Joseph Cassano — the guy who ran the AIG unit that sold all those credit default swaps — is testifying today before the Financial Crisis Inquiry Commission.
Basically, he says, AIG might have been just fine if the government hadn't stepped in to bail the company out — a bailout that centered on the company's credit default swaps and has cost taxpayers more than $100 billion.
Here's a key paragraph from Cassano's testimony:
As I look at the performance of some of these same CDOs in Maiden Lane III, I think there would have been few, if any, realized losses on the CDS contracts had they not been unwound in the bailout.
Here's what all that jargon means:
CDS contracts are credit default swaps. They are like insurance policies that pay off when a borrower defaults on a loan.
CDOs are complex bonds ultimately backed by mortgages.
Maiden Lane III is the special company created by the New York Fed as part of the AIG bailout. Maiden Lane bought CDOs that were insured by credit default swaps sold by AIG.
So what Cassano is saying here is: It turns out, those bonds we were insuring, and that led to the bailout, did just fine.
But what ultimately triggered the bailout wasn't the long-term status of the bonds. It was AIG's short-term ability to come up with cash.
Cassano left AIG in February 2008, months before the bailout. By that time, worries were already mounting about the risks the company was facing because of credit defaults.
As the housing market deteriorated further, the people who had bought CDS contracts from AIG demanded that the company put up more collateral. Ultimately, it looked like AIG wouldn't be able come up with enough money to meet all these calls for collateral. That's what led to the bailout.
Cassano doesn't address this situation directly. But he does note that, before he left the company, he aggressively challenged calls for collateral. As a result, he says, "we got steep reductions in the called-for amounts from all counterparties who made the largest calls."
Not everybody agrees with Cassano.
Stephen Kohlhagen, a former Wall Street exec and derivatives expert, testified that AIG's sale of $80 billion in unhedged CDS's was "an act of incredible corporate irresponsibility" and a "bubble enabler."
AIG's chief risk officer Robert Lewis testifed that "we were wrong about how bad things could get. What ended up happening was so extreme that it was beyond anything we had planned for."
But Lewis, like Cassano, said the ultimate problem was a liquidity crunch — and that, "given more time, the values would have been expected to come back."