Joseph Cassano has been referred to as 'patient zero' of the global financial crisis. He ran AIG's Financial Products Division for many years. Under his watch, AIG sold credit default swaps (CDSs; a bit like insurance) on securities tied to the US housing market. These CDSs were part of the reason AIG needed to be bailed out in September 2008. If there is a quote that perhaps embodies the hubris before the crisis, it was Cassano's quip, in August 2007, that:

It is hard for us, without being flippant, to even see a scenario within any kind of realm of reason that would see us losing one dollar in any of those transactions.

It was with some incredulity that observers witnessed Cassano's appearance at the Financial Crisis Inquiry Commission (FCIC) in 2010, where he claimed:

I think there would have been few, if any, realized losses on the CDS contracts had they not been unwound in the bailout.

In his testimony, Cassono painted a picture of a liquidity squeeze. As the prices of the securities upon which the CDSs were based fell, AIG had to hand over collateral to their counterparties. They were asked to hand over a lot – more than they had, which necessitated the bailout. But, Cassano's testimony indicates that he thought there was nothing fundamentally wrong with the CDSs they sold. I guess he interpreted those price movements as temporary, and that everything would return to normal at some point.

I always thought that claim was odd, but I had not seen proof that he was wrong. I certainly lack the accounting expertise to find out myself. That is why a recent paper in the Journal of Economic Perspectives by Robert McDonald and Anna Paulson is really helpful (I've confessed my love for the journal before). These researchers (and others) have done the hard work so you and I don't have to. And the findings are grim. So far, those securities that the CDSs were written against have lost at least $10 billion.

But the article also points out some things that are perhaps not as well known about AIG. First, another large source of AIG's losses were from it's securities lending program, not controlled by Cassano. Basically, AIG held some securities, lent them out for cash, and then invested that cash in other securities. In the case of AIG, they invested a 'substantial portion' of the cash in 'securities dependent on the performance of subprime residential mortgages.' Whoops.

Second, the article points out that AIG stopped increasing its CDS exposure to real estate in 2005. Cassano made much of this virtuous decision in his testimony to the FCIC. However, as the article points out, because of the nature of the securities insured, AIG still had exposure to the disastrous mortgages that were made in 2006 and 2007. While AIG's decision in 2005 could have been worse, other decisions could have been a lot better!

Photo by Flickr user woodleywonderworks.