An exhaustive Wall Street Journal investigation has revealed what everyone already knew about AIG: They bellied up to the craps tables, rolled the dice, and lost the firm.
No, they didn’t think of it that way at the time. They thought they were excercising the utmost caution, hiring a Wharton/Yale professor to build “risk models,” writing insurance on bonds that would never default, etc. We assume that, when the AIG autopsy is finally complete, AIG’s “risk models” will be shown to have taken about a decade of history into account, that a scenario like the current one was never considered (even though world history has produced dozens of them in the past hundred years), and that AIG either 1) had no idea how much risk it was taking, or 2) didn’t care. In fact, if the investigation reveals anything different, it will be shocking.
But the WSJ does reveal details that are already shocking, at least as far as the colossalness of AIG’s stupidity is concerned.
AIG’s risk models, the WSJ says, analysed only the likelihood that AIG would be forced to pay off credit default swap policies insuring bond defaults. They did not, reportedly, analyse the possibility that AIG would have to post collateral in the event of the decline in value of bonds that had yet to default–despite the fact that AIG was contractually obligated to do so.
In other words, AIG’s PhDs analysed only the most unlikely risk the company faced–defaults–and not a far more likely risk: That the value of the bonds it was insuring might decline, forcing it to come up with more capital as collateral.
Is it really possible that AIG’s managers could have been that stupid? Is it really possible that NO ONE in the organisation other than Joseph Cassano (the man who killed AIG and then “retired” with a consulting fee of $1 million a month) understand how huge a risk this created?
After two decades in and around the financial services industry, we are rarely surprised by the monumental stupidity the industry displays in every boom and bust cycle, and we’ve been plenty stupid ourselves. But if the Wall Street Journal’s report is accurate, AIG’s behaviour takes the cake.
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