidity to dispute the calls.” He noted further that the only other collateral call AIGFP had received had been from Société Générale, the large French bank, “which was spurred by GS calling them. In that case, we also disputed the call and have not heard from SocGen again on that specific call.”
On November 2, Cassano said Sherwood gave him a “heads-up” that Goldman was increasing its collateral call again, to $2.8 billion, in addition to the $450 million it already had. “We’re not going to pay that amount,” Cassano said he told Sherwood. “Yea, I didn’t think you would,” Cassano said Sherwood replied. On November 9, Forster e-mailed Cassano with comparisons between Goldman’s marks and Merrill Lynch’s marks on the same securities: Where Merrill’s marks on a given security were at 95 cents on the dollar, Goldman’s were at between 60 cents and 80 cents. By November 14, both Société Générale and Merrill Lynch had asked AIGFP to post collateral to them as well, in the amounts of $1.7 billion and $610 million, respectively, based largely on the Goldman precedent, according to the FCIC.
By the end of November 2007, Forster had cataloged the extent of its collateral disputes with nine banks and Wall Street firms in an eight-page memorandum. He wrote that because of the “extreme illiquidity” in the market—acknowledged by all the counterparties—the discussions had been “friendly” rather than “disputed,” although that thought seems inconsistent with the ongoing confrontation with Goldman. “All of the dealers feel that as the market is under extreme stress that prices should perhaps be lower but none have any real idea as to how to best calculate the price or if indeed that statement is true,” Forster wrote. “The market is so i
lliquid that there are no willing takers of risk currently so valuations are simply best guesses and there is no two-way market in any sense of the term.”
Despite the caveat, Forster’s analysis of the trades AIGFP had with each firm was quite specific, as were the values of the securities involved. With Merrill Lynch, he noted, AIGFP had close to $10 billion in exposure, in twenty different trades. He noted there was an “8% price threshold”—meaning the price would need to fall to 92 cents on the dollar—“before any posting [of collateral] is required” based on the underlying bond price, not the value of the credit-default swap. As of the end of November, Merrill was asking for $610 million in collateral, but, Forster pointed out, “[W]e are disputing the call with them and they agree prices are too illiquid to be reliable.”
With $23 billion of exposure, Goldman was the Big Kahuna for AIGFP. Goldman was the AIG counterparty on fifty-one different positions, in thirty-three trades. Goldman had also negotiated more favorable terms than its competitors, whereby AIGFP had to start posting collateral mostly when the value of the underlying securities fell to 96 cents on the dollar. “They have made collateral calls totaling $3 bn on 38 positions covering 23 different transactions,” Forster wrote. He then listed the thirty-eight positions and Goldman’s discounted prices for them. There was no mention with Goldman, as there had been with Merrill, of any disagreement or potential dispute resolution. Forster did take note of the price discrepancy of one CDO—Independence V—that Merrill had underwritten in 2004. As of November 2007, Merrill valued Independence V at 90 cents on the dollar, while Goldman valued it at 67.5 cents on the dollar. Cassano sent Forster’s analysis to William Dooley, the head of the AIG division under which AIGFP operated, with the note that despite the disputes, the dealers were working with AIGFP in a “positive framework toward seeking resolution.”
According to Greenberg, “Goldman had the lowest marks on the Street by everything I hear. There was no exchange. Where was the price discovery? It was all in the eye of the beholder.” AIG board members and executives also viewed Goldman’s collateral requests with a high degree of skepticism. Some thought it was nothing more than a way for Goldman to get “a free loan from AIG,” according to one AIG executive. Goldman would announce that it had marked its AIG swap book down by, say, $5 billion and then insist, “Send us a check for $5 billion.” Cassano and Sullivan would explain to the AIG board that Goldman was the only counterparty to be so aggressive about collateral demands. “Goldman’s just taking advantage of the company,” the two men told the board. Explained one former AIG board member about Goldman: “They were the first demanding collateral and their mark[downs] were always much greater than everybody else’s.… Goldman was right on top of it. You have to give them credit for that.”
In short order, Cassano’s house of cards collapsed. On November 7, 2007, AIG announced third-quarter net income of a little more than $3 billion but revealed, deep in the announcement, that AIGFP had suffered a “$352 million unrealized market valuation loss” on its super-senior swap portfolio and that October’s loss alone on that portfolio could be another $550 million pretax. The next day, Cassano told investors there was “opacity in the market” and that valuations for the securities underlying the swaps were all over the place, ranging from 55 cents on the dollar (likely from Goldman) to as high as 95 cents on the dollar. If all the valuations were like Goldman’s and the collateral calls started pouring in, AIG’s write-downs on the swaps would be far greater than the $550 million. But “rest assured,” Cassano said, “we have plenty of resources and more than enough resources to meet any of the collateral calls that might come in.” On November 23, Goldman demanded another $3 billion in cash collateral from AIGFP; AIG “protested,” according to the FCIC, but paid $1.55 billion, bringing the total collateral payments to Goldman to $2 billion. Cassano told the FCIC he decided to make the payment because his boss wanted “to avoid airing dirty laundry” in the market about the disputes. A week later, based on AIGFP’s own calculations and other market input, Cassano phoned Sherwood and demanded the money back from Goldman. In an e-mail summarizing his conversation with Sherwood, he wrote that Sherwood had called him back from “his sick bed” and took the request “in stoic fashion with little push back. He certainly sounded discourage[d]. He did ask, ‘Well, where do we go from here?’ I said, ‘I think you need to pay me back my cash.’ He said, ‘We need to understand your numbers.’ I said, ‘Sure, we can do that.’ He then said, ‘Ugh,’ and said, ‘I guess we will be speaking more next week.’ We hung up on good terms.” But Goldman did not pay the money back to AIGFP and, in fact, increased its collateral demands further.
