Page 230 - untitled

THE MADNESS 

CDS protection on subprime mortgage–backed securities. In an email to Cassano on
February , Park wrote:

Joe,
Below summarizes the message we plan on delivering to dealers later
this week with regard to our approach to the CDO of ABS super senior
business going forward. We feel that the CDO of ABS market has in-
creasingly become less diverse over the last year or so and is currently at
a state where deals are almost totally reliant on subprime/non prime
residential mortgage collateral. Given current trends in the housing
market, our perception of deteriorating underwriting standards, and
the potential for higher rates we are no longer as comfortable taking
such concentrated exposure to certain parts of the non prime mortgage
securitizations. On the deals that we participate on we would like to see
significant change in the composition of these deals going forward—i.e.
more diversification into the non-correlated asset classes.
As a result of our ongoing due diligence we are not as comfortable
with the mezzanine layers (namely BBB and single A tranches) of this
asset class. . . . We realize that this is likely to take us out of the CDO of
ABS market for the time being given the arbitrage in subprime collat-
eral. However, we remain committed to working with underwriters and
managers in developing the CDO of ABS market to hopefully become
more diversified from a collateral perspective. With that in mind, we
will be open to including new asset classes to these structures or in-
creasing allocations to others such as [collateralized loan obligations]
and [emerging market] CDOs. 

AIG’s counterparties responded with indifference. “The day that you [AIG] drop
out, we’re going to have  other people who are going to replace you,” Park says he

was told by an investment banker at another firm. In any event, counterparties had
some time to find new takers, because AIG Financial Products continued to write the
credit default swaps. While the bearish executives were researching the issue from
the summer of  onward, the team continued to work on deals that were in the
pipeline, even after February . Overall, they completed  deals between Sep-
tember  and July —one of them on a CDO backed by  subprime
assets. 
By June , AIG had written swaps on  billion in multisector CDOs, five

times the 8 billion held at the end of . Park asserted that neither he nor most
others at AIG knew at the time that the swaps entailed collateral calls on AIG if the
market value of the referenced securities declined. Park said their concern was sim-

ply that AIG would be on the hook if subprime and Alt-A borrowers defaulted in
large numbers. Cassano, however, told the FCIC that he did know about the possible