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FCIC Interview of Gary Gorton, May 11, 2010

United States of America
Financial Crisis Inquiry Commission

INTERVIEW OF
GARY GORTON

Tuesday, May 11, 2010

*** Confidential ***

Financial Crisis Inquiry Commission
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FCIC Interview of Gary Gorton, May 11, 2010

INTERVIEW OF
GARY GORTON

Date:
Tuesday, May 11, 2010

Location:
Milbank, Tweed, Hadley & McCloy LLP
1 Chase Manhattan Plaza
New York, NY 10005-1413
United States of America

Participants:
Professor Gary Gorton
Dorothy Heyl, Milbank, Tweed, Hadley & McCloy LLP
Andrew Tomback, Milbank, Tweed, Hadley & McCloy LLP
Thomas Santoro, Milbank, Tweed, Hadley & McCloy LLP
Dixie Noonan, FCIC
Clara Morain, FCIC
Al Crego, FCIC (by phone)
Mike Easterly, FCIC (by phone)

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FCIC Interview of Gary Gorton, May 11, 2010
Tuesday, May 11, 2010
MS. NOONAN:

Thank you for letting us come and

use your office space to do this.
So, you know who we are.

You came and

presented at the forum that the Commission held in
February in D.C. and I know that you have been in
contact with other members of our staff on various
issues.

So, I appreciate your taking the time to meet

with us today, specifically about your role at American
International Group Financial Products.

And just wanted

to start there and get you to tell us a little about
when you got involved with AIG-FP and the nature of, I
believe it was a consulting role, but if you could just
fill us in on the details.
MR. GORTON:

That’s pretty much it.

started in the spring of 1996.

I mean, I

I’m not sure what month

and I was hired as a consultant without really much of a
mandate.

That’s it.
MS. NOONAN:

I’m assuming they brought you on

for some reason.
MR. GORTON:

They had a financial economist

from Wharton before me who had left and gone to Goldman,
and they wanted someone to replace him.
MS. NOONAN:

Okay, and what did he do?

MR. GORTON:

Do you mean when he was at AIG?
3

FCIC Interview of Gary Gorton, May 11, 2010
MS. NOONAN:

Yes, for the company.

MR. GORTON:

I don’t know what he did.

There’s –- I just have no idea.
MS. NOONAN:

Once you got there, what sort of

things did you start working on for the company?

And

I’m assuming you worked out of the Wilton, Connecticut,
office; is that right?
MR. GORTON:

Well, it was at Westport, yes, at

MS. NOONAN:

Okay.

MR. GORTON:

You know, I think they had the

the time.

view that I was going to be a resource; but you know, it
was kind of an entrepreneurial environment so you know,
I asked a lot of questions, started talking to people,
and, you know, that’s what everybody there did.
MS. NOONAN:

So, what kind of business was

AIG-FP engaged in when you started there?
MR. GORTON:
derivatives house.
FX derivatives.

It was at the time completely a

It did interest-rate derivatives,

It was still very close to its roots.

It started as a long-dated derivatives place.

And it

was clear that that was not going to be the future, that
nobody knew what the future was going to be.

They were

looking at other things.
MS. NOONAN:

So you started in the spring of
4

FCIC Interview of Gary Gorton, May 11, 2010
1996.

At the time, you were also on the faculty at

Wharton, is that correct?
MR. GORTON:

Uh-huh.

MS. NOONAN:

Okay.

And how were you

compensated initially?
MR. GORTON:

I was paid by the hour.

MS. NOONAN:

Is that how you were compensated

the entire time you worked at FP?
MR. GORTON:

Yes, I always got paid by the

MS. NOONAN:

And did --

MR. GORTON:

Later, later I got a bonus.

MS. NOONAN:

What year would you have started

hour.

Much

later.

getting a bonus?
MR. GORTON:
don’t know.

I don’t think I even remember.

I

It was certainly, I don’t know, four, five,

six years after I started.
MS. NOONAN:

In the early 2000’s?

MR. GORTON:

Yes, that would be a guess.

MS. NOONAN:

So, I’m sort of curious.

You

said that you just sort of came on to brainstorm and it
was entrepreneurial.
MR. GORTON:

Yes.

MS. NOONAN:

Could you give me a little bit
5

FCIC Interview of Gary Gorton, May 11, 2010
more background on -MR. GORTON:

Well, yes.

I mean we, at the

time I sat next to a guy who had just been hired from
Goldman in Credits so I talked to him at lot, and he
explained -– you know, I asked him what he was working
on and he would tell me.
lot of questions of.

Lots of people I would ask a

MS. NOONAN:

And -Who is person from Goldman who

was working on credit?
MR. GORTON:

Jim Wolf.

MS. NOONAN:

Okay.

MR. GORTON:

He -- so he explained to me —-

you know this was the early days of credit derivatives.
So I asked a lot of questions about that, and we started
thinking about that, and that’s sort of how a whole
group of people started thinking about credit
derivatives.
MS. NOONAN:

So when you first started working

with FP, about how much of your time would you allocate
to that work?
MR. GORTON:

Which work?

Oh.

MS. NOONAN:

As opposed to being a professor,

and the other -MR. GORTON:
week.

Oh, a day a week.

It was a day a

I went there a day a week.
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FCIC Interview of Gary Gorton, May 11, 2010
MS. NOONAN:

One day a week?

MR. GORTON:

Yes.

MS. NOONAN:

And was that consistent

throughout -MR. GORTON:

Yes.

MS. NOONAN:

-- your work at FP?

MR. GORTON:

Yes.

I mean, there was a few

years where I took a leave, and I was there more than a
day a week.

And there was some times when we got really

busy and I would do some work at home.

But otherwise, a

day a week.
MS. NOONAN:

Okay, okay.

I think we now know

that you developed, at some point, a model that the
Financial Products Group used in its credit derivatives
business.

Is that right?
MR. GORTON:

Yes.

MS. NOONAN:

And when did that model -- when

did you develop that model?
MR. GORTON:

My guess, it would be in ’98 or

MS. NOONAN:

And why did you develop the

’99.

model?

Was it your idea?
MR. GORTON:

a quasi academic place.
models.

Was it someone else’s idea?

AIG Financial Products is kind of
So they were very used to

The idea of a model was, you know, how the
7

FCIC Interview of Gary Gorton, May 11, 2010
whole business was —- all the businesses was run.
When I was hired, the CEO was a Ph.D. at
mathematics.

So it wasn’t the kind of place that would

do anything without a model.
MS. NOONAN:

So wasn’t --

What was it that AIG-FP wanted to

do that it needed your model for?
MR. GORTON:

Well, we didn’t know what we

wanted to do in the beginning because it wasn’t a place
that could compete with a firm like Goldman.

So, we

weren’t going to do the same business as Goldman.

So,

eventually we realized that, you know, we would have the
possibility of investing in large portfolios —- pieces
of large portfolios.
So, I mean, AIG Financial Products was an
investor.

There was no clients.

There was nobody --

you know, we weren’t trading for anybody or with any -—
we were an investor.

So -- so the model was developed

to -MS. NOONAN:

When you say you were an

investor -— I’m sorry to interrupt you -- did you see FP
as a proprietary trading organization?
MR. GORTON:
sure what that is.

No.

It wasn’t -- I mean, I’m not

Normally, I think of that as a small

group inside a big bank that trades for the bank.

We

weren’t —- we were completely separate from AIG
8

FCIC Interview of Gary Gorton, May 11, 2010
physically.
business.
with them.

So we didn’t know anything about their
We, you know, the model had to be developed
You know, their risk management was always

working with us.
But, so it wasn’t –- it wasn’t proprietary
trading in the usual sense.

Anyway, so the model was

developed to assess these various portfolio trades.
MS. NOONAN:

In English, please.

MR. GORTON:

It was the —- the -- a large

number of obligations would be referenced and then we
would invest with a derivative in a piece of that.

So

initially it was corporate portfolios.
MS. NOONAN:

Okay.

So, I mean, just to give

you a little —- we are really interested to
understanding how your model works, what it was designed
to do, what it was not designed to do, and how AIG-FP
used it or did not use it in understanding and assessing
the risks involved and taking the investments that it
took and the credit defaults swaps portfolio, and – so
that’s so that I hope you can, can elucidate, you know a
little bit about -- about that as we go, just so you
know that’s sort of -— I really want to understand that.
And I want to understand it from the genesis of the
business all the way through to the end.

And if it

started —- it sounds like you said it started in 1998 or
9

FCIC Interview of Gary Gorton, May 11, 2010
’99.

And it was developed initially to work on —- was

it always collateralized debt obligations -MR. GORTON:

No, no, no, no, no.

MS. NOONAN:

Okay, okay.

MR. GORTON:

No.

No, that was -- that was a

small thing that came at the end.
MS. NOONAN:

Okay, okay

MR. GORTON:

By that time I was working at

commodity futures.
So, originally it was a list of corporate
names.

And this thing would be tranched.

Do you know

that word?
MS. NOONAN:

Uh-huh.

MR. GORTON:

Okay.

So, in the beginning we

worked with the parent company risk officers to develop
a model.

I mean, I came up with the idea for our model,

but they —- we investigated a number of models that you
could buy.

And in fact, they bought one.

that as a way of checking our model.
agreed, they would be happy.

And they used

If the two models

So these models are

actuarial models that calculate the distribution of
losses.

That’s what they do.

And that’s what they were

designed to do, and that’s what they were expected to
do.
The parent company risk officer, Bob Lewis,
10

FCIC Interview of Gary Gorton, May 11, 2010
set the criterion for how these models would be used.
And then later, you know, different versions of the
model were developed for other asset classes.
And then eventually, year later, it was used
for these CDO things.
MS. NOONAN:

Okay.

So when you say it started

out with a list of corporate names –
MR. GORTON:

Uh-huh.

MS. NOONAN:

-- are you saying that was those

were corporate bonds?
MR. GORTON:

No, no.

MS. NOONAN:

Or were those credit default

swaps on a company itself?
MR. GORTON:

No, no.

It’s just a list of

companies’ -MS. NOONAN:

Okay.

MR. GORTON:

-- names.

MS. NOONAN:

Okay.

MR. GORTON:

Right.

So a portfolio is a list

of 200 companies, and there is an amount of money
associated with each one, say, $10 million.
MS. NOONAN:

Where does the amount of money

MR. GORTON:

There is no money.

come from?
It’s just a

number.
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FCIC Interview of Gary Gorton, May 11, 2010
MS. NOONAN:

Okay.

MR. GORTON:

This is derivatives, so there’s

no money; right?
So, we are going to specify this list, we are
going to specify the number of dollars per name, and we
will say, you know, to whomever we are talking to, “We
will protect the senior 60 percent of that portfolio.”
A portfolio has no money, there’s no money,
right?

It’s just a specification of a portfolio.
MS. NOONAN:

What is it based on?

Their stock

price or the -MR. GORTON:

No, no, no.

MS. NOONAN:

-- performance of their bond?

MR. GORTON:

No, no.

MS. NOONAN:

But the list of names have to go

It’s just a list of

names.

in one direction or another; don’t they?
MR. GORTON:

No. No.

The contract says that if enough of these
names default -MS. NOONAN:

Default on what?

MR. GORTON:

There is a credit event.

MS. NOONAN:

Okay.

MR. GORTON:

Right?

They go

bankrupt.

So there is a -- is the
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FCIC Interview of Gary Gorton, May 11, 2010
specified number of events, changed over the years,
which would trigger credit default swap.
And if enough of these -– enough of the
companies on this list go bankrupt and then lose a
certain amount, which can depend on recovery rate and
the bond price and so on, then, you know, somebody
loses.
In my example, it was 200 -- it was what? Two
hundred -- I forget what I said -- $200 million
portfolio.

We took 50 percent.

So somebody would have

to lose $100 million before we would pay out anything.
MS. NOONAN:

And so, essentially there are

people on both sides of this deal.
MR. GORTON:

No there doesn’t have to be.

I

mean somebody has to be receiving the money, but we
don’t have to have the full capital structure, right?
So, suppose you do it with –- I mean with a
CDO, you have to have the full capital structure.
this, you don’t necessarily have to; right?

With

So you

could go to Goldman and say, “I will write protection on
the senior 50 percent of this list, 10 million each.”
And they decide whether they want to do the trade or
not.

We’re investing in that and they are doing

something else.

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FCIC Interview of Gary Gorton, May 11, 2010
MS. NOONAN:

And you would analyze it from the

perspective of, “We don’t think that 50 percent of the
companies on this list are going to go bankrupt.”

And

Goldman, if it is on the other side, would analyze this
saying, “We think that at least 51 percent of these
companies are going bankrupt.”
MR. GORTON:

Well Goldman, you know, has -—

wouldn’t necessarily keep this risk, right?

So, we

don’t -- I don’t know what -MS. NOONAN:

Or whoever they sell it to.

I’m

just trying to understand the -MR. GORTON:

Well, somewhere.

MS. NOONAN:

-- the rationale for the product

to begin with.
MR. TOMBACK:

I think just to be clear.

In

terms of the sides, maybe Gary can explain this perhaps
better, but Goldman’s not of the view that if they buy
this product that 51 percent are going to go bankrupt.
They’re of the view that it’s worth having the
protection against the possibility of that event at the
price that AIG is willing to sell the product.
MS. NOONAN:
MR. TOMBACK:

Understood.
And second, I think what Gary’s

trying to tell you is, is that Goldman, if they have
that product, or they go out and buy that product to
14

FCIC Interview of Gary Gorton, May 11, 2010
match the portfolio that AIG is, you know, offering to
them, may sell it.
MS. NOONAN:

Understood.

MR. GORTON:

So this example --

MS. NOONAN:

I’m just trying to understand

sort of where is idea came from.
MR. GORTON:

What idea?

MS. NOONAN:

The idea to write protection on a

list of 200 names and -MR. GORTON:

Oh, I don’t know where it came

MS. NOONAN:

-- assign -- assign $200 million

from.

to it and then sell protection of 50 percent of it.
mean, it seems so of out of the blue.

I

I mean,

eventually we’ll get to the -MR. GORTON:
us.

The thing, it didn’t start with

I mean it was a whole -MS. HEYL:

It was a basic credit default,

right?
MR. GORTON:

-- there’s a whole market that

developed, right, that -- I’m not sure who started it.
I mean, I know, there’s people outside the industry
who’ve written about this, but I’m not sure they’re
right.

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FCIC Interview of Gary Gorton, May 11, 2010
So I don’t know who started it.

But

they’re -- they’re —- a market requires lots of
participants, so you can’t -- you can’t do these things
unless there’s lots of people -- firms willing to do
this.
So, the way the entire market started was with
single name swaps and then came portfolio trades.
MS. NOONAN:

So your model then, if we take

your example of the early genesis of this at FP —- was
you4 model designed to then figure out where the, quote,
unquote, attachment point would be on the —- whether AIG
is going to write protection on 50 percent or whether it
would write protection of 60 percent or 40 percent.
MR. GORTON:

Well, the –-

MS. NOONAN:

What was the model designed to do

in that scenario?
MR. GORTON:

The model was designed to

calculate a distribution of losses.

So a dollar number

of losses and a probability that you would have that
loss, okay?

And it was designed to do that in a setting

which actually hadn’t happened in human history -— even
now, I suppose -- because it was calibrated to the worst
post World War II recession so that the mean would be
that.

And then you would have this tail, and then where

we would attach was the number that Bob Lewis came up
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FCIC Interview of Gary Gorton, May 11, 2010
with, the chief risk officer at AIG.
He said, “I want you to attach at this point.”
That’s what we’re going to call an acceptable
transaction given that he believe the model was telling
him meaningful information because it agreed with this
other model he’d purchased.
MS. NOONAN:

So your model would spit out --

MR. GORTON:

A distribution, a picture.

A

distribution.
MS. NOONAN:

A graph?

MR. GORTON:

Not a number.

A pic- -- yes, think of it as a graph.
MS. NOONAN:

And it would say --

MR. GORTON:

It would say --

MS. NOONAN:

-- there’s X probability of this

dollar loss.

There’s Y probability of another amount of

dollar loss.
MR. GORTON:

Yes.

And then Lewis said that “I want it to be the
case that 99.85 percent of the time, there is no
losses.”

That was his -- that number -MS. NOONAN:

So the attachment point was

whatever dollar amount correlated -MR. GORTON:

Yes, yes.

MS. NOONAN:

-- to that?
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FCIC Interview of Gary Gorton, May 11, 2010
MR. GORTON:

Yes.

MS. NOONAN:

What did you say, it was?

MR. GORTON:

99.85

MS. NOONAN:

99.85.

98.5?

And how did he come up with that number?
MR. GORTON:
don’t know.

I don’t remember really.

He -- I

I mean, we had -- I mean he had looked at a

lot of models.

I don’t know where he came up with that

number.
MS. NOONAN:

And what was the model he bought

to check yours against?

Vasicek.

MR. GORTON:

It was KMV.

MS. NOONAN:

KMV?

MR. GORTON:

Kealhofer -- somebody, and

model.

It was a model.

What is that?

It was basically a famous

It was the Merton, Robert Merton’s, that won the

Nobel prize.

It was a famous paper he wrote.

that model and implemented it with real data.
Moody’s later bought it.

They took
And

It doesn’t really exist

anymore.
So, so the KMV model was a slightly —- well, a
very different methodology.
idea.