Toward the end of November, AIG announced it would convene a conference call for investors on December 5 to review the AIGFP portfolio and its view of the risk in it. On November 29, the top executives at both AIG and AIGFP met with Pricewaterhouse, AIG’s auditors, to discuss the ongoing collateral disputes with Goldman. At one point during the meeting, Cassano told Sullivan the AIGFP did not have “the data to dispute Goldman’s marks” but that the disagreement with Goldman had the potential to reduce AIG’s earnings “by $5 billion” in the first quarter of 2008. “Oh, my God!” Cassano said Sullivan exclaimed. “That could wipe out the quarter … I am going to have a heart attack!” (Sullivan later told the FCIC he didn’t recall that part of the meeting.) Timothy Ryan, a PricewaterhouseCoopers partner, told Sullivan at the meeting that in “light of AlG’s plans to hold the investor conference on December 5” that Pricewaterhouse believed there was a growing possibility of a “material weakness” in AIGFP’s credit-default swap portfolio that could result in potentially huge future losses. Such a warning needed to be disclosed to investors, according to SEC rules, but AIG did not disclose the warning for months. In the days leading up to the December 5 call, Cassano was scurrying about in preparation for it and wondering whether he could or should open up the AIGFP black box to investors. “As you know the exposure we have within these transactions is a mark to market, potential replacement cost,” he wrote in a November 28 e-mail to his colleague Robert Lewis. “[A]ll the entities that we have swaps with are highly rated (triple A primarily) and in an event of default or nonpayment we generally become pari passu with the bond holders. Once again an extremely remote risk with little real exposure. No other company of our ilk[—] dealers, bank[s] etc[.—]have gone into explaining these exposures in any detail[.] [T]his is just normal course business with highly rated counterparts. Attempting to explain this segment of the business briefly I worry will only add to the confusion of the audience as they will conflate this exposure with the super senior exposures they have such difficulty coming to grips with. [F]urther this will open a new area where we can spend a lot of time drilling down but will have a bit of a turbulent time as we attempt to get the message clarified.”
On December 5, still in denial, Martin Sullivan and Joseph Cassano gave an Oscar-worthy performance on the investor conference call related to AIGFP’s credit-default swap portfolio—and made no mention of Pricewaterhouse’s comment. “AIG has accurately identified all areas of exposure to the U.S. residential-housing market,” Sullivan said that day. “We are confident in our markets and the reasonableness of our valuation methods.” Added Cassano, in yet another moment of profane understatement: “It is very difficult to see how there can be any losses in these portfolios.” Cassano made no mention of the disputes AIGFP was having with Goldman, and presumably some of the other counterparties, about the posting of collateral. “We have, from time to time, gotten collateral calls from people,” Cassano said at the meeting, according to the transcript. “Then we say to them, ‘Well, we don’t agree with your numbers.’ And they go, ‘Oh.’ And they go away.”
A week later, after a collateral call that came from Calyon, the big French bank, Tom Athan wrote to a colleague, “We are in uncharted waters for our firm. I realize that. I’ve been on [Wall Street] for 17 years, mostly in new derivatives businesses so I know ho
w it goes. We’ll all get better together. Takes time unfortunately.”
On December 14, Forster again tried to get AIGFP’s money back from Goldman. He wrote Neil Wright, at Goldman Sachs International, that “Given the significant amount of collateral in dispute that is held by Goldman, we expect either that you now return to us the amount of the collateral that we have called for, or that you continue next week to engage actively and constructively with us in discussions with us toward resolving the dispute. It would not be appropriate to delay the discussions at this stage.” But the discussions were delayed further by the holidays. Before Christmas, Cassano wrote both Sherwood and Viniar, Goldman’s CFO, that he appreciated getting Goldman’s pricing information from the firm on the various securities but even on a preliminary look he could tell the Goldman prices were too low, compared to the rest of the Street. “[I]t’s already evident that your exposure calculations are significantly higher than is warranted by third party indications that you yourself have provided to us,” Cassano wrote, adding, “You currently hold $2 billion of collateral for these positions, which is demonstrably in excess of what is contractually required.” He told the Goldman executives he wanted to resolve the matter early in January.
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