What I Told Jamie Dimon, Warren Buffett and the Wall Street Journal about AIG, a Year Before the Financial Crisis

By Janet Tavakoli

In August 2007, the Wall Street Journal's David Reilly called for hot news.* I replied that AIG had material mark-to-market losses for the second quarter of 2007, yet it took no write-downs whatsoever for its credit default swaps on underlying mortgage related "super senior" collateralized debt obligations (CDOs). I looked at one aggregate position of credit default swaps (CDSs) amounting to more than $19 billion.** The mark-to-market losses were just one part of the problem. Since too many of the assets backing the position had high risk of severe principal losses, it also had a lot of "cliff risk," as in falling off of one. AIG had a grave problem just from this position alone, and AIG had other serious problems.

Initially, I agreed to talk to Reilly on background, but I didn't want to be named or quoted. AIG vigorously denied it would ever take a write-down or a loss on the CDSs, much less one that was material to its earnings statement. Reilly called me again asking if I were sure. I said I was positive. He called AIG again and then me, asking for a quote this time. I didn't want to get into a fight with AIG in the "Heard on the Street" column and reminded Reilly that I only agreed to talk to him on background. Reilly's editor, called me and said that given that AIG's denial was so forceful, the paper needed me to go on the record. I know and trust this editor, so I agreed. Reilly quoted me but omitted that I said the difference was material. Even the Wall Street Journal hesitates to use the word "material" to describe an accounting misstatement. It guarantees a conference call with lawyers.

I called Warren Buffett about my concerns, but stuck to the public information already in the article. (Dear Mr. Buffett Pp. 164-165, 246).

I stuck my neck out and met with Jamie Dimon, CEO of JPMorgan Chase, adding that the difference was material. JPMorgan Chase's credit derivatives positions exceeded those of all other U.S. banks combined at the time. JPMorgan was not a participant in the problematic deals, and it was not a recipient of AIG's subsequent settlement payments, but stability in the credit derivatives markets was an important issue. Jamie dismissed my explanation of the looming cliff risk and said he understood CDOs. (Dimon later said he wished he had listened to me back then.) In August of 2007, he did not want to contemplate a potential implosion of AIG.

Goldman Knew (or Should Have Known) the Consequences

Unbeknownst to me at the time, in July 2007, Goldman Sachs and AIG began a prolonged battle over prices and collateral payments. In February 2008--six months after Reilly's Wall Street Journal article--PricewaterhouseCoopers (PWC) said it found "material weakness" in AIG's accounting. PWC was also Goldman Sachs's auditor. Goldman hedged against the possibility that AIG could go bankrupt and also extracted billions more in collateral from AIG before the crisis. By September 2008 initial bailout, Goldman Sachs had extracted $7.5 billion in collateral from AIG against these trades.

Goldman should have been well aware of the cliff risk posed by CDOs that it hedged with AIG. Moreover, Goldman created CDOs that other banks hedged with AIG, including some hedged by French banks Calyon and Societe Generale. In fact, Goldman Sachs was a key architect of AIG's crisis.

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