So it was kind of a good

We always built two different models to -- you

know, under different assumptions just to make sure you
getting sort of in the same place.
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FCIC Interview of Gary Gorton, May 11, 2010
So the parent —- I mean, we did that
ourselves, but the parent company said, “Okay, let’s run
this portfolio through your model.
it through this model.

We’re going to run

And we are going to compare.”

And for many years thereafter, the two models were
compared.

And if they didn’t match up very well, we

spent a lot of time trying to figure out why.
MS. NOONAN:

Were the models similar in their

MR. GORTON:

No.

MS. NOONAN:

So they spit out the same thing,

inputs?
No, they weren’t similar.

The KMV --

but they didn’t put in the same thing?
MR. GORTON:

Yes.

Right.

Some of it -- some

of it was the same inputs, but a large part of it
wasn’t.

I didn’t like the KMV model.

I thought it was

too many assumptions and -– but -- but anyway, so that’s
how

we -- that how the whole thing was run.
So for, you know, every transaction has an

approval memo that goes to the parent company.

And

Lewis, who was the chief credit officer at the time or
one of his assistants, you know, would have to sign it
and read it and sign it.

They would often call up with

questions so we often reported –

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FCIC Interview of Gary Gorton, May 11, 2010
MS. NOONAN:

And you drafted this memo?

MR. GORTON:

No.

I usually wrote -— sometimes

I wrote a small section, but it was somebody else.
MS. NOONAN:

Who would it have been?

MR. GORTON:

Well, it depends.

I mean, there

was a lot of people in this business, you know, who -so, it depends on whose -- what office it was, who was
working on it, and…
MS. NOONAN:

So I think it makes sense, just

for my purposes to understand -- in my mind, I already
understand that there was -- and maybe there was more
than one -- but at least there was a model that was used
to evaluate the super-senior credit default swap,
multi-sector CDO portfolio.
MR. GORTON:

Yes.

That’s different.

That’s

comes much later.
MS. HEYL:

That’s later.

This is the earlier period.
MS. NOONAN:

Exactly.

I understand and so

that’s where FP ultimately gets to -- and that’s
obviously the focus of a lot of what ultimately happened
with AIG-FP’s losses.
MR. TOMBACK:

To be really fair.

They

ultimately get there, as you put it, but there is no
connection between Gary’s model or, I take it, the FMB
20

FCIC Interview of Gary Gorton, May 11, 2010
model -- although I’m not that familiar with it -- and
the valuation model you are talking about.
MS. NOONAN:
valuation model.

I’m not talking about the

I’m talking about the model that was

used when AIG-FP entered into these transactions.
MR. TOMBACK:
MS. NOONAN:

Okay.
I understand that at a later

point in time, there was a model that was used starting
in 2007 when collateral calls came in to start trying to
value these things because they had been held at par, et
cetera.

I understand that that’s a different model than

the model that was used, that I believe was your model
that was used in making the business decision to enter
into each of the transactions in the first instance.
MR. GORTON:

Well, I don’t think that’s

exactly accurate.
The model wasn’t –- there’s a long process
that a transaction would go through.

It would have to

go through quite a bit before it got to the model.
MS. NOONAN:

Okay, and actually let’s table

that because I want to talk about that, but I want to –
I think it would be helpful – I know it would be helpful
for me to map out if we know that this is one line of
business, the multi-sector CDO super-senior credit
default swap business.

We’re starting from a point of
21

FCIC Interview of Gary Gorton, May 11, 2010
the corporate names, right?

So, if you could walk me

through maybe just a list of the ones that you recall,
the different of types of transactions that you
developed models for.
MR. GORTON:

Okay.

MS. NOONAN:

And whether the model was the

same throughout and just tweaked, or whether you
actually built different models for these different
business lines.

That’s something that I – I don’t know,

and I don’t want to conflate what you’re saying about,
sort of the ‘98, ‘99, stuff -MR. GORTON:

Right.

MS. NOONAN:

-- with what happened later.

I just want to make sure that I understand
exactly what businesses you touched and your model was
used for, and if you developed new models or tweaked
them so that when we talk about assumption and inputs
going into the 1998 model, that we can work from there
on “Okay, were those same inputs used in these other
areas?”

Because I’m guessing that maybe there were

significant differences in the inputs, but maybe that’s
not the case.
MR. GORTON:

I mean, broadly speaking, there

was two classes of models.

There’s one big group that

has to do with mortgages, right?

And those are all
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FCIC Interview of Gary Gorton, May 11, 2010
European mortgages.
MS. NOONAN:
model now?

You’re not talking about your

You’re talking -MR. GORTON:

No, I’m talking about -– I’m

talking about another model that we built.
MS. NOONAN:

Okay.

MR. GORTON:

I’m not exactly sure that we

should call it “my model,” by the way, but, you know…
MS. NOONAN:

The popular – the popular

parlance has been the “Gorton model” or the “Wharton
model,” so I mean we can give it -MS. HEYL:
MS. NOONAN:

I think it’s an actuarial model.

MS. HEYL:

An actuarial model, okay.

MR. GORTON:

As compared with a valuation model.
I think if people of the firm

heard you say that, they’d be irate.
So, you know, there was a lot of people who
contributed to -MS. NOONAN:

Well, I’m not going to take

credit for being the first person to say it, but -MR. GORTON:

In any case, there’s -- there was

another -- you know, the bulk of the business basically
had to do with European mortgages eventually -- you
know, for most of the time.

And so those are quite

different, depending on the country they’re in.

And so
23

FCIC Interview of Gary Gorton, May 11, 2010
there was a different model for each country.

And then

the basic corporate model was then adapted for later,
for the CDO business.
MS. HEYL:

Can I just try to clarify this?

So initially, you have the model that finds
loss distributions on corporate names?
MR. GORTON:
MS. HEYL:

Right.
Is that the same -- is that what we

call sort of the ER [phonetic] model, like the beginning
model; and then the others come from it?
MR. GORTON:

No.

The basic idea -- since the

business was -- you know, we want to know the loss
distribution actuarially to make this underwriting
decision, the output always had to be a distribution.
But the mortgage models were very different because
mortgages are just different than, you know, corporate
names.
So corporate names -- so that was, you know,
in spirit, a similar kind of model, but the inputs and
so on were different
MS. HEYL:

So if we look at the genealogy of

the models, like it’s animal kingdoms or something.
MR. GORTON:
MS. HEYL:

Yes.

MR. GORTON:

You have the -The corporate model.
24

FCIC Interview of Gary Gorton, May 11, 2010
MS. HEYL:
MR. GORTON:

-- the corporate model?

MS. HEYL:

Then you have mortgage models.

MR. GORTON:

Separate, next to it?

MS. HEYL:

Yes.

MR. GORTON:

Okay.
And then later, this CDO stuff

comes in.
MS. HEYL:
MR. GORTON:

It descends from which one?
It descends from the corporate

one.
MS. HEYL:

All right, so let’s not talk about

the European one.
MR. GORTON:

Okay.

MS. NOONAN:

So you have the corporate model,

you have the mortgage model, and the CDO model descends
from the corporate model?
MR. GORTON:

Right.

MS. NOONAN:

Even though CDOs often contain

mortgage securities?
MR. GORTON:
though.

Or referenced mortgage securities?
They -- that’s the difference,

That’s exactly the difference.
In Europe, you’re referencing actual

mortgages, right?

In CDOs, you’re not referencing

mortgages; you’re referencing bonds, some of which might
be backed by portfolios of mortgages.
25

FCIC Interview of Gary Gorton, May 11, 2010
MS. HEYL:

So to answer her question, how does

it change from the one that’s for corporate bonds -MR. GORTON:
MS. HEYL:

Well, the corporate --- to the one that’s for CDOs?

MR. GORTON:
based on ratings.
ratings.

The corporate bonds model is

But we never used, you know, their

We had our credit officers rate them.
The CDOs were based on ratings, but we never

believed the absolute meaning of the rating.

We just

believed the relative ranking of the rating.

And then

we stressed those ratings.
MS. HEYL:

Okay, so did the model change

between the time you used it for the corporate bonds and
the time you used it -MR. GORTON:
MS. HEYL:

Yes, the model changed.
Okay, so how did it change?

MR. GORTON:

It changed by adding all these

additional stresses because we were -- so the ratings -the rating -- the part of the ratings that we liked, was
the fact that the agencies could tell you Company A is
riskier than Company B.

So that ordering we used.

Whether Company B was ten times riskier than
Company A or not, that’s the part we didn’t believe.
So we -- when we got to the CDOs, we added
this big layer of stressing that, again, was worked out
26

FCIC Interview of Gary Gorton, May 11, 2010
with the parent company.
MS. HEYL:

So why don’t you tell her how that

stressing works?
MR. GORTON:

Okay, so the way one of these

CDOs would work would be, come -- an investment bank
would say, “Here’s the proposed portfolio rules,” okay?
So they’d say, you can have 10 percent in
prime mortgages, 10 percent in auto loans, 10 percent in
this.

You know, they have a whole, big list of rules.
And the rules would have -- they’re just a

whole, big page of things -- pages, sometimes, of rules,
right?
MS. NOONAN:

Investment criteria?

MR. GORTON:

Yes.

And the reason there’s rules is because they
haven’t purchased all the bonds yet.

So they don’t

necessarily know what bonds they’re actually going to
buy, but they know they have to satisfy these rules.
And moreover, sometimes there’s a manager who can
actually trade things, right?
And so we had lots of rules that had to be
worked out and, oftentimes, deals wouldn’t happen
because they didn’t like our rules.

Our rules were much

tougher than the rating agencies.
For example, we insisted that managers own
27

FCIC Interview of Gary Gorton, May 11, 2010
half the equity, and we insisted on all sorts of
triggers that the rating agencies didn’t want to
include.

And then we would stress the ratings.
So when we would simulate, we’d go to the

first bond and we’d look at it, and it says that it’s
a student loan -- backed by student loans and it’s
rated A.

So when we simulate it, 20 percent of the

simulated paths would bump that bond from A to Bbb.
MS. NOONAN:

The next notch down?

MR. GORTON:

The next full notch down --

MS. NOONAN:

Okay.

MR. GORTON:

-- right?

So this -- this -- these stresses -- so people
refer to that as a 20 percent stress-down.

A full

notch.
So basically you’re saying, “I’m not sure the
agency’s got this right when they called it A.
think they really understand the stuff.

I don’t

We’re going to

stress it down.”
So there’s a whole series of stresses that
were worked out, and then these additional criteria that
would have to be adhered to.

So many transactions would

fall apart because counterparties would complain that,
you know, we -- this thing had already been rated, and
what was wrong with us, and so on and so forth.
28

FCIC Interview of Gary Gorton, May 11, 2010
So -- so all these -- all these things were
added, you know, in consultation with the parent
company, because the parent company wasn’t going to let
us do this business unless we explained and they agreed
with all the criteria.
MS. NOONAN:
one second.

Okay, that’s -- going back just

The mortgage model, that was used for

European deals?
MR. GORTON:

Right.

And they’re very

different because there, you’re dealing directly with
the bank, and you know there is these 80,000 mortgages,
and you know lots of information about each borrower.
And they already have the mortgages.

Whereas with the

CDOs, they have to go buy the bonds.
MS. NOONAN:

Okay, okay.

So the mortgage

model was used for the European business -MR. GORTON:

Correct.

MS. NOONAN:

-- which I believe is referred to

as a “regulatory arbitrage business”?
MR. GORTON:

Yes.

MS. NOONAN:

Is that the same, or is that

MR. GORTON:

No, that’s the same, that’s the

MS. NOONAN:

Okay.

different?

same.

29

FCIC Interview of Gary Gorton, May 11, 2010
MR. GORTON:

This was a bank equity business

in economic substance.
MS. NOONAN:

Okay.

MR. GORTON:

Which everybody understood.

MS. NOONAN:

Would you mind, actually, if we

took just a brief break?

I think that we actually have

a colleague who would like to dial in.
Is that possible?
MS. HEYL:
MS. NOONAN:

Sure.

Go ahead.

Let me -- should I use that phone

over there?
MS. HEYL:
MS. NOONAN:

Who is that going to be?
Al Crego.

-- BREAK --

MS. NOONAN:
MR. CREGO:

Hi.

MS. NOONAN:

Yes.

Is this Al?
Hi.

Hi, Al.

Good morning.
This is Dixie and Clara.

We’re here with Dr. Gorton and Andy Tomback and Dorothy
Heyl and Tom Santoro of Milbank.
Is there somebody else there with you?
MS. HEYL:
MR. CREGO:

Hi.

MS. NOONAN:

I’m waiting for folks to come in.
Okay.
30

FCIC Interview of Gary Gorton, May 11, 2010
MS. HEYL:

So what’s Al’s full name?

MS. MORAIN:

Alberto Crego.

MR. CREGO:

Do you want to give us a couple

more minutes?
MS. NOONAN:
MS. HEYL:

Well, actually, we’ve already -Maybe we should take a break.

MS. NOONAN:

Yes, we can give you a couple

more minutes.
MS. HEYL:

We’ll take a break.

MR. CREGO:

Thank you, Dixie.

-- BREAK --

MS. NOONAN:
model.

-- talking about Dr. Gorton’s

And so I’m not going to back through that.

We

can fill you in later.
MR. CREGO:
MS. NOONAN:
MR. CREGO:
MS. NOONAN:

That’s fine.
Okay, cool.

Thanks.

Thank you.
So, back to the models.

You said

that there was criteria that the investment bank would
have in selecting, I think, the underlying assets for
the deals, and that AIG had criteria that sometimes or
maybe often differed, and that sometimes that worked to
derails the transactions.
31

FCIC Interview of Gary Gorton, May 11, 2010
Could you just give us some examples of
criteria that you might have had that would have
conflicted with -- or even specific examples of deals
you know that didn’t happen because of criteria that
conflicted?
MR. GORTON:

Too many deals were rejected.

I can’t remember a specific deal.

I think the main --

one of the main problems was this requirement that the
manager owned half the equity.

And that trading

stock -- you see, we had -- they’re allowed to trade
certain amounts for a certain period of time, and we
didn’t like them to trade.

So we required that they

hold equity and we put in many more triggers to stop the
trading.

They could sell, but they couldn’t buy.
MS. NOONAN:

So this is the difference between

what’s called a dynamic or a static pool?

Is that what

you’re referring to, or -MR. GORTON:
MS. HEYL:

Yes, the static is -Actively managed.

MR. GORTON:

There’s actively managed and

MS. NOONAN:

Okay, okay.

static.
I’ve heard some

people refer to actively managed as a dynamic pool,
but -MS. HEYL:

Actively managed in the sense of a
32

FCIC Interview of Gary Gorton, May 11, 2010
reinvestment period.

And you say you didn’t like that.

MS. NOONAN:

And so, do you know if most of

the deals that FP did were static pools?

Is that your

understanding, or…
MR. GORTON:

I don’t remember.

MS. NOONAN:

Okay.

Would you have been

involved in the negotiations of -- in that part of the
negotiation?
MR. GORTON:

No.

I mean, I basically, you

know, from roughly 2002 or 2003 to the end, I didn’t
really work on this anymore.

I mean, I was working on

commodity futures, and I had another big project, but,
you know, this was done by the credit team.
MS. NOONAN:

Okay.

Okay.

So going back to --

so the corporate model is used for the CDOs.

So I’m

interested in if you could walk me through, and I know
this may be slightly painful given my lack of experience
in quantitative models, but I would like to have an
understanding of what inputs you put into the model.
What was the criteria that went in that affected the
distribution?
MR. GORTON:

So the -- I mean, very roughly

speaking, there’s just two pieces of information that
you need for each bond.

You need its rating and you

need to have an assumption about its recovery rate.
33

FCIC Interview of Gary Gorton, May 11, 2010
MS. NOONAN:

What do you mean by recovery

MR. GORTON:

If there’s a default, how much do

rate?

you -- are you going to get back?
MS. HEYL:
MR. GORTON:

In other words --

MS. HEYL:

So, for --- it’s like in a bankruptcy

proceeding.
MR. GORTON:

It’s a bond, so if the bond, yes,

if the bond suffers losses, if it gets to the point
where it suffers losses, how much are you going to
recover?
MS. NOONAN:

And how would you go about making

that assumption?
MR. GORTON:
punitively.

Well, you make them very

You just say you’re going to recover zero,

unless it’s so -- for most ratings, it was a zero.

And

then for, you know, I forget the exact numbers, but for
Aaa and Aa, it was positive, but it was like 20 percent.
So it was way below anything that we’d ever seen before.
MR. CREGO:
MR. GORTON:
MR. CREGO:

Professor Gorton?
Yes.
Did I hear you say that the first

primary element of the model input was the credit rating
from an NRSRO?
34

FCIC Interview of Gary Gorton, May 11, 2010
MR. GORTON:

Yes.

MR. CREGO:

Okay.

Is there any -- is there

any sensitivity given the inherent lag in some of the
ratings?

And at the time that they had not fully

updated their rating models, do you account for their
rapidly deteriorating underlying collateral?
MR. GORTON:

So you missed the first part of

this, so let me -MR. CREGO:

I apologize.

MR. GORTON:

--just quickly summarize.

First

of all, these are new deals, so…
MR. CREGO:

Okay.

MR. GORTON:

In fact, many of them haven’t

even been issued yet when you’re analyzing the
transaction.
The second thing is, we didn’t believe the ratings.
We never, in the entire history of this business,
believed the ratings.

So, either we had our credit

officers give their ratings in the case of corporates,
or we stressed downwards the agency ratings in the case
of structured products.

So the thing, the piece of

information that we take from the agencies is the
relative ranking.

Not the rating, the relative ranking.

So we think -MR. CREGO:

Okay.
35

FCIC Interview of Gary Gorton, May 11, 2010
MR. GORTON:

-- that they do get it right,

that Bbb is in fact worse than A.
MR. CREGO:
MR. GORTON:

Gotcha.
That’s the only piece of

information that we take.
MR. CREGO:
MS. NOONAN:

Okay.

Thank you.

So, on the second part, the

assumption about the recovery rate if there is a
default?

And you said for most it was zero, and then if

it was an Aa or an Aaa-MR. GORTON:

Yes, I don’t remember exactly--I

can’t remember what the numbers were--it’s like 10, 20,
30, I can’t remember, but it’s something like that.
MS. NOONAN:

So, I’m just -- and I apologize,

but that seems pretty stark that the assumption would be
zero.

I mean, doesn’t it then make the assumption about

if and when there’s going to be a default -- it seems
like there are two assumptions embedded there, right?
What would the recovery rate be if there was a default,
and if there’s a default is a second assumption really,
right?

I mean, how do you -MR. GORTON:

Yes.

I mean, if it’s a default,

then what’s the recovery rate?

That’s the -- it’s

conditional on default that you would recover.
MS. NOONAN:

Right.
36

FCIC Interview of Gary Gorton, May 11, 2010
MR. GORTON:

I want to make sure I understand

the question -MS. NOONAN:

So -- so, is it an input into the

MR. GORTON:

Yes.

MS. NOONAN:

-- is there an assumption input

model --

into the model about the probability of a default?
MR. GORTON:

No.

That’s what you’re going to

simulate from the ratings, right?
So, you have the history of ratings, and you
know this is the information you’re going to use to
simulate, right?

So ratings can go up and they can go

down and you simulate that under this assumption that
you’re in the worst post-war recession in the U.S. for
the entire life of the transaction.
MS. NOONAN:

So when you say you assume the

worst post-war recession in the Unites States, does that
differ depending on the asset class?
MR. GORTON:

No.

MS. NOONAN:

So what is it?

What time period

do you use?
MR. GORTON:

I can’t -- I think it was ‘73-

’74, it was early seventies.

I don’t remember the exact

dating of the recession, but…
Anyway, so the model was calibrated to that,
37

FCIC Interview of Gary Gorton, May 11, 2010
and with the parent company’s agreement, we stuck to
that the whole time.
MS. NOONAN:

For these U.S. things.
Just trying to figure out how

that gets fed into the model.

I mean, I understand sort

of qualitatively looking that time period, but is it the
performance of bonds at that time period, or is it -MR. GORTON:
go up or down.

So, it’s -- it’s -- ratings can

And whether they go up or down is a

function in part of what the overall economy is doing.
So you pick periods where most of the ratings go down,
until you get a loss rate, an average loss rate that’s
equal to the worst post-World War II recession.

Then,

in the distribution, the average is that, but the tail,
the really unlikely events, are huge losses that we
never experienced in history, but which is what you’re
using for the underwriting standard.
MS. NOONAN:
entirely understand.

Okay.

Okay.

I’m not sure I

I mean, is it basically that you

take something that was rated Aaa in, say for example,
1970, and in 1973 it was rated Bbb and it experienced
losses of X amount and then you -MR. GORTON:

You track -- you track what

ratings actually did, right?

So you have millions of

these ratings transitions, right?

So you track these

paths, and you simulate these paths.

So you draw a
38

FCIC Interview of Gary Gorton, May 11, 2010
path, you see where it went; and if it hits -- you know,
it defaults, then you figure out how much you lost and
you accumulate that for all the however many bonds there
are.
MS. NOONAN:

Okay.

Okay.

So the inputs are

the rating, the relative rating with some stresses -MR. GORTON:

Uh-huh.

MS. NOONAN:

-- and assumptions about recovery

MR. GORTON:

Uh-huh.

MS. NOONAN:

-- and then the exports, I think

rates --

you’ve already said this, but it’s the probability of
loss –MR. GORTON:

It’s the –

MS. NOONAN:

-- it’s the dollar amount of

MR. GORTON:

The distribution.

MS. NOONAN:

-- distribution of loss.

loss --

Which would tell you the dollar amount at a
given probability.
MR. GORTON:

Yes.

And then for our piece, 99.85 percent of the
time, we have to have zero losses.
MS. NOONAN:

And that’s where the attachment

point comes in?
39

FCIC Interview of Gary Gorton, May 11, 2010
MR. GORTON:

Well, that’s not the attachment

point, but that’s the minimum, right?

So we always

asked for a buffer, right?
Remember the model -- you’re attaching way too
much weight to the model.

The way the business actually

worked is, I go, the model says to Al Frost:
20 percent.

Attach at

Al calls his counterparty who says it’s

30 percent.
MS. NOONAN:

Okay.

So we’re going to get to

that.
So you said that the model comes in at the
end, so now I would like to go back to that process,
sort of the whole deal process.

What you know of it --

I understand that you weren’t involved in all of it -MR. GORTON:

Yes.

MS. NOONAN:

-- but it sounds like you have a

general familiarity, and -MR. GORTON:

Yes.

MS. NOONAN:

-- that’ll help us as we go

throughout the course of the rest of the day, I think.
If you know, if you can give us sort of a
walk-through of the steps.
MR. GORTON:

Yes.

I mean, as you say, I’m

not sure I have all the details, but my general
understanding is, you know, a trade would come in to
40

FCIC Interview of Gary Gorton, May 11, 2010
somebody in some office, some bank would call up.

And

they would, you know, e-mail the criteria, and you know,
maybe they had a term sheet or something, and the
person, you know, in that office, is going to look at
this and if they’re not a credit person, they’re going
to take it to the credit person.

The credit person is

going to say “This is not going to work.
these things.”

Tell them

And there may be --

MS. NOONAN:

So all deals would eventually

come to the credit person to -MR. GORTON:
person, right?

All deals pass through the credit

So there’s going to be a credit person

who’s going to, you know, be the point person on the
trade.
MS. NOONAN:

And who were the credit people

MR. GORTON:

Well, it’s a changing group, you

involved?

know, over the years, I mean--

name.

MS. NOONAN:

So starting in ‘99?

MR. GORTON:

Yes.

Jesus.

So -- I can’t remember his

The guy who –- Few- -- no, Forster

replaced a guy who -MS. HEYL:
MR. GORTON:

Tom Fewings?

remember.

No, not Fewings.

I can’t

Anyway -41

FCIC Interview of Gary Gorton, May 11, 2010
MS. NOONAN:

We can find that out separately.

MR. GORTON:

Yes, I can’t remember.

MS. NOONAN:

So it would have been -- it would

I can’t

remember.

have -- Andrew Forster would have replaced this person?
MR. GORTON:

Yes.

Forster eventually replaced

this guy, I can’t remember his name.
MS. NOONAN:

Okay.

MR. GORTON:

But anyway, so that -- he was the

head of credit trading.
officers.

And then you have credit

So the credit officers were always involved,

and then you have –- so, the credit group was, you know,
a group that had people in every office.
And, so there would be, you know, a whole
series of iterations about their criteria versus our
criteria.
MS. NOONAN:

On the underlying --

MR. GORTON:

The rules.

MS. NOONAN:

-- on the type of assets.

MR. GORTON:

The type of assets of the rules.

And, you know, I don’t know how many trades
died at that point because I wasn’t, you know, typically
involved in that process, but if they got a trade that
would satisfy their rules, then they would put it
through the model.
42

FCIC Interview of Gary Gorton, May 11, 2010
MS. NOONAN:

And so the credit department

really was the one who issued the rules on the criteria?
MR. GORTON:

No, the rules were developed --

so there was a group that met every quarter to review
the portfolios, to talk about issues in the business,
and to discuss every aspect of this.
And this group, you know, originally was maybe
12 people and it grew to, you know, it would be like 25,
30 people including people from the parent company and
so on.

And -MS. NOONAN:

Were you on that group -- in that

MR. GORTON:

Yes.

group?
This was the quarterly

meetings, I mean, I wasn’t always there for the meeting,
but I would try to go to the meetings.
review.

So this was this

There was this continuous review process, and

this group also, you know, considered all sorts of
things about the business.

So I don’t really remember

exactly how these rules were, how they came into being.
MS. HEYL:

What was this group that held the

meetings?
MR. GORTON:

This was the quarterly -- it was

called the quarterly credit meeting -MS. HEYL:
MR. GORTON:

I see.

Okay, thank you.

-- was the name of it.
43

FCIC Interview of Gary Gorton, May 11, 2010
So I’m not sure where the rules came from, but
we had these rules.

So if you --

MS. NOONAN:

Who led those meetings?

MR. GORTON:

It was Forster, mostly.

would be a big conference call.

But it

And sometimes the

parent company people would come to Connecticut and join
us for that call.
MS. NOONAN:

Who from the parent company would

MR. GORTON:

Well, it was typically Kevin

have come?

McGinn in the later parts, and then in the earlier
parts, before – before -- in the early days, Cassano and
I would actually go to the parent company and sit there
for like half a day and discuss the whole business with
them.
MS. NOONAN:

With “them” meaning still Kevin

McGinn, or…
MR. GORTON:

No, then it was Lewis and Weibel.

MS. NOONAN:

So this is the chief risk

MR. GORTON:

Yes, Bob Lewis, at the time I

So Bob --

officer?

started, was the chief credit officer.
he becomes the chief risk officer.

And then later,

And he’s replaced by

Kevin McGinn.
44

FCIC Interview of Gary Gorton, May 11, 2010
MS. NOONAN:

As chief credit officer?

MR. GORTON:

As chief credit officer.

But that was probably 2004, something like
that.
Anyway, so, you know, the transaction gets to
the model stage and sometimes, you know, our attachment
number would be so far off from where they wanted us to
attach that a trade would die also.

So, you know, my

guess is most trades died.
MS. NOONAN:

So it sounds like there were –

there was maybe a stage, at least one stage outside of
AIG-FP where the investment bankers are putting together
a deal, it gets somehow in the door, and it makes it way
to the credit department?
MR. GORTON:
firm, right?

Yes, I mean, this is a small

So, you know, it’s pretty easy.

MS. NOONAN:

It’s fluid?

MR. GORTON:

Yes, I mean --

MS. NOONAN:

Okay.

MR. GORTON:

-- you’re all sitting next to

each other.
MS. NOONAN:

Okay.

And then they decide up or

down, yes this works, no it doesn’t.
If it does work, then they bring it to you.
MR. GORTON:

No.

I -45

FCIC Interview of Gary Gorton, May 11, 2010
MS. NOONAN:

Okay.

MR. GORTON:

--I -- there’s -- the model was

built from scratch in every office.

And there’d be

some -MS. NOONAN:

In every office?

MR. GORTON:

Yes.

MS. HEYL:

He developed the model.

He didn’t

necessarily run the model.
MR. GORTON:
MS. HEYL:

I didn’t run the model.

MR. GORTON:

Others ran it.
Right.

I’m not doing

transactions.
MS. NOONAN:

Okay.

MR. GORTON:

So there’s U.S., London had the

model, and Tokyo had the model.
MS. NOONAN:

Okay.

MR. GORTON:

Right?

So there’s people who run

the model in these various offices, so -MS. NOONAN:

But we’re still working on the

two basic frameworks for the models?
MR. GORTON:
MS. HEYL:

Yes.
Two being what?

MS. NOONAN:

The corporate and the mortgage.

MR. GORTON:

No, no.

We’re talking about

CDOs.
46

FCIC Interview of Gary Gorton, May 11, 2010
MS. HEYL:

Right now, we’re just talking about

CDOs.
MS. NOONAN:

Oh.

Oh, okay.

Okay.

So we’re

just talking about the CDO model and there were
different CDO models for the different offices.
MR. GORTON:

No, no, no.

They’re all the same

MS. NOONAN:

Oh, I thought you said that they

model.

were built for each office.
MR. GORTON:

They were built -- the model was

built, so you have to make sure you don’t have coding
errors; right?
once; right?

So you always build models more than
So you don’t want the computer program to

contain a mistake; right?
So, in Wilton, two people could separately
write the program.

London writes their own program.

Tokyo writes their own program.
MS. NOONAN:

And then we compare.

So you basically write the

instruction booklet on how to build the model -MR. GORTON:

Yes.

MS. NOONAN:

-- and then they go build it.

MR. GORTON:

Yes.

MS. NOONAN:

And then are you involved in

Right.

testing it?
MR. GORTON:

Well, we tested it -- you know,
47

FCIC Interview of Gary Gorton, May 11, 2010
that’s the part that involved this interaction with the
parent company for a long time; right?
So nothing gets done until the parent company
agrees, and then, you know, then you still have to go
through this whole process, write the approval memo, and
the parent company has to agree.
MS. HEYL:

I’ll ask something.

Did you write

an actual instruction manual on how to do the model?
MR. GORTON:

I wrote lots of things over the

years.
MS. HEYL:
MR. GORTON:

What, like memos?

MS. HEYL:

Yes, memos.

MR. GORTON:

Right, various memos -Big memos.

Lots of big memos,

mostly, you know, for the parent company and internally
and, you know, you had to have something to send to the
other office, and the people downtown wanted to build a
model, they needed to see it -MS. HEYL:

So various people built models

based on these memos you wrote?
MR. GORTON:

Right.

They built the same

model, right?
MS. NOONAN:

Do you still have copies of those

MR. GORTON:

I don’t -- I don’t know.

memos?
I don’t
48

FCIC Interview of Gary Gorton, May 11, 2010
know.

I’m sure AIG has them.
MS. NOONAN:

Right.

MR. GORTON:

I don’t know if I have them.

MS. NOONAN:

I just am wondering if it would

be more expeditious on our part if you had them -MR. GORTON:

I can look.

The problem is my

whole e-mail -- you know, I just left at AIG all my
files, I didn’t take that with me.

I just, you know,

one day I stopped going there, and that was just it.
MS. NOONAN:

When did you leave AIG?

MR. GORTON:

Well, I didn’t -- I mean--

MS. NOONAN:

When did your relationship with

AIG formally end?
MR. GORTON:

Well, it ended after the second

retention payment, but I actually didn’t go to the
office some point, like, I probably went in 2008 and I
didn’t go any further.
MS. NOONAN:
payment paid?

And when was the second retention

That was in two thousand --

MR. GORTON:

Well, that was like, just, like

MS. NOONAN:

Of this year?

MR. GORTON:

Of this year.

MS. NOONAN:

But you didn’t do any work --

January.

MS. HEYL:

You haven’t been to the office
49

FCIC Interview of Gary Gorton, May 11, 2010
since -MR. GORTON:

I haven’t been to the office in,

I don’t know, probably two years.
MS. HEYL:

And when’s the last time you did

work for them?
MR. GORTON:

Three years, or something.

mean, I would go into the office.
should I show up?

I

I asked –- I asked,

What should I do?

MS. NOONAN:

Well, can we be a little more

specific, because I mean, three years, there was a lot
going on, sort of, three years ago.
MR. GORTON:

So there’s --

Yes, I don’t really remember.

I

mean, I was there -- in 2008, in the beginning I was
certainly there.

I probably, I think I went in through

2008, but I didn’t have anything to do for a good part
of that time.

And then I just stopped going in.

I

talked -- they put in this new head of the company, and
I said, “What do you want me to do?”

And he said,

“Well, you know, we’ll call you if we need you.”
said, “Fine.”

That was it.

I

So…

And then I sat there -MS. HEYL:

But as far as the documents, we can

talk about that.
MR. GORTON:
MS. HEYL:

Yes, the documents -I mean -50

FCIC Interview of Gary Gorton, May 11, 2010
MR. GORTON:
MS. HEYL:

-- I can look, but I --- I don’t have copies of memo, or

I’d go and get you one this week.
MS. TOMBACK:

I think in fairness to AIG, we

would take the position that the documents belong to it,
not to Gary.

So I think that we’ll all end up going

back to AIG to get the paper.
MS. NOONAN:

Well, we could certainly get

their permission for you to give it to us.
MR. TOMBACK:
MS. NOONAN:

Right.
But I’m just -- they’re actually

collecting quite a few documents for us, as you can
imagine.

And if you happen to have them in a way that

was easily accessible and we could get them more
quickly, it would be very helpful to us.
MR. TOMBACK:
MS. NOONAN:

Absolutely, we’ll look and -And so, and I don’t think it

would be an issue with them to get that permission, as
long we worked through you and they got copies, and
things like that.
MR. TOMBACK:

We’ll look.

They authorize.

You’ll get.
MS. NOONAN:
MS. HEYL:

That would be great, yes.
That’s not clear that -- I mean,

did you have -- you see, part of the issue has to do,
51

FCIC Interview of Gary Gorton, May 11, 2010
because I know we’ve been through this before with him.
The move from Wharton to Yale is also relative -- very
relevant to documents, I think.
MR. GORTON:

Right.

So a lot was lost --

MS. NOONAN:

When did that happen?

MR. GORTON:

August 2008 --

MS. NOONAN:

Okay.

MR. GORTON:

-- I moved --

MS. NOONAN:

Okay.

MR. GORTON:

-- and I lost a big chunk of

e-mail files.
MS. HEYL:

Meaning, you left them at

Pennsylvania?
MR. GORTON:

Yes.

I mean, I, you know, I mean

I didn’t take the computer from my home computer.
somehow -- I don’t know what happened.

So

Anyway, I lost a

bunch of files and I lost a bunch of paper things in the
move somehow.

I don’t know where they are.

But I have -- I have files from those days
still, but I don’t think there’s anything in there,
because I’ve looked for other things that people have
asked, but I can go look again.
MS. NOONAN:

Okay.

MR. GORTON:

But most of it should be -- I

mean, all my old, you know, files are on some computer
52

FCIC Interview of Gary Gorton, May 11, 2010
at AIG, and certainly these memos, I mean, I don’t know
how many times I sent the same memo downtown.
MS. NOONAN:

But you would have drafted it on

your computer at AIG?
MR. GORTON:

Yes.

MS. NOONAN:

Not on your personal computer?

MR. GORTON:

Right.

Exactly.

And there –- there are descriptions of, you
know, what the model does, basically.
And I didn’t write all of them.

Sometimes

there was somebody I was working with who wrote part of
it.
MS. HEYL:

So as far the CDO modeling, when

would you have written a memo about that?
MR. GORTON:

I don’t think -- I’m not sure I

ever wrote a memo about CDO modeling.
MS. HEYL:

All right.

Did you ever send

another memo you wrote about modeling in general to
people who were working on the modeling of the CDOs?
MR. GORTON:

No, because it was the corporate

model and then we agreed on these stress and recovery
rates, and we didn’t need a memo for that.
MS. NOONAN:

So the only change to the

corporate model when you started -- when AIG started
using it for the CDOs, was different stresses and
53

FCIC Interview of Gary Gorton, May 11, 2010
different -MR. GORTON:

Right.

MS. NOONAN:

-- assumptions about the recovery

MR. GORTON:

Right.

rates?

happened outside the model.

And all the other stuff

So much more happened

outside the model for the CDO business -MS. NOONAN:

In terms of the criteria

MR. GORTON:

Yes, right.

selection?
So that -- I don’t

know that -- I don’t know if that was ever written down
frankly.

It wasn’t a model -- it wasn’t a technical

thing, so…
MS. HEYL:

Okay, but you’ve written a lot of

memos about the model?
MR. GORTON:
MS. HEYL:

Yes.
And so, the question is, you know,

are there e-mails -MS. NOONAN:

Or if you could give us a

timeframe when these –- when you would have been writing
these, sending them, because -MR. GORTON:

I mean, the basic memo, I mean,

it’s just a guess, but my guess is that it’s prior to
2002 or 2003.

So there’d be, you know, a basic memo

about the corporate model, and a memo about the mortgage
54

FCIC Interview of Gary Gorton, May 11, 2010
model.

So those are the two memos.
But then over the years, for various purposes,

I wrote, you know, lots of memos about the business or,
you know, at least how the models work for various
people -MS. NOONAN:

And would these have come out of

those quarterly meetings?
MR. GORTON:

No, no.

These were things

like, for example, the parent company hired a more
quantitative person who said, “Can you send me the
memos?”
MS. NOONAN:

Okay, and his or her name was?

MR. GORTON:

His name was Paul -– what’s his

name?
MS. HEYL:
MR. GORTON:

Narayanan?
Narayanan.

Right.

So at some point they hire this guy -MS. HEYL:
MR. GORTON:

N-A-R-A-Y -- Narayanan.
So at some point, we send him all

the memos and we send him all the inputs, you know, we
get him tooled up.
MS. NOONAN:

Okay.

MR. GORTON:

So just as an example, so there

were many such examples.
MS. NOONAN:

Okay.

So, but basically by 2002,
55

FCIC Interview of Gary Gorton, May 11, 2010
2003, the models were designed, written, up and running
for the CDO business?
MR. GORTON:

Yes.

MS. NOONAN:

Okay.

Somewhere in there, yes.
And that’s about the

timeframe when they started doing the CDO business?
MR. GORTON:

I think that’s right.

MS. NOONAN:

Okay.

Okay.

Were you involved

when -- wait a minute, let me make sure -- I may come
back to a few things about the model, but maybe we’ll
take a break and I’ll look at my notes.
Were you involved in -- when would you -- when
did AIG-FP get involved in the multi-sector CDO
business?
MR. GORTON:

Well, that’s what we were just

talking about, so -MS. NOONAN:

So that’s the 2002, 2003?

MR. GORTON:

I think that’s right, yes.

I

mean, Frost would probably know better than I -MS. NOONAN:

Okay.

MR. GORTON:

-- but that’s my guess.

MS. NOONAN:

And when, if you know, would

those CDOs have started containing assets that were
backed or related to subprime or Alt-A U.S. residential
real-estate mortgages?
MR. GORTON:

I don’t know.

I mean, you know,
56

FCIC Interview of Gary Gorton, May 11, 2010
I wasn’t looking at all these transactions.

And then

there comes a point where Gene Park takes over.

And

Park comes over to my desk one day and says, you know,
“What is this stuff?”
MS. NOONAN:

Takes over what?

MR. GORTON:

He takes over Frost’s -- Frost

was running this business in the U.S.

Al Frost.

And

Frost was going to go work on some other stuff, and Gene
Park is going to do this business.
MS. NOONAN:

And what do you -- roughly a

MR. GORTON:

Oh, gosh.

MS. NOONAN:

Was it baseball season?

timeframe?

MS. HEYL:
MR. GORTON:

January 2006?
So, I think it must have been,

yes, January 2006 or before that, it must have been -MS. HEYL:
MR. GORTON:

Late 2005?

Late 2005.

Late 2005.

Right.

Park takes over, and Park comes

over and he says, you know, “What is this stuff?”

So

I’m explaining to him what it is.
And he says, you know, the trades we’re seeing
have a lot of this stuff.
MS. NOONAN:
MS. HEYL:

What was Park -“Trades we’re seeing” meaning?
57

FCIC Interview of Gary Gorton, May 11, 2010
MR. GORTON:

The stuff that were being shown

to us.
MS. HEYL:

“Stuff we’re seeing,” new trades?

MR. GORTON:

Yes, new trades.

MS. NOONAN:

I’m sorry.

MR. GORTON:

The new transactions that the

I didn’t quite follow

that.

investment banks were showing to us are increasingly
these kinds of assets.
MS. NOONAN:

Which kind of assets?

MR. GORTON:

Subprime and Alt-A.

MS. NOONAN:

Okay.

Okay.

What was Gene

Park’s role before he took over Al Frost’s role?
MR. GORTON:

Well, he was part of the credit

team, but, you know, he did a variety of transactions,
different kinds of transactions, not only credit.
I think officially he was in the credit group.

But

I mean,

the groups are very fluid, so many people worked on
multiple things.
MS. NOONAN:

So, let’s step back a little bit.

If you developed the model for CDOs around 2002, 2003,
and if you ever remember a more specific time period,
please -MR. GORTON:

Okay.

MS. NOONAN:

-- just let me know, and we can
58

FCIC Interview of Gary Gorton, May 11, 2010
be more specific.
What was your involvement after building the
model when the deals came in?
MR. GORTON:
involved.

I typically wasn’t really

I mean, I was -- I would go -- so I’m

basically working on commodity futures, and -- but we
sit on these trading floor, so you know, I would talk
to, you know, all sorts of people, and I would try to go
to the quarterly meetings.

I think I probably did go to

every quarterly meeting or I called in.
And the quarterly meetings were to review -you know, it was a big preparation for the quarterly
meeting, because you would re-run the model and see
where the transaction stood now, you know, one year, two
years, five years later.

And there would be all this

discussion about it, and there’d be this intense focus
on transactions that looked like there’d been a little
deterioration, and, so I would go to that.
But, you know, by this time, you know, Adam
Frost -- Al Frost and Adam Budnick -- Adam Budnick had
been hired at some point -- and they worked on this.
They -- you know, I didn’t really -- they didn’t need
me.

So I didn’t have any input on it.
MS. NOONAN:

So you never ran the models, say,

from January 2004 after?
59

FCIC Interview of Gary Gorton, May 11, 2010
MR. GORTON:

I don’t think I ever ran a model.

I never –- I never actually physically ran the model.
MS. NOONAN:

Like, gathered the data that

would go into it, and -MR. GORTON:

Well, I gathered the data, and I

wrote memos saying, “Here’s how to build the model.”
And then somebody would go -- we’d run all these
experiments, and somebody would go run it and report
back.

And then we’d go to the parent company and

discuss it, and so on.
But in terms of, you know, literally running a
model -- like I type on the computer, input the
portfolio, get the results -- no, I never did that.
You know, I don’t even know how to do that.
So, but beyond that, I mean -MS. NOONAN:

It’s interesting.

How do you --

I mean, really, I’m just curious, how do you know how to
write a model but not run the model?
MR. GORTON:

It’s very simple, right?

half of my academic work is math.

I mean,

I do math, right?

You write math down.
So a model is a lot of math, and that’s what
you write down.

You write down the math, you write down

how you use the data, you write the memo, you hand it to
a programmer, and you hand it to another programmer, and
60

FCIC Interview of Gary Gorton, May 11, 2010
you say, “Go do this.”
MS. NOONAN:

Aren’t you curious about how --

MR. GORTON:

It’s not -- it’s very easy for

them, right?

They’re computer programmers.

They take

the math, and they write it into computer -MS. NOONAN:

I’m not talking about the

computer programmer part.

I’m talking about once you

actually get to the deal, and you put in the ratings,
and you put in the assumptions about the recovery
rates -MR. GORTON:

Right.

No, there was in the

beginning, there was a lot of discussion about this,
right.

And what these numbers looked like, and whether

they were reasonable and what the stresses should be,
and what would it look like if we had bigger stresses,
and…
So the sensitivity of the model to various
inputs was something that we studied, right?

But we had

to study it and we had to report to the parent company
all these experiments so that we all sort of understood,
you know, how this things behaved in order to finally
get to the point where you were willing to write
business on the model.

And then once that happens, I

typically wasn’t involved, although, sometimes I would
write the little paragraph in the approval memo saying,
61

FCIC Interview of Gary Gorton, May 11, 2010
you know, “Here’s the various scenarios we ran.

Here’s

the model numbers.”
MR. TOMBACK:

And just to be clear, in terms

of stresses, was one of the stresses that you ran
against the model or ran through the model, significant
economic downturn?
MR. GORTON:

No, the model was in a

significant economic downturn.

That’s what, you know,

you didn’t have to model that because the model was in a
significant economic downturn the whole time.
MR. TOMBACK:

Right.

So, the model itself has

integrated into it -MR. GORTON:

Yes.

It’s built in that the

entire life of the transaction is in a significant
economic downturn.
MS. NOONAN:

Have you gone back and compared

what the early seventies looked like to 2008?
MR. GORTON:

No.

I mean, I -- I’ve asked, you

know, how -- you know, are there any losses, and the
answer was:

No, we don’t have any realized losses in

any of these positions.
I mean, the company had a loss in Maiden
Lane III, I’m told, because of the way the accounting
worked, how they priced it or something.

I don’t really

know the details.
62

FCIC Interview of Gary Gorton, May 11, 2010
But a few months ago is the last time I asked.
And I said, “Do any of our positions have any realized
losses?”

And the answer was no.

So, you know, and I

was curious about that, because, you know, the model had
been predicated upon:
happened?

Could you survive exactly what’s

And at least so far, the answer appears to be

yes.
I mean, there’s no -- no dollar has been paid
out to a counterparty under one of these swaps.
MS. NOONAN:

Not under the actual terms of the

swap as opposed to the collateral -MR. GORTON:

Yes, the collateral was

something -MS. NOONAN:

-- provisions.

MR. GORTON:

-- completely separate.

MS. NOONAN:

Right.

Right.

Did you know that the model for the CDOs -did it make any difference to you what assets were in
the CDOs?

Whether it was -MR. GORTON:

a difference, right?

Oh, yes, yes.

Absolutely it made

I mean, we -- we, you know --

MS. NOONAN:

I mean, as long as they have a

MR. GORTON:

No, no, it’s not as long as they

have a rating, right?

The criteria, you know, required

rating.

63

FCIC Interview of Gary Gorton, May 11, 2010
various category -- different categories of, you know,
asset classes and so on.
MS. NOONAN:

The criteria for the model or the

criteria for getting the deal done for -– for -MR. GORTON:

The criteria -- the model just

takes in the ratings, so this is outside the model.
MS. NOONAN:

So what’s -- right.

So putting

aside what’s outside the model -MR. GORTON:

Right.

MS. NOONAN:

-- for a moment, do you -- does

the model -MR. GORTON:

No, no.

MS. NOONAN:

-- care about the type of asset?

MR. GORTON:

No.

MS. NOONAN:

Okay.

MR. TOMBACK:

So --

You’re asking like, if you put

in Fff as opposed to Aaa assets-MS. NOONAN:

No, actually that’s not what I

mean, because I think that actually would be taken -MR. GORTON:

Right.

MS. NOONAN:

-- into account in the model?

My questions is really do you care if these
are corporate bonds versus subprime mortgage-backed
security bonds?
MR. GORTON:

Oh, we would care -64

FCIC Interview of Gary Gorton, May 11, 2010
MS. HEYL:

Versus cars or credit loans?

MR. GORTON:

They do care about --

MS. NOONAN:

Versus cars or student loans,

things like that.
MR. TOMBACK:

Yes, let’s be clear, because

they do care about the type of instrument.
MS. NOONAN:

Well, as I understood it, the

group cares about -MR. GORTON:

Right, the model –- the model --

MS. NOONAN:

I’m asking if the model has -- if

the model differentiates at all between the different
types of assets.
MR. GORTON:

No.

MS. NOONAN:

That may all be rated Aaa.

MR. GORTON:

Yes.

MS. NOONAN:

That may all be bonds that have

cash flows.
MR. GORTON:

Yes.

MS. NOONAN:

But the model doesn’t treat them

differently?
MR. GORTON:
MS. HEYL:

No.
So the model doesn’t take

diversification into account -MR. GORTON:

No, that’s outside the model.

MS. NOONAN:

That’s sort of -- thank you,
65

FCIC Interview of Gary Gorton, May 11, 2010
that’s really -MR. GORTON:

That’s outside the model.

But the model assumes that these things are
going to be -- have highly correlated performance
because you’re in this significant economic downturn the
whole time.

And so --

MS. NOONAN:

So could you explain how the

model takes -- because the correlation was actually the
next place I was going -MR. GORTON:

Uh-huh.

MS. NOONAN:

-- and I’m curious to know what

correlation assumptions that the model had -MR. GORTON:

Right.

So --

MS. NOONAN:

-- or indirectly or directly.

MR. GORTON:

So the -- the model assumes a

very high correlation implicitly, because it assumes
that you live your entire life in this significant
economic downturn.

So when things go bad, everything’s

highly correlated.

You know, and so, we could build

this because we had an actuarial model.
weren’t doing what Goldman does.

We didn’t -- we

We weren’t, you know,

running a big book of business and have to worry about
market prices and all that.

So they had, you know,

insolvable correlation problems and -- the whole street
did.

They didn’t know what to do about it.

They didn’t
66

FCIC Interview of Gary Gorton, May 11, 2010
know, you know, how to treat it, and so on.
We had a completely different business, so we
were able to take it into account by assuming it’s
always very high, because you’re assuming that we’re
always in this worst economic scenario.
MS. HEYL:

So why don’t you spell it out--why

a terrible economic scenario makes high correlation?
MR. GORTON:

Because everybody gets downgraded

much more frequently regardless of your asset class.
MS. NOONAN:
true, though?

Well, I mean, is that really

I mean, weren’t there -- were there bonds

that weren’t downgraded in 2008 and 2009?
MR. GORTON:

No, no.

It’s a probabilistic

statement.
Of course -MS. NOONAN:

Because there –- there --

MR. GORTON:

Of course, there are bonds that

have been upgraded in the crisis, right?

But most bonds

get downgraded in a crisis.
MS. NOONAN:

And so I’m -- I mean, I’m

assuming, and you can explain, that the data that you
put into the model to replicate the 1970s recession
would have included a wide array of different types of
assets that got downgraded?
MR. GORTON:

Yes.

I mean it, it –- what do
67

FCIC Interview of Gary Gorton, May 11, 2010
you mean by wide array?
We had the entire -MS. NOONAN:

Diverse.

MR. GORTON:

-- we had the entire history of

MS. NOONAN:

For every --

MR. GORTON:

-- to choose from, right?

ratings --

So we

selected -MS. NOONAN:

Right.

MR. GORTON:

-- these periods where everybody

gets -- is more likely to be downgraded, in order to
model this worst economic scenario; right?
So we picked periods that had exactly this
feature.
MS. NOONAN:

And within that period is every

MR. GORTON:

No, not every bond.

MS. NOONAN:

Okay.

MR. GORTON:

Nothing -- it’s never everything.

MS. NOONAN:

Right.

MR. GORTON:

Right, it’s --

MS. NOONAN:

So that’s -– so --

MR. GORTON:

It’s probabilistically much more

MS. NOONAN:

But did you pick a diverse --

bond?

likely.

68

FCIC Interview of Gary Gorton, May 11, 2010
did you pick diverse assets to go in there, so for
example -MR. GORTON:

In the history of ratings since

1970, you know, you don’t have.
securitization.

This is before

So again, we’re taking a relative

ranking of the ratings, right.

That’s the piece of

information, so -- that we’re using.

We’re asking,

“Let’s pick periods where everybody’s more likely to go
down,” and, you know, whoever has these ratings, the
basic -- you take the ratings and you trace sort of what
happens to them.

And in that period that we focused on,

we wanted to have the worst case.

We didn’t want to

have the worst case during -MS. NOONAN:

Businesses that had done well in

this recession?
MR. GORTON:

Well, we didn’t want to have

that, but we also don’t want to have just the recent
period, just because they’re certain asset classes.
don’t care about that.

We

What we care about is the

relative ranking; right?
So if the rating agencies can get the relative
ranking right, the more data you have the better to pick
this period that you want.
MS. NOONAN:

But even within the period, as

you say, you don’t pick every rated asset in the period?
69

FCIC Interview of Gary Gorton, May 11, 2010
You pick certain rated assets within the period?
MR. GORTON:

We picked what happened on

average in the bad scenarios.
MS. NOONAN:

So that makes it sound like you

picked everything.
MR. GORTON:

So everything, you know,

everything over a limited period of time.

But

everything -- just the point I’m trying to make is that
everything that exists today didn’t exist, you know,
always.
MS. NOONAN:

Right.

So, there’s a handicap

MR. GORTON:

No, I’m not sure that is a

there?

handicap.

I think going the other way would be the

handicap.

Emphasizing picking diversity today, but

having a shorter history would be mistake.
MS. NOONAN:

I’m just trying to figure out how

diverse the assets were in the underlying data.
MR. GORTON:

It doesn’t -- that’s not the

right way to think about it, right?

Because the

correlation issue is what you care about, right?

If

correlation goes up, there is no diversification.
So you want to pick a period where you know
correlation is high, and assume you’re always living in
that period.
70

FCIC Interview of Gary Gorton, May 11, 2010
MS. NOONAN:

So do you know, for example, the

percent of correlation in the period that you picked?

I

mean, was it -- were the ratings and downgrades -MR. GORTON:

No, no, I mean, you -- I don’t --

I mean, we never actually computed the actual
correlation coefficient.
periods, right?

We compared it to other

So we’re looking at these transitions,

we want to pick periods where everything tends to go
down on average.
MS. NOONAN:

But then in terms of -- so if we

move forward to the -- not underlying the model, but the
model itself and how it was used at AIG…
Maybe, can we just speak in hypotheticals just
for purposes of testing my understanding, or maybe
explaining how this worked?
If you had a CDO in 2003 that was 10 percent
subprime RMBS and 90percent a whole bunch of other
stuff -MR. GORTON:

Uh-huh.

MS. NOONAN:

-- and then in 2005, you have a

CDO that’s 95 percent subprime and 5 percent something
else, I mean, would the correlations not be different in
those two CDOs?
MR. GORTON:
answer to that.

I don’t think anybody knows the

I mean, the key question is, how many
71

FCIC Interview of Gary Gorton, May 11, 2010
different bonds did you have?

And then in our scenario,

where everything is in the worst case, the only thing
we know so far is that there haven’t been any losses.
So, so far, it seems like the answer is no.
I mean, most Aaa CDO tranches don’t have any
losses -- subprime CDO tranche -- subprime securitized
transactions don’t have losses.
MS. NOONAN:

Maybe this would -- this may be

related, it may be not, so, I apologize if it’s not.
I’m going to show, Al, I’m going to show
Dr. Gorton just an excerpt from the December 5th, 2007,
AIG investor presentation and conference-call
transcript.
MR. CREGO:

Okay.

Also --

MS. NOONAN:

Oh, do you have --

MR. CREGO:

-- Mike Easterly --

MS. NOONAN:
MR. CREGO:

Okay --

MS. NOONAN:

-- has entered the room.
Okay, great.

Thanks.

So the part I just want to understand is
actually, it’s a little hard to tell.

This copy is not

very good.
One, two, three, four.
MS. HEYL:

It’s on the--

You’re showing him the PowerPoint,

not the transcript, right?
72

FCIC Interview of Gary Gorton, May 11, 2010
MS. NOONAN:

The Power- -- well there’s an

excerpt from the transcript on the end of this.
MS. HEYL:

Okay.

MR. SANTORO:

Could you tell me the Bates

numbers that you’re looking at?
MS. NOONAN:
Bates.

It’s on page five.

There is no

This is on AIG’s website.
MR. SANTORO:
MS. NOONAN:

Okay.
It’s the December 5th, 2007, AIG

investor meeting presentation.
MR. GORTON:

We have it.

MS. NOONAN:

And it’s slide 17.

It’s actually

titled “Subprime RMBS Models Versus Reality, Moody’s
2005 and 2006”-MR. GORTON:

Uh-huh.

MS. NOONAN:

And basically what it seems to

show, it has the 2005 vintages and then the 2006
vintages.

It has tranches on the left side, Aaa, Aa, A,

Baa, and Ba.
And then it has the percent of Moody’s rated
subprime, AIG-FP model stress, and AIG-FP experience
columns.

And then it does the same for 2006.
Could you maybe just explain this?

And I

specifically want to focus once we sort of get like a
baseline explanation, just for the record, of the 2006
73

FCIC Interview of Gary Gorton, May 11, 2010
vintage and sort of like the three bottom rows there.
MR. GORTON:

So for each vintage, there’s

three columns.
The first column is the actual percent of
the 2005 vintage bonds that have been downgraded.

So

none of -- so the first column -- the first number zero
says -- means that of the transactions that Moody’s
rated in 2005, at the time of this computation, none
of them had been downgraded, is what that means.

And

similarly for the numbers below it.
The model, which is very noisy over this kind
of horizon, says that we would have predicted, based on
the model, that, you know, between 32 and 38 percent of
the Aaa’s would have been downgraded.

That’s what the

model would say.
And then our experience with transactions, the
bonds underneath in our transactions, none had been
downgraded.
2006, so now you have a very short period, the
first column is the same.

You can see that bonds are

rated Ba, you know, as you’d expect, lots of them have
been downgraded -MS. NOONAN:

Right.

I think it’s 93.7 percent

MR. GORTON:

-- but many more have been

downgraded compared to what the model would have
74

FCIC Interview of Gary Gorton, May 11, 2010
predicted over a year.
And the experience is that of the Ba bonds, I
guess we had some Ba -- probably had like two or
something, I don’t know.
MS. NOONAN:

So I was wondering about

because -- and tell me, there are a few questions here,
and so, we can take them in turn.
It looks to me like on the 2006 vintage, once
you get to the A tranche and below, that the model is no
longer accurately predicting the losses that were
experienced.
Am I reading that correctly or not?
MR. GORTON:

Yes, yes.

MS. NOONAN:

Okay.

Okay.

And, I mean, can

you -- I mean is there an explanation for that?
MR. GORTON:

Yes.

We stopped writing the

business for exactly this reason.

We were finished.

We were out of the business by the time of this call.
MS. NOONAN:
MR. TOMBACK:
MR. GORTON:
MR. TOMBACK:

And so, we’ll get there -Just to be clear -We were concerned about --- this call in December 5,

2007, you’re no longer in this business and you’re not
writing -- you’re not writing CDSs.
MR. GORTON:

Right.

I think there were -- I
75

FCIC Interview of Gary Gorton, May 11, 2010
think Frost had agreed to some transactions that hadn’t
closed yet, that I think closed in 2008.
MS. NOONAN:

You mean ‘06?

MR. GORTON:

Or 2006.

yes, closed in 2006.

I can’t remember, so,

So --

MS. NOONAN:

Because there must have been

MR. GORTON:

So there was some --

MS. NOONAN:

-- 2006 vintage --

MR. GORTON:

Right, there was some.

MS. NOONAN:

-- for there actually be losses

MR. GORTON:

Right.

some --

here.
But the whole point of us

getting out of this business was exactly this kind of
concern.
MR. TOMBACK:

And just to be clear this,

because Dixie uses the word “losses” to describe what’s
being -MR. GORTON:
MR. TOMBACK:
MR. GORTON:
MR. TOMBACK:

Yes, these aren’t losses.
-- these are downgrades -Yes, these are downgrades.
--not losses, right?

So this doesn’t reflect the loss by AIG of
one cent.

This-MR. GORTON:

No.

There haven’t -- there
76

FCIC Interview of Gary Gorton, May 11, 2010
haven’t been any losses.

That’s a good point.

These --

MS. NOONAN:

I appreciate that point.

Thank

MR. GORTON:

These are -- these are downgrades

you.

over a short period of time, but, you know, we were
concerned about what was going on, you know, again,
outside the model.

It has nothing to do with the model.

And the decision was taken to exit the
business.

And you know, the 2006 and 2007 vintages, you

know, just were horrible compared to earlier vintages.
MS. NOONAN:

I guess, I thought that the model

didn’t care about the asset class.
MR. GORTON:

That’s right.

care about the asset class.
MS. NOONAN:

The model doesn’t

That doesn’t mean --

But does the model have

limitations, then, on -- I mean -MR. GORTON:

Well, all models have

limitations.
MS. NOONAN:

Okay, so what were the

limitations of this model?
MR. GORTON:

Well, you know, it depends on

what your standard is, right?

You know, I think the

relevant question is, could you have built a better
model?

And I think -- I don’t think that we could’ve.

I don’t think -- you know, so, all models are models.
77

FCIC Interview of Gary Gorton, May 11, 2010
They’re -- all models are wrong.

All models have

limitations.
So the purpose of a model is to organize very
complicated reality in a way that makes it kind of
understandable and comparable across time for different
transactions.
MR. TOMBACK:

And just to be clear, right.

I

mean, I think Gary’s explained that given the model and
its reliance on ratings that exogenous to the model. but
impacting any output that the model had, was, I don’t
even know if all exogenous in the model, but both –- but
you factored in sort of a haircut where you made more
negative the ratings when using the model.
MR. GORTON:

Yes, the stresses.

Is that -No, that’s

right.
But the thing about a model is one of the
reasons that AIG Financial Products always built its own
models, and never used purchased models, is so that we
would always understand the model.

And understanding

the model means exactly knowing its limitations.
Like you keep saying, well, what about the
underlying asset class, and so on and so forth.
you know, you tell me your model.
you why my model is better.

Well,

I’m going to tell

So you can’t -- you know,

at the time, the question is what would we have done
78

FCIC Interview of Gary Gorton, May 11, 2010
differently, and I think the street did things
differently, and they made -- I think they made
mistakes, they did things that were -- I wouldn’t have
done.

I mean, I think I might have done those had I had

their business, but, you know, the decision to stop the
business was in large part that we thought that, you
know, the world had changed and the model wasn’t going
to be able to pick that up.

That’s why we exited this

business.
MS. NOONAN:

So why wouldn’t the model have

been able to pick it up?
MR. GORTON:

Well, I think it’s because we

were concerned about the underwriting standards of
subprime brokers and originators and whether the
agencies -MS. NOONAN:

The rating agencies?

MR. GORTON:

-- the rating agencies were

taking that into account properly.
We didn’t know.

We spent a long time

investigating this, like two months.
meetings.

We had millions of

And you know, we were pretty sure that

somehow things had changed.

We weren’t exactly sure at

the time how bad it was or what exactly had changed.
But everybody, you know, in the business noticed this
kind of thing about the 2006 vintage.

But by that time,
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FCIC Interview of Gary Gorton, May 11, 2010
we had already taken the decision to exit.

And I don’t

remember the exact date, but, so we ended up with some
2006 transactions that turned out to be really bad,
because they’d been agreed to in 2005.
MS. NOONAN:

So just to get, just to get back

here, on the A tranche of the 2006 vintage, the percent
of the Moody’s rated Aaa tranches that were downgraded
was 56 percent.

AIG-FP beat that with 47.8 percent.

MR. GORTON:

I think the thing you want to

keep in mind here is that, you know, this is a
completely honest representation of things, but the
point is exactly the point you’re making; right?
sucked, right?

And we didn’t have a lot of 2006.

2006
We

had some, but -MS. NOONAN:

Well, I mean, I was wondering if

the denominator being small is actually part of what
highlighted -MR. GORTON:

No, no --

MS. NOONAN:

No?

MR. GORTON:

-- because it’s not a -- it’s,

you know, you put in a dollar and you simulate, and you
get a percent out.

So it’s not -- it’s apples to apples

here -MS. NOONAN:

Okay.

MR. GORTON:

-- but it’s exactly the point
80

FCIC Interview of Gary Gorton, May 11, 2010
you’re making.

We had the same view; right?

MS. NOONAN:

That there are limitations --

MR. GORTON:

Yes.

MS. NOONAN:

-- and that’s why you exited.

MR. GORTON:

Exactly.

MS. NOONAN:

And it’s actually reflected by

the fact that the model isn’t -MR. GORTON:

Yes.

MS. NOONAN:

-- really sort of working in this

MR. GORTON:

Yes.

MS. NOONAN:

Okay.

period.
Yes.

[Knock on door.]
MS. HEYL:

Come in.

MR. GORTON:
MR. TOMBACK:

So -–
You know, just to summarize, I

mean, Gary, tell me -MS. NOONAN:

No, this is really helpful.

I

mean this is -- I appreciate your -MR. TOMBACK:
right.

Gary, tell me if I’ve got this

The model is dependent, at least in significant

part, on ratings being reasonably accurate, right?
MR. GORTON:
MR. TOMBACK:

Right.

Yes.

Once ratings become, you know,

less than reasonably accurate for whatever reason, it
81

FCIC Interview of Gary Gorton, May 11, 2010
becomes more and more difficult to tweak the model to
take that into account.
MR. GORTON:
should be right?
instruments.

We don’t know how big the stress

You’re just flying, you know, without

So nobody wants to write, you know, huge

numbers of trades on that.
MR. TOMBACK:

So one -- if you believe

underwriting standards or other reasons that should be
other things that should be taken into account by the
raters are not being taken into account by Moody’s, et
cetera, that causes the model to be less and less
reliable as a predictive device.
MR. GORTON:

Right, and then we stopped using

MR. TOMBACK:

And that’s -– and that –- the

it.

gap -MS. HEYL:

Well, you didn’t stop using the

model?
MR. GORTON:

We stopped -– we stopped writing

new business, so…
MS. HEYL:

But you used the model to monitor

and stuff like that.
MR. GORTON:
MR. TOMBACK:

Yes.

Yes, right.

And the –- and the gap that’s

reflected here in a document that’s -– what is it -82

FCIC Interview of Gary Gorton, May 11, 2010
December 5, 2007, is, in fact, I think you’re saying
that the difference between the column AIG model stress
versus AIG experience is reflective of the model’s
inability to keep up with the adjustments needed in
the ratings that are immediately spat out by the
agencies -- rating agencies.
MR. GORTON:

Yes.

MS. NOONAN:

Did you agree with that decision

at the time?

I mean, were you on –-

MR. GORTON:

Oh yes.

I absolutely agreed.

I was a big advocate for a huge short
position.
MS. NOONAN:

Was there any reason why you

couldn’t have just raised the attachment point?
MR. GORTON:

We didn’t know how much to raise

it by, right?
MS. NOONAN:

Okay.

MR. GORTON:

So we, you know –- you have to –-

I mean, it wasn’t – it wasn’t the way we did things, to
just, you know –- we needed to have some structure to
know by how much to raise the attachment point.

So to

decide –MS. NOONAN:

I see, so if the model tells you

that the attachment point at a minimum should be –MR. GORTON:

30.
83

FCIC Interview of Gary Gorton, May 11, 2010
MS. NOONAN:

It – it goes to the 99.85 --

MR. GORTON:

Right.

MS. NOONAN:

-- or whatever.

And then, beyond that it’s, sort of anyone’s
guess how much above that you would actually need.
MR. GORTON:

Right, and we didn’t want to make

MS. NOONAN:

Although, I think you said

a guess.

earlier, that the way this business actually worked was
you came in and said it should be 20 and then Frost
would go tell somebody it was 30.
MR. GORTON:

Right, but that was -– that was a

way to get an additional buffer, right?
MS. HEYL:

It’s added protection.

MR. GORTON:

It’s added protection, right?

So

if –MS. HEYL:

It’s not arbitrary, right?

MR. GORTON:

It’s not arbitrary.

It’s a

negotiating –MS. NOONAN:

Oh, I thought that was making – I

thought that was making AIG’s position bigger.
MR. GORTON:

No, smaller.

MS. NOONAN:

Smaller.

MR. GORTON:

Right?

MS. NOONAN:

Okay.
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FCIC Interview of Gary Gorton, May 11, 2010
MR. GORTON:

So, so when you say its

attachment is 20, that means 20 percent has to be lost
before AIG gets hit, and if you -MS. NOONAN:

20 percent of the super senior,

or of the triple -MR. GORTON:

No, 20 percent of the portfolio.

MS. NOONAN:

-- of the portfolio.

MR. GORTON:

If you make it 30, then 30

Okay, okay.

percent has to be lost.
MS. NOONAN:

Okay.

MR. GORTON:

So, by making it 30 instead of

20, you’re buying a lot more protection.

So –-

MS. NOONAN:

AIG is buying a lot more –-

MR. GORTON:

Yes.

MS. NOONAN:

Just to be clear.

MR. GORTON:

Yes, yes, AIG’s getting a lot

more protection, so the, you know, the benchmark –- the
model was the benchmark, and then if you could get
further protection, we would prefer that.
MS. NOONAN:

And that was the negotiation

MR. GORTON:

Yes.

MS. NOONAN:

-- and that would have been Al

point –-

Frost, too.
MR. GORTON:

Yes, Frost would take less money
85

FCIC Interview of Gary Gorton, May 11, 2010
and more protection, that was basically the philosophy.
MS. NOONAN:

Did you -– were you aware that

the model –- the CDO model was starting to be used for
deals that included subprime.
MR. GORTON:

Yes, yes.

Because when Gene came

over, that was what we talked about.
MS. NOONAN:
over?

When Gene – and when did he come

But that was later –- I’m sort of thinking more

like the ‘04 timeframe.
MR. GORTON:
subprime.

Yes, yes.

It included some

Subprime wasn’t always bad.

Subprime isn’t

always bad, you know, I mean –- it’s -– it’s -– the
reality is a lot different than what you read in the
papers, so…
But anyway…
MS. NOONAN:

So you didn’t –- there was no

thought on your part that the model wouldn’t have been
suitable -MR. GORTON:

No.

MS. NOONAN:

-- for –-

MR. GORTON:

No.

MS. NOONAN:

-- for that asset class in

MR. GORTON:

Right.

general.

MS. HEYL:

Do you think we could take a break?
86

FCIC Interview of Gary Gorton, May 11, 2010
MS. NOONAN:

Yes, that’s fine.

-- BREAK --

MS. NOONAN:
MR. EASTERLY:

Okay, Mike, go ahead.
One question –- there are

basically three questions that I had.
One was, my understanding is that the model
was based on the 1974 recession, and that this was
before, you know, we had Alt A and subprime, so I was
wondering, how did you adjust the models for, you know,
those types of things?
MR. GORTON:

So the –- as I was explaining

earlier, the model takes the ordering associated with
ratings, and it assumes that the rating agencies can
relatively order risks correctly.
So, we chose to use as much data as we could
to find the worst case and because we calibrated to the
worst case, the implied correlations are very high, and
the only thing we did later was to increase for change
the stresses for different asset classes.
MR. EASTERLY:

Okay.

I apologize if these

questions have been asked before.

I’ve been in and out

because I was at other meetings.

87

FCIC Interview of Gary Gorton, May 11, 2010
In terms of the model, my understanding is
that it also –- it was a credit model and not a
valuation model and so therefore it didn’t take into
account some of the things that went into the collateral
calls; am I correct?
MR. GORTON:

Yes, it didn’t -– it was an

actuarial model that was designed to produce a
distribution of losses.
MR. EASTERLY:

It had –-

MR. GORTON:

Right, and –It had nothing to do with

valuation; it had nothing to do with collateral.
MR. EASTERLY:

Right.

Given that those were in the contracts, CDS
contracts, why wasn’t there some sort of -- or was there
some separate initiative to make sure you were covered
there?
MR. GORTON:

I don’t know the answer to that.

I didn’t know -– basically I didn’t know –MR. EASTERLY:

Would you know who would be

making the call on that, or –MS. NOONAN:

Who would have looked at the

contracts for the –- who would have negotiated the
initial contracts?
MR. GORTON:

I mean -– the contracts would

have been -88

FCIC Interview of Gary Gorton, May 11, 2010
MS. NOONAN:

That included the collateral

provisions.
MR. GORTON:

It would have been Al Frost, for

most of the deals –MR. EASTERLY:
MR. GORTON:

Right.
-- I presume.

I mean, I don’t know, to tell you the truth,
because I was -– I didn’t know anything about this
collateral until I walked in, and people were on the
phone, you know, answering collateral calls.

So I’m not

sure I can really help you on that -MR. EASTERLY:
MR. GORTON:

Okay.
But Frost would know, you know,

whether he did it, or who -– I don’t know, but he would
be the person to ask.
MR. EASTERLY:
MR. TOMBACK:

All right.
Let me just –- let me just say

one thing –- it’s Andy Tomback.

I’m with Gary.

Just briefly, and you can ask Alan on this –I don’t think Alan is going to know.

I think you’re

going to have to ask other clients of ours or other
people, but I don’t think that any valuation model took
into account collateral calls, per se.

In other words,

those just weren’t -– they weren’t inputted, they were
external to the valuation process.
89

FCIC Interview of Gary Gorton, May 11, 2010
MR. EASTERLY:

Uh-huh.

Okay, but -- all

right.
And then, I had thought that Al Frost was in
on this meeting?
MS. NOONAN:

No, he is this afternoon at

3:00 p.m.
MR. EASTERLY:

Oh, at 3:00 p.m.?

Okay, so

that wipes out my next question.
MS. NOONAN:
MR. EASTERLY:

All right, are you done?

MS. NOONAN:

Yes, yes.
Okay, thanks Mike.

Does your -– did the model have any
assumptions about –MR. TOMBACK:
MS. NOONAN:

Hang up?
Hang on one second -– no, no, no,

no, no, no, no, no –- I mean, I think he -– Mike said
that someone from their research staff might be joining
us.
MR. TOMBACK:
MS. NOONAN:

Go ahead.
And, Mike, would you just let

them know to tell us when they’re there, and who it is?
MR. EASTERLY:
MS. NOONAN:

Absolutely.
Great, thanks.

Did your –- did the model have any assumptions
about housing prices?
90

FCIC Interview of Gary Gorton, May 11, 2010
MR. GORTON:

No.

MS. NOONAN:

So the -– it really would have

been sort of, an indirect based on the -MR. GORTON:

Right.

MS. NOONAN:

-- the recession data built into

MR. GORTON:

Yes, and also, it was a large

the –-

part of the discussion when we were deciding whether to
close the business or not.
MS. NOONAN:

Okay, and I want to get to that,

but I wanted to get that out of the way.
So, it’s interesting, actually what -– a
little bit of what Mike raised about the contractual
terms on what we know, ultimately caused the problems
that AIG- had, were, not, as you point out, the
protection that AIG-FP wrote, which you said that you
recently heard that there weren’t any actual losses on
that protection -- but all these liquidity issues that
it had based on the collateral calls -MR. GORTON:

Right.

MS. NOONAN:

- and as I understand it, and I

don’t know how much of this you know or don’t know or
knew at the time, even if maybe you know it now, so I’ll
just -– my understanding is that there are two
provisions:

One required AIG to post collateral upon a
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FCIC Interview of Gary Gorton, May 11, 2010
downgrade of the parent company.

I think it was AA at

the time, and so if it was downgraded, then it required
AIG to post collateral on the various swaps that it had.
And the other trigger was, if the market value of the
bonds declined –- of the underlying bonds declined.
Are you familiar –- were you familiar with
that at the time?
MR. GORTON:

Not really.

I mean I knew that

when you trade a derivative, you know, you have to be
able to, kind of make good when you owe somebody money
and it looks like you’re going to have to pay.
derivatives require some kind of backing.

So,

I didn’t

really think about it.
I mean, I know that we sometimes were in a
position to have counterparties say, “Well we can’t do
any more trades with you because we have too much
exposure to you, unless you’re willing to post,” right?
So, you know, why we said, “Yes, we’re willing to post,”
or who we said that to, I don’t know.

But when all of

this happened, you know, I was very surprised that we,
you know, had so much that we had to post and that so
much of it was based on prices.

I mean, basically, it

was news to me as well as you.
MS. NOONAN:

Right, right.

It sounds like Al

Frost negotiated the deals, and as I understand it –92

FCIC Interview of Gary Gorton, May 11, 2010
and this also may go beyond -MS. HEYL:

That’s okay.

He doesn’t know,

really.
MS. NOONAN:

No -- I understand, I understand,

but I’m sort of curious.

I mean, this gets to, I think

where I’d like to focus is, who at AIG would have known,
not only how your model worked and how the deals were
structured, per the model, and also would have had the
knowledge about how the other components of the
contracts might affect AIG independently?
trying to figure out, is it Al Frost?

I mean, I’m

Or are there

other people that would have had that knowledge of –that would have sort of, the universe of knowledge, not
discrete pieces of –MR. GORTON:

Right.

MS. NOONAN:

-- knowledge?

But is there a person or people who have sort
of the overall picture that we can talk to that should
have or would have understood this at the time?
MR. GORTON:

I frankly don’t know the answer.

I mean, there was a risk officer, there’s Cassano.

I

don’t know who knew what, frankly.
MS. HEYL:

Maybe that’s really a better

question for Alan.
MS. NOONAN:

Okay, okay.
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FCIC Interview of Gary Gorton, May 11, 2010
Was Alan at the quarterly credit meetings?
MR. GORTON:

I think he came to some of them.

MS. NOONAN:

Okay.

MR. GORTON:

I’m not sure he came to all of

MS. NOONAN:

Was this discussed at those

them.

meetings at a later point in time when –MS. HEYL:

What is “this”?

MS. NOONAN:

The collateral calls, and the

issue of needing to post collateral on these two
triggers that I mentioned.
MR. GORTON:

You mean, in the crisis?

MS. NOONAN:

Yes.

MR. GORTON:

Oh.

there was a quarter.

I’m trying to remember if

I mean, you know, what happened

was, you know, bond prices plummet, right?
crisis.

That’s the

When bond prices plummet, you have all these

marks, to these low prices, there’s no more trading,
there’s no more prices, there’s all these disputes and
all hell breaks loose.
had a quarterly call.

I frankly don’t remember if we
Because everything – everybody,

you know, it was like a 24-hour fighting-the-fire kind
of thing, so I –- frankly, I don’t remember if there was
a call.
MS. NOONAN:

Okay.
94

FCIC Interview of Gary Gorton, May 11, 2010
MS. HEYL:

That was a yes or no question.

MR. GORTON:

Yes, I don’t remember.

I don’t

MS. NOONAN:

I appreciate your –-

MR. GORTON:

I just don’t remember, I mean --

MS. NOONAN:

-- elaboration.

know.

MS. HEYL:

Yes, I mean, I’m just responding

that way because I think -- I don’t know if there’s a
quarterly call either, and I think that that needs to be
figured out before anybody know what was discussed at
them.
MS. NOONAN:

Oh, okay, so maybe if you

remember when the quarterly calls may have quit taking
place?
MR. GORTON:

Again, there’s a -– after a

quarterly call, there’s a report written, so the parent
company, and somebody at FP would have the report.
MS. NOONAN:

And what’s the report called?

MR. GORTON:

It’s called a “quarterly credit

report,” or something like that.
MS. NOONAN:

And, what sort of things would

the credit report -- the quarterly credit report have in
it?
MR. GORTON:

It would give overall numbers for

exposure, it would discuss particular problems that came
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FCIC Interview of Gary Gorton, May 11, 2010
up, and it would summarize some of the discussion, and
it would list who was at the meeting.
MS. NOONAN:

Okay, okay.

So sort of like

MR. GORTON:

Kind of like minutes, I mean, it

minutes?

was the same format every meeting, and, you know, parts
of it would always be the same with different numbers,
and then there’d be this little part at the end, kind of
discussed, you know, other issues that came up, and
those might vary from meeting to meeting.

But it would

also say who was there, so, I mean, you want -– you can
ask Al whether he was there, but it would also say on
all these things –MS. NOONAN:

Okay.

MR. GORTON:

-- who was there.

MS. NOONAN:

Okay, that’s helpful.

MR. GORTON:

And it would divide them up, too,

like credit officers, risk people, you know.
MS. NOONAN:

So, I want to make sure I

understand exactly your level of involvement after, sort
of 2002-2003.

I understand you didn’t put in the

inputs into the models, for the various -–
MR. GORTON:

Oh, I’d never put in the inputs.

MS. NOONAN:

-- CDO deals that were done.

You did participate in these quarterly credit
96

FCIC Interview of Gary Gorton, May 11, 2010
meetings up until some point.
MR. GORTON:

Yes, I think went to -– I tried

to go to all of them.
MS. NOONAN:
MS. HEYL:

Okay.

I think he told you, was that he

wrote the section of the approval memos that had to do
with the model.
MS. NOONAN:
MS. HEYL:

Each approval memo.

MR. GORTON:
do that always.

That’s right –-

Well, I did –- I mean, I didn’t

I did that in the beginning.

At some

point I stopped doing that and Adam Budnick started
doing it.
MS. NOONAN:

Okay, okay.

Were you involved at all –- so we’ve talked a
little bit about, sort of, how these deals worked, and
the due diligence that was involved on the front end,
and the criteria, whether it met the criteria, or not,
and then it goes into the model, and then we come out
with the result on the other side, and we figure out the
attachment point, and at that point, presumably, if AIG
decides to enter into the deal and somebody else on the
other side wants to do it, AIG prices the deal.

Were

you involved at all in setting or evaluating the price
at which AIG sold the protection?
97

FCIC Interview of Gary Gorton, May 11, 2010
MR. GORTON:

No.

MS. NOONAN:

Okay.

And who -– do you know who

would have done that?
MR. GORTON:

I think it –- again, I think it

would be, you know, Frost and Forster.

So Forster was

in London, so, most of the credit team was in London,
and then in the U.S. you had Forster, Budnick, and Park.
MR. TOMBACK:
MR. GORTON:
and Park.

Frost, Budnick, and Park.
Oh, I’m sorry –- Frost, Budnick,

So –MR. TOMBACK:

And those are all time-shifted.

Mainly Frost and eventually Budnick and Park.
MR. GORTON:

Exactly.

MS. NOONAN:

Right.

MR. GORTON:

So, some combination of those

people decided on the pricing.
MS. NOONAN:

Okay, Okay.

So you were never

involved in that part of it?
MR. GORTON:

I was involved in the boring

MS. NOONAN:

Has the model that you developed

stuff.

for AIG been used for other companies, or have you kept
an interest in it?

I mean, do you own the -– I don’t

know if there’s a copyright or I don’t -– I have no
idea -98

FCIC Interview of Gary Gorton, May 11, 2010
MR. GORTON:

No.

MS. NOONAN:

-- what particular law –-

trademark, I guess.
MR. GORTON:

It’s -– no, it’s owned by AIG.

I

mean, when I -– I signed a consulting agreement, so it’s
owned by AIG.

But, I think the model is extremely

specific, for a very specific kind of business, and the
universe of people who, you know, would, you know, maybe
be interested in it would be big institutional
investors, and I’m not sure they –- I’m not sure that’s
really how they think about the world.

Because they

don’t buy super-senior stuff, they buy cash bonds, so
I don’t –- I’m not sure there’s really a clientele for
it.
I don’t know, I haven’t really, you know,
pursued it.
MR. TOMBACK:

The likely clientele would be

other entities that sell protection in –MR. GORTON:
MR. TOMBACK:

Yes, on portfolios
-- like CDS.

And it’s unlikely

that AIG would want to sell that to their competitors,
and as you’ve testified or stated, most places like to
build their own.
MR. GORTON:

Yes, so I don’t…

MS. NOONAN:

To your knowledge, did AIG’s
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FCIC Interview of Gary Gorton, May 11, 2010
Financial Products group hedge any of the positions that
it did enter into before it decided to leave this
business in late ‘05?
MR. GORTON:
at various points.

Over time, in the past, it did,

The parent company would want

certain things hedged, so that you’d have certain
positions that -– they were super-senior, but then
they’d have a little sliver that would be, say Aaa, or
Aa, and the parent company would want things to be
hedged, which was really hard to do, I gathered.
I mean, to find somebody who would, you know,
but I don’t know –- I don’t know over the years how much
was actually hedged.

The parent company asked them for

it to be hedged.
MS. NOONAN:

But the parent company wouldn’t

have cared about having the super senior part hedged.
MR. GORTON:

No, no, not – not typically,

they, you know, never were worried about that.
MS. NOONAN:

So, if we move to the point in

time in –- in some point in 2007, when Goldman-Sachs,
and other counterparties start calling up and asking for
collateral –
MR. GORTON:

Right

MS. NOONAN:

It’s my understanding that AIG

developed different models, not the model that you
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FCIC Interview of Gary Gorton, May 11, 2010
worked on.

That it used what’s called a “value-at-risk

model,” and that it used a binomial-expansion-technique
model to start valuing these positions.

Were you

involved at all in helping on those?
MR. GORTON:

No.

I was very surprised that

suddenly this thing appeared one day.

I had no idea –-

I have no idea where it came from, or who worked on it,
or anything about it.
MS. NOONAN:

Why were you surprised?

MR. GORTON:

Well, I was –- I was –- I mean,

usually, these things were sort of, you know, discussed.
But I think they were discussed, I just wasn’t, you
know, involved in discussing it.

I was, you know, I

mean -– you know, people had the frame of mind that
I was off doing commodity futures at that point, so I
was spending most of my time working on that.
So, I mean I’m not saying I should have been
involved, I’m just -– you know, I was a little amazed at
the kind of -– it seemed like it just suddenly appeared,
but that was only, it suddenly appeared to me.
MS. NOONAN:

Do you know how those models

MR. GORTON:

I mean, this binomial expansion

worked?

thing, is a –- comes from Moody’s –MS. NOONAN:

Moody’s?
101

FCIC Interview of Gary Gorton, May 11, 2010
MR. GORTON:

Moody’s, yes, and I –- I remember

thinking, well, this is a -– this was a very good
choice, because it’s very transparent.

And so, people

want to know how you value, and you would like them to
know the model.

So, you know, you don’t want -– that’s

a –- that’s a case where you don’t necessarily want to
build your own very strange model.

You want to have a

model that people are very familiar with.
of it, I knew.

So that part

The rest of it, how they got inputs, you

know, from prices and stuff, I had no idea what they
were doing.
MS. NOONAN:

And you weren’t involved not only

in –- in developing it, but in implementing it in any
way?
MR. GORTON:

No.

MS. NOONAN:

Where am I?

Do you have –- let’s see –
So just -MR. EASTERLY:
MS. NOONAN:

Can I jump?
Yes, go ahead Mike.

MR. EASTERLY:

I was just wondering about

Gary’s opinion of the binomial-expansion model.
All models as we’ve discussed have
limitations.

What limitations do you see in the

binomial-expansion model?

Or technique?
102

FCIC Interview of Gary Gorton, May 11, 2010
MS. HEYL:

Someone is asking you your opinion.

MS. NOONAN:
MR. EASTERLY:

Yes, that’s –- that’s right.

MR. GORTON:

Yes, that’s your opinion.
I mean, you know, it’s a -– it’s

a -– in many ways, a kind of primitive model.

You know,

Moody’s made this model public, and we –- we never
really used it, so, I think –- I mean, I think the
biggest problem from –- from our –- for our -– from
our –- for our business, and our uses, this model, you
know, it uses an average transition matrix that’s fixed,
so it’s just not –- it’s too primitive and it –- you
know, for our purposes, it would -- you know, for the
business, it was too primitive, and it wasn’t in the
worst case.
For the -- for purposes of valuation, you
know, I -- as I was saying, I think it has the advantage
that it’s transparent, and that everybody understood it,
but it requires these inputs that they somehow got from
market prices, and I don’t -– I don’t know what –- I
don’t how they did that part.

I just don’t have any

idea.
MS. NOONAN:
you done?

So, let’s see.

Mike is up -– are

Okay.
So let’s see –- we sort of -– I don’t know

which –- I have a few of these, I think you mentioned
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FCIC Interview of Gary Gorton, May 11, 2010
the memos about getting a deal approved, and it had to
go up.
MR. GORTON:

Right.

MS. NOONAN:

Et cetera.

And I just have a

sample, and this one is the –- can you get a copy.

It’s

this one?
I’m sorry, I don’t have, like, bunches of
copies of these.

I apologize.

MS. HEYL:

I’m sorry.

MS. NOONAN:

What’s the --

It’s 312177 is the Bates.

I just wanted to get you to walk us through it
a little bit, so that when we go back and we look at all
of them, we sort of understand.
See, it has an attachment.
Ah, thank you.

Oh, these two go together,

yes?
MS. MORAIN:

It’s the same --

MS. NOONAN:

Kind of?

MS. MORAIN:

-- memo?

MS. NOONAN:

Well, we’ll see.

MR. SANTORO:

1/17/05.

I’m sorry.

What’s the number

for the one we’re actually looking at?
MR. TOMBACK:
MS. HEYL:

This is –-

It’s a different Bates number

from -– oh, we have it
104

FCIC Interview of Gary Gorton, May 11, 2010
MR. SANTORO:
MS. NOONAN:

Oh, I’m sorry –-

MR. TOMBACK:
4-3-4-3-6.

We -– we should have it.

It’s AIG-FCIC, bunch of zeroes,

And the other one is -MS. NOONAN:

No, no, no, that’s –-

MR. TOMBACK:

-- is AIG-FCIC --

MS. NOONAN:

Switch that one out.

MR. GORTON:

Oh, this one?

MS. NOONAN:

Yes, yes, yes.

MR. TOMBACK:
MS. NOONAN:

--3-1-2-1-1-7.
Thank you.

That’s okay.

MR. SANTORO:

We’re looking at 1-1- -- -1-7-7?

MR. TOMBACK:

3-1-2-1-1-7, which is Budnick to

Gorton, et al., January 17, 2006, at 3:26 P.M.
MS. NOONAN:

So the e-mail is 117 and 118, and

then the memo is 119 through 128.

So I just –- it’d be

really helpful for me if we could sort of walk through
this, if you could walk us through this, and so –because there is some stuff in here that’s -- and you
can flip past the e-mail, and -MS. HEYL:

Can you just make a copy of this,

so we can –MS. NOONAN:

Yes.

Sure.

-- BREAK -105

FCIC Interview of Gary Gorton, May 11, 2010

MS. NOONAN:

Back on.

Okay, so -- so, yes, as we were talking about,
I’m starting -- there’s a cover e-mail, AIG-FCIC00312117 to -118; and then the memo, AIG-FCIC-00312119,
that is a memo from -- to Kevin McGinn, pardon me -copying Joseph Cassano and Douglas Poling from Eduardo
Diaz Perez.
And, I mean, I guess I should note that on the
cover e-mail, that you’re cc’ed.
MR. GORTON:

Uh-huh.

MS. NOONAN:

So you would have gotten this.

MR. GORTON:

Yup.

MS. NOONAN:

Referencing transaction requiring

approval, credit-risk committee, asset purchase, or
credit derivative with Société Générale, New York
Branch, Soc. Gen., in respect to the senior-most tranche
of TABS 2005-4 Limited, the CDO, dated January 17th, ‘05.
So is this the standard form that would have
been used to gain approval of the CDO transaction?
MR. GORTON:

Yes, pretty much.

MS. NOONAN:

And would this have been both for

multi-sector CDOs as well as for the other types of
CDOs?

The European regulatory arbitrage, et cetera?
MR. GORTON:

Yes, the basic form would be the
106

FCIC Interview of Gary Gorton, May 11, 2010
same.
MS. NOONAN:

Okay, okay.

And who’s Eduardo

Diaz Perez?
MR. GORTON:

He was the chief credit officer

of AIG Financial Products.
MS. NOONAN:

Okay.

From what time period, if

MR. GORTON:

So he came when I was there.

you know?

I’d say -- I don’t know, maybe 2003.

So

A guess.

MS. NOONAN:

Would you have helped write this?

MR. GORTON:

At some point -- at some point, I

would have written this little part here, where it says,
“Constructed worst-case scenario existing,” that stuff.
MS. NOONAN:

Give me one second.

MR. GORTON:

And this one, probably I did

write that little section, since my name is on here.
MS. NOONAN:

Okay.

MR. GORTON:

So the numbers -- so -- yes, I

would have put in the numbers, and I probably would have
written, you know, a couple of these paragraphs.
MS. NOONAN:

So if you wouldn’t mind sort of

flipping back to the first page of the executive
summary.
MR. GORTON:

Uh-huh.

MS. NOONAN:

Just 121 are the last three
107

FCIC Interview of Gary Gorton, May 11, 2010
numbers of the Bates.
MR. GORTON:

Yup.

MS. NOONAN:

So it’s a transaction summary of

a $400 million CDO deal.

And I believe it says that the

Class A notes would be $264 million, and that AIG-FP
would either invest in such a -- either purchase the
Class A notes or enter into a credit-derivative
transaction, or to effect a combination of the two,
depending on which approach would be most advantageous.
Was there -- was it typical to -- what was
AIG’s standard practice?

Would it normally purchase the

bond or would it normally do the credit-derivative
transaction or the combination?

Was there a standard

practice?
MR. GORTON:

It changed because AIG had a

number of CDOs, and so they were buying assets for
that -– AIG-FP.
MS. NOONAN:

It managed CDOs?

MR. GORTON:

Yes.

I think it managed a

couple -- at least two or three.
Horizon.

They were called

You have to ask Forster about it.
So at some point, these -- these things had to

be populated with bonds.

So sometimes they would buy

the bonds
MS. NOONAN:

Okay, so that would have been -108

FCIC Interview of Gary Gorton, May 11, 2010
okay, for CDOs that AIG managed.
MR. GORTON:

Right.

MS. NOONAN:

But the credit -- the CDS

business, so if we refer to the super-senior
credit-default swap business, that would have been a
transaction where you entered into the credit-derivative
transaction?
MR. GORTON:

Right.

I mean, I don’t know what

happened on this particular deal but, you know, they
might have purchased 264 million of bonds or written a
derivative or some combination.
MS. NOONAN:

Okay.

MR. GORTON:

I don’t know –- I don’t know what

actually happened in the end.
MS. NOONAN:

Okay.

And then if you -- let’s

see here.
And then the next page, it has the structured
asset classification table.
MR. GORTON:

Yup.

MS. NOONAN:

And it has ABS CDO, autos, CMBS,

credit cards, RMBS prime, mid-prime, and subprime.
MR. GORTON:

Uh-huh.

MS. NOONAN:

And who would have -- this would

have been the deal terms that would have been brought to
AIG-FP by the investment bank or -109

FCIC Interview of Gary Gorton, May 11, 2010
MR. GORTON:

No, no, no, this would be the

outcome of some negotiation that ended up with this.
MS. NOONAN:

Okay.

MR. GORTON:

Right.

MS. NOONAN:

The negotiation being between…

MR. GORTON:

Between Al and Soc. Gen.

MS. NOONAN:

Okay.

MS. HEYL:

Whoever it was between.

It might

be Al.
MS. NOONAN:

Well, this was Soc. Gen.

MR. GORTON:

Well, this one has Al’s name on

it, so I assume it was Al.

And then the counterparty is

Soc. Gen.
MS. HEYL:

Right.

The only thing I’m

objecting to is “negotiations,” because I think that
wasn’t just Frost who did all that.

There might be

other people that -MR. GORTON:

Yes, there might have been other

people, that’s true.
MS. NOONAN:

And it talks on here, in the

first paragraph after the chart -- let’s see here, I’m
trying to –- “All of the” -- so if you go down, sort of
seven or eight lines.

It says, “All of the securities

will be rated Ba3 or better upon purchase.

Furthermore,

in no event will any collateral security have an average
110

FCIC Interview of Gary Gorton, May 11, 2010
weighted life, or WAL, greater than 12 years.”
What is -- were you involved in any of this or
this was all just part of the -MR. GORTON:

This is all just standard.

I

mean, part of the criteria has to do with the maturity.
And for structured bonds, the maturity is a little bit
complicated because it depends on how fast cash is paid
back.

You know, so you have to have some measure of,

you know, how long you think this bond is going to live.
And the street, you know, typically uses
different measures.

And so those measures would be

reported.
So the part that you indicated is basically
saying, “We’re not going to have -- we’re limiting how
long these things could be by this measure.”
MS. NOONAN:
come up with that?

And why -- I mean, how would you

Or why would you limit?

MR. GORTON:

Well, it’s a risk mitigation --

MS. NOONAN:

And this is a limit, by the way,

not of the bonds, the life of the bonds, but of the life
of the credit protection; is that right?
MR. GORTON:

No, it’s the life of the

underlying bond.
MS. NOONAN:

Oh, it is the life of the

underlying bonds?
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FCIC Interview of Gary Gorton, May 11, 2010
MS. HEYL:

The CDO.

MR. GORTON:

Yes.

MS. NOONAN:

Okay.

MR. GORTON:

And that’s the same as the credit

protection, right.

So your credit protection is going

to be shorter if the bonds are shorter, right?
So you want -- you want -- you don’t want to
be in a position where you’ve written protection on this
thing and it lasts for 40 years, right?

So you want to

have some, you know, structure or rules that keep that
from happening.
For example, mortgages, you know, could last
30 years.

And in Europe, they could last 50 years.

you don’t want to be in a transaction that long.

So

So you

have to structure it so that this thing kind of winds
down much quicker somehow.
So here it’s part of the rules.
MS. NOONAN:

Okay.

And was AIG -- did AIG-FP

always write credit protection that was -- that had the
same length of time as the underlying bonds?
Because -- the reason I ask is because I’m
familiar with some credit-default swap contracts that
would be limited to, say, three or five years, and not
necessarily be the same -- have the same life span that
the underlying bonds would.
112

FCIC Interview of Gary Gorton, May 11, 2010
MR. GORTON:

Right.

See, you can do that when

you write protection on, you know, IBM, right?

But you

can just say, “I’ll write protection for three years,”
right?
With these transactions, you can’t do that.
You -- because you’re writing protection on a piece of
the portfolio.

So the portfolio life, you know, is what

the other side is concerned about.
So, you know, if we said to them, “We’ll write
protection for three years but not for the life of the
deal,” nobody would, you know, want to buy it.
We could -- you know, in principle, we could
have done that.

But, you know, the market for this

stuff wasn’t demanding that kind of protection.
But we could limit it by saying, “Well, the
bonds that you put in have to be limited in their
lives.”
MS. NOONAN:

Okay, I see.

So then if you go to the next paragraph, it
talks about the ten-year weighted-average rating
factor -MR. GORTON:

Yup.

MS. NOONAN:

-- of the portfolio being

approximately 475.
MR. GORTON:

Right.
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MS. NOONAN:

Is this -- could you explain that

a little bit and how that -MR. GORTON:

Right.

So that’s how -- so these

are Moody’s things.
So you have this portfolio, and Moody’s wanted
ways to summarize the portfolio.

So, you know, the

problem was that, you know, if you have some bonds that
are Aaa and some are Aa and some are A, how do you -how do you -MS. NOONAN:

You can’t add A and Aa, and Aaa.

MR. GORTON:

Yes, you can’t add it.

And you

also don’t want to just say Aaa is 1 and Aa is 2.

So

you want to have numbers that reflect -- are more
reflective of the ordering, or the likelihood that
they’re going to default.

So Moody’s came up with these

ratings factors, right.
So, you know, it says here, where 360
corresponds to Baa2, and 610 is Baa3.

And they have

this whole, big chart, right?
So 16.35 -- so the weighted average rating
factor is 475.

And what they’re saying is, it falls

between Baa2 and Baa3.
So that’s the average quality of the bond by
this -MS. NOONAN:

Underwriter bond?
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FCIC Interview of Gary Gorton, May 11, 2010
MR. GORTON:

-- by this measure, right, of the

underlying bonds by this measure.
MS. NOONAN:

Okay.

MR. GORTON:

So a lot of this is just sort of

summary information that the parent company wanted to
see.

So in addition to the model numbers, they want to

have a picture of the risk just by these kinds of kind
of rules-of-thumb measures.
MS. NOONAN:

So is it right for me -- is it

right to say then, the CDO -- the assets of the CDO are
bonds whose average rating -MR. GORTON:

Right.

MS. NOONAN:

-- is between a Baa2 and a Baa3?

MR. GORTON:

Right.

MS. NOONAN:

So --

MR. GORTON:

Roughly.

Average, roughly, by

this method of averaging.
MS. NOONAN:

Okay, okay.

MR. GORTON:

Yes, that’s right.

weighting it.

So you’re

You’re weighting it you by these numbers;

but that’s right.

That’s the weighted average.

MS. NOONAN:

Okay.

MR. GORTON:

Yup.

MS. NOONAN:

Is there anything about a Baa2

that sounds particularly risky or not risky to you?

I
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mean, is that like a standard -- is that sort of a
typical -MR. GORTON:

No, there’s different kinds of

deals, and they have different attachment points, and
they have -- I mean, you know, this is why you need a
model, right?
right.

They have all these dimensions of risk,

You have the quality of the bonds.

You have the

maturity.

You have the number of bonds.

You have what

they are.

So it’s very hard to get a good sense of the

risk just by looking at these one-dimensional things.
So we’ve put all the one-dimensional things in
here, but then all that’s going to be taken into account
by the model.
MS. NOONAN:

Okay, so this was something

that -- this was part of that first input into the
model?
MR. GORTON:

No, it’s not an input.

MS. NOONAN:

Oh.

MR. GORTON:

This is not an input into the

model.
These are numbers which are just summarizing,
you know, in this -- in this -- with these, you know,
kind of rules of thumb what this portfolio looks like.
MS. NOONAN:

Okay.

MR. GORTON:

So that the box tells you some
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stuff, and then we’re telling you some other stuff.
MS. NOONAN:

But this is more -- just to

understand what the portfolio is made up of -MR. GORTON:

Yes.

MS. NOONAN:

-- than it is to actually put

into the model?
MR. GORTON:

Right.

MS. NOONAN:

Okay.

Although the ratings are

separately taken into account in the model?
MR. GORTON:

Right.

MS. NOONAN:

Just not using these particular

MR. GORTON:

Right.

MS. NOONAN:

Okay.

numbers?

And then it goes on to

say, “The correlated diversity score, the correlation
factor is 16.5.”
MR. GORTON:

Again, another Moody’s thing.

MS. NOONAN:

And, I mean -- so we talked a

little bit about correlation earlier.
MR. GORTON:

Uh-huh.

MS. NOONAN:

Is this a similar concept?

Is it

based on the types of assets that are in the CDO?
MR. GORTON:

Moody’s -- Moody’s came up with

this methodology, right?

So it’s -- you know, a lot of

these things, whether we like them or not, they became a
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FCIC Interview of Gary Gorton, May 11, 2010
sort of language that people spoke in, right?

So you

would call up -MS. NOONAN:

And I’m trying to understand it.

MR. GORTON:

You would call up and say, “Oh,

I have a deal,” and I would say, “What’s the” -- you
know, “What’s the WARF?

What’s the correlation factor?

So, you know, it’s just a language.
MS. NOONAN:

So --

So what would a correlation

factor of 16.5 said to you?

What would that have meant

to you?
MR. GORTON:
frankly.

I don’t know what that means,

Either, I can’t remember or I never knew.

I don’t know.

I don’t know.

I don’t remember the methodology.
there’s a little box and you compute it.

I mean,

I don’t know.

MS. NOONAN:

Okay.

MR. GORTON:

I don’t even think I remember.

MS. NOONAN:

Would it have been something that

was important to you at the time?
MR. GORTON:

No, not really.

I mean, I think it’s important to report all
of this information because, you know, lots of people
are going to read this memo, and many of them aren’t
going to really understand the model.

So, you know,

they need to understand a lot about the transaction in a
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FCIC Interview of Gary Gorton, May 11, 2010
way which makes sense to them.

So we want to report

lots of information, especially the kind of common
terminology, right.

Because you have lots of credit

officers at AIG who don’t necessarily work on this but
may end up reading this memo.
So -- you know, so when Moody’s came out with
these things, you know, the parent company would say,
“Could you include this in the memo?”

“Okay, we’ll

include this.”
MS. NOONAN:

So it would just require sort of

going to Moody’s, maybe, to figure out what -MR. GORTON:

No, I think we knew how to

commute it ourselves.
MS. NOONAN:

Okay, who would -- would Al Frost

have worked on this?
MR. GORTON:

No, no.

There would be some

programmer or assistant-type person who, you know, you
would just ask, “We need a correlation factor for this
portfolio.

I just e-mailed it to you.”
MS. NOONAN:

Okay.

MR. GORTON:

Something like that.

MS. NOONAN:

Okay, but you’re not sure sort of

how it’s computed or -MR. GORTON:

I don’t remember.

MS. NOONAN:

-- what goes into it?
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FCIC Interview of Gary Gorton, May 11, 2010
MR. GORTON:

Yes.

MS. NOONAN:

Okay, okay.

(Speaking to Ms. Morain):

Would you make a

note of that, so that we can sort of follow up on that?
MR. GORTON:

I mean, it lists the Moody’s

document here to look at.
MS. NOONAN:

Right, yes, that’s what I was --

yes.
So then we go to the next page.
Is this table something that you worked on?
MR. GORTON:

I don’t remember this one; but

certainly, this is typical of the kinds of criteria that
was important.
MS. NOONAN:

Okay, okay.

And then where would

we have -- where would sort of your section have
started?

Would it have started with the table –MR. GORTON:
MR. TOMBACK:

I think –24.

MS. NOONAN:

-- or the paragraphs above the

MR. GORTON:

I think it would start with the

table?

“Next.”

The paragraph starting, “Next, we constructed…”
MS. NOONAN:

Okay, so if you could just sort

of take me through -MR. GORTON:

Or maybe the paragraph before
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FCIC Interview of Gary Gorton, May 11, 2010
that.
So here’s the basic issue -MS. NOONAN:

Okay.

MR. GORTON:

-- when they -- when we’re

writing this memo, they have only purchased 90.2 percent
of the portfolio.

So they have --

MS. NOONAN:

The CDO manager?

MR. GORTON:

The CDO -- the investment --

MS. NOONAN:

Soc. Gen.?

MR. GORTON:

Right.

Soc. Gen.

They’re warehousing this,

these bonds.
So they -- so we have three things we can do.
One thing is, we can say, “Okay, let’s just
assume that’s just the entire portfolio,” right, and,
“Let’s look at what the number is there.
is this worst-case VAR.”

And the number

So that says, we would have to

attach a 22.58 percent for that 90.2 percent of the
portfolio, okay.
Now, the problem is -MS. NOONAN:

And when you attach at

22.58 percent, that means, roughly, you could write
protection on 77 percent?
MR. GORTON:

Yes, yes.

MS. NOONAN:

Okay.
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FCIC Interview of Gary Gorton, May 11, 2010
MR. GORTON:

Exactly.

Now, the problem is, for the remainder of the
portfolio -- roughly 10 percent -- they have to live by
these rules.

But within those rules, they could very

cleverly come up with the worst-possible set of bonds.
So we can figure out what the worst-possible
set of bonds is, too.

And we’re going to assume that

that’s what they do, okay?
So it says, “Constructed worst-case scenario,”
right?

So that says, “Let’s assume the whole portfolio

is this -- the worst thing they could do under the
rules.”

And that comes up with this number

26.33 percent.
MS. NOONAN:

For the attachment point?

MR. GORTON:

For the attachment point.

Now -MS. NOONAN:

Okay, so this refers to the

attachment point?
MR. GORTON:

Right, that’s the attachment

point.
So then -- then we said -MS. NOONAN:

And can I just pause, just for a

MR. GORTON:

Sure.

MS. NOONAN:

-- and say, “When AIG is defining

moment --

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FCIC Interview of Gary Gorton, May 11, 2010
the worst thing they can do, does that mean it’s
investing in the riskiest assets?
MR. GORTON:

No, this is the -- yes, the

manager -- the manager -- we’re saying, under the rules,
the manager could pick the riskiest, worst assets.
MS. NOONAN:

Okay, because some people in this

world would say the risky ones are the good ones because
they return -- they have more -- a higher yield, or a
higher return.
MR. GORTON:

No, no, no.

So we’re

thinking they’re -MS. NOONAN:

I just want to make sure.

MR. GORTON:

-- they’re like cherry-picking

us, right?
So they’re saying, under the rules, we’re
allowed to put in this really toxic, horrible thing.
And we say, “Gee, you know, under the rules, they are.”
So let’s assume they do that, all right, and let’s
assume they do that with the whole trade, never mind
that they purchased 90 percent.
entire trade.

They do that with the

So that gets this 26.33 number.

So then we say, “Okay, what if we -- what if
it’s the case that the average life -- this arbitrarily
goes longer by a year,” right, or goes longer by two
years, then you can see the effect of that, right?
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FCIC Interview of Gary Gorton, May 11, 2010
So it could be 32.75 if this thing goes longer
by two years.
Now, this case, you know, can’t actually occur
because they’ve already purchased 90 percent of the
portfolio.

But it is informative to know, you know,

what they could -- what the worst case under the rules
actually is.
Now, so the rules -MS. NOONAN:

And that would then get at -- for

example, if it was an actively managed pool.
MR. GORTON:

Well, then, you’re only allowed

to reinvest over a certain period of time, and only a
certain amount per year.
But you’re right -MS. NOONAN:

But this would catch that?

MR. GORTON:

This would catch that.

Because

we would say -- let’s suppose you actively manage to the
worst case, to the extent you can under the rules, and
that’s the -- that would be what we actually model.
So this -- this -- in this -- for this trade,
this constructed worst-case scenario is -- you know,
can’t actually happen.
MS. NOONAN:

Uh-huh.

MR. GORTON:

But we put it in, anyway, so we

can see what it looks like.
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FCIC Interview of Gary Gorton, May 11, 2010
The realistic case is the bottom one, where we
say, “Okay, you have 90 percent of the portfolio.

Let’s

assume the other 10 percent is the worst case.”
And, again, you see that the base is 24.69
compared to 22.58.

And, again, it goes way up if you

add one or two years.
MS. NOONAN:

So this was -- was this --

MR. GORTON:

So we ended up with a transaction

where we asked for a 34 percent attachment point.

See,

that’s -MR. TOMBACK:

So assuming the worst on the

average life.
MS. NOONAN:

Where do you see that?

MR. GORTON:

That’s on the first page.

MS. NOONAN:

Of the executive summary?

MR. GORTON:

No -- yes, where it says

34 percent is the buffer.

So that’s how much we have

junior to us.
So the transaction is structured to be -- have
more of a buffer than even this case I said could never
happen, plus two years, right?
That’s why -- that’s why, you know, strictly
speaking, the model number should be something in this
bottom table, right?

But we asked for significantly

more than that.
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FCIC Interview of Gary Gorton, May 11, 2010
MS. NOONAN:

Just to sort of test the limits,

was there a limit to how far beyond the weighted average
life the deal could actually run?
So here, we’re assuming a plus-two years,
which is bad -- bad.
MR. GORTON:
right?

Well, these deals amortize,

So they amortize according to schedules.
So it could, it could, but it would be very

unlikely for all of them to do that.

You know, one or

two might, for some odd reason.
MS. NOONAN:

Say, for example, the United

States government comes in and guarantees all mortgages
and outlaws prepayments.
MR. GORTON:

You know, I guess if they outlaw

prepayments, then the mortgages are going to, you know,
the end.

And in that case, you know, the categories of

mortgages that we have here, you know, it’s about, you
know, I don’t know, 75 percent of this deal, they would
go to the end, yes.
MS. NOONAN:

Okay, okay.

I mean, just really

testing the limits -MR. GORTON:

No, no.

MS. NOONAN:

-- from a sort of contractual?

MR. GORTON:

Yes, that’s right.

MS. NOONAN:

The same point?
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FCIC Interview of Gary Gorton, May 11, 2010
MR. GORTON:

That’s right.

MS. NOONAN:

Okay, okay.

MR. GORTON:

That’s what would happen.

MS. NOONAN:

Okay, okay.

And this -- so the VAR models that are here,
the attachment points that are calculated over here on
the right on these tables, was this a separate model?
MR. GORTON:

No, this is the one we were

talking about before.
This WVAR number is the 99.85.

And then the

“W” just means it’s in this worst case that we were
talking about before.
MS. NOONAN:

Okay.

MR. GORTON:

Somehow, this became the

terminology.
MS. NOONAN:

Okay, okay.

The only reason I

ask is because the model that I think AIG ended up using
in part of 2007, before it went to the binomial
expansion technique model to value the CDS portfolio,
was a VAR model.
MR. GORTON:
doing.

Oh, I don’t know what they were

I mean, I don’t think it was this model.
MS. NOONAN:

No, no, I don’t think it was,

either; but I just…
MR. GORTON:

Right.

Yes, I don’t know.
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FCIC Interview of Gary Gorton, May 11, 2010
MS. NOONAN:

Okay, okay.

So this says -- and

then on know the next page, “These results are
consistent with the risk of AIG-FP’s position being
super-Aaa risk.”
MR. GORTON:

Yes.

In this case, it was

actually rated.
MS. NOONAN:

By the rating agencies?

MR. GORTON:

Yes.

If it’s cash, it has to have a rating.
MS. NOONAN:

So when you say it’s cash, does

that mean that AIG -MR. GORTON:

No, no, no.

MS. NOONAN:

-- paid money to buy it?

MR. GORTON:

No.

So you have this

special-purpose vehicle which is going to buy a
portfolio, and it’s going to finance that portfolio by
issuing these bonds that were listed in the table,
right?
MS. NOONAN:
page.

Wait, we’ll get to the right

Hang on one second.
MR. GORTON:

So it’s 1, 2, 1 [one to one] –-

MS. NOONAN:

The class notes?

that’s -The Class B

notes, the Class C notes -MR. GORTON:

Yes.
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FCIC Interview of Gary Gorton, May 11, 2010
MS. NOONAN:

-- right?

MR. GORTON:

This tells you the notes that are

going to be issued in the capital market, except for
equity, which is going to be retained by the manager
here, which was -- I saw it somewhere in here, who it
was.

But, anyway -- so somebody is going to buy these

bonds.
Now, one possibility is that Soc. Gen. is
going to buy the bonds and we’re going to write
protection on it.
MS. NOONAN:

Okay.

MR. GORTON:

Right.

MS. NOONAN:

On the Class A or on all of them?

MR. GORTON:

On just the Class A notes, right.

So because you’re buying actual bonds, you have to have
the money to buy the bonds; so you have to actually
issue and get the money.
So this -- this is not, you know, a synthetic
deal.
In other cases, in Europe, we could write
protection to, you know, commerce bank on, you know, the
senior 80 percent of a particular portfolio.

And for

that part, there’s no money that changes hands because
there’s no SPV and so on.
MS. NOONAN:

Right.

It’s unfunded?
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FCIC Interview of Gary Gorton, May 11, 2010
MR. GORTON:

It’s unfunded, yes.

MS. NOONAN:

But this was you be funded.

And

the way it was -- so unless AIG is going to buy the
Class A notes because of a CDO it’s managing on its own
behalf -MR. GORTON:

Yes.

MS. NOONAN:

-- then the deal here is for

AIG-FP -- for someone, whether it be Soc. Gen. buying
it -MR. GORTON:

Or someone else.

MS. NOONAN:

-- in the first instance or

buying it and selling it to someone else, or immediately
selling it to someone else, the deal is for them to
actually pay in the 264 million in cash into the SPV?
MR. GORTON:

Uh-huh.

MS. NOONAN:

And then AIG-FP enters into a

separate contract to write credit protection on that
class?
MR. GORTON:

Yes.

MS. NOONAN:

Okay.

Correct.
And does the swap follow

the owner of the bond?
MR. GORTON:

It’s written -- it’s -- that’s a

good question.
MS. NOONAN:

You know what I mean?

MR. GORTON:

Yes, I know what you mean.
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FCIC Interview of Gary Gorton, May 11, 2010
I think the answer is no.
It’s not like insurance guarantees on
municipal bonds, that follows the bond around, right?
So I think -- it’s going to be written to Soc. Gen.
referencing these bonds.
should check with Al.

But that’s something you

I’m pretty sure that’s right,

though.
So, it’s not attached to the bond, like an
MBIA wrap.
MS. NOONAN:
contract?

Okay, so it’s a separate

It’s not actually within the deal?
MR. GORTON:

Right.

I mean, it’s a good

question, you should ask Al.
MS. NOONAN:

Okay.

MR. GORTON:

I don’t think that AIG-FP was

writing protection to the SPV.

I think AIG-FP was

writing protection to Soc. Gen. and referencing the
bonds, but I’m not positive about that.
MS. HEYL:

Could Soc. Gen. transfer its rights

under the -MR. GORTON:

I think you’d have to novate it.

Again, these are questions – these are not questions
for me.
MS. NOONAN:

Or Soc. Gen. to keep it but enter

into a mirror swap permanently?
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FCIC Interview of Gary Gorton, May 11, 2010
MR. GORTON:

Something like that, yes.

I

don’t know.
MS. NOONAN:
MR. TOMBACK:

That’s fine.

That’s fine.

I imagine if protection is

worthwhile, it would be retained upon transfer in some
way.
MS. NOONAN:

Well, I mean, the one thing

that’s interesting, I don’t know if it’s this one, I
know I read somewhere that the swap calls for -- swaps
called for -- some swaps called for physical settlement.
MR. TOMBACK:
MS. NOONAN:

Right.
So if AIG -- if the subordinate

tranches were ever eaten up such that the losses seeped
into the portion of the structure that AIG had written
protection on, then AIG has to pay out the value, right?
But they get back the bond -MR. GORTON:

Right.

MS. NOONAN:

-- because, presumably, the bond

still has some value, and that required a physical
settlement.
MR. GORTON:

Right.

MS. NOONAN:

And it would be really hard for

Soc. Gen. to physically settle if it had sold the bond
that kept the default swap protection.
MR. GORTON:

Right, then has to go buy it or,
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FCIC Interview of Gary Gorton, May 11, 2010
you know.
MS. NOONAN:

Right.

MR. GORTON:

This way, single names work.

You

have to go buy it.
MS. NOONAN:

Right, right.

But this would

presumably be harder to go buy it in this instance?
MR. GORTON:

Yes, but, I mean, it surely is a

sort of technical matter.
MS. NOONAN:

I don’t know.

Okay.

Hold on one second.

Thanks.
I mean, are there other things about this that
I sort of should focus in that I haven’t so far?

I

know -- I apologize for the open-ended question.

But if

there are -- I feel like I have a better understanding
now, and I appreciate your sort of taking me through
this.
MR. GORTON:

I mean, I think that’s pretty

MS. NOONAN:

Okay.

MR. GORTON:

I mean, the actual bonds that

much it.

they had purchased were always -- would always be
included.
MS. NOONAN:
bonds?

And who would diligence these

Like, who would be in charge of sort of going

through, looking up the QCIPs and…
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FCIC Interview of Gary Gorton, May 11, 2010
MR. GORTON:

The library.

MS. NOONAN:

If that happened, assuming that

that happened?
MR. GORTON:

The library.

Oh, yes, absolutely, that would happen.

The

library would do that.
So there’s a little -MS. NOONAN:

The library?

MR. GORTON:

Yes.

We had a group of three

people who was called the Research Library.

And they

were the people you’d go to for a whole range of
different things, including finding the QCIPs and
checking the ratings and all that.
MS. NOONAN:

Do you remember their names?

MR. GORTON:

The head librarian was a woman

named Deonna Taylor, and then there was Frank Levantino
and Howard Zhang.
These were the three people at the end.

There

was a few people who were, you know, kind of at the
beginning, they were a little bit different.
MS. HEYL:

Zhang is Z-A-N-G?

MR. GORTON:

Howard Zhang is -- I can’t

remember if it’s -- I think it’s an “H.”
Z-H-A-N-G.

So --

I think a

And Levantino is L-E-V-A-N-T-I-N-O.

And

then Deonna Taylor.
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FCIC Interview of Gary Gorton, May 11, 2010
So they were the library
MS. NOONAN:

And Deonna is D-E-O-N-A?

MR. GORTON:

Yes, D-E-O-N-A, right.

MS. NOONAN:

Okay, okay.

That’s

right.

So, actually, if you look at the cover e-mail,
I just think it’s -- it just happens to be on this one.
I think it’s sort of interesting.

It appears to be a

discussion of what constitutes the definition of
subprime versus Alt-A.
MR. GORTON:

Right.

MS. NOONAN:

Was there a common understanding

within AIG-FP?
MR. GORTON:

There was not a common

understanding in the world.

There were not, for a long

time -- I’m not even sure there is now -- but the
agencies differed from the iBanks differed as to what
they called Alt-A, subprime.
So, you know, it was -- if you’re going to
report it or have rules, you have to have some
understanding of what it is.

You have to define it.

So

that’s what this e-mail is about.
MS. NOONAN:

And do you remember of there

being a resolution of that within -MR. GORTON:

I don’t remember what -- I don’t
135

FCIC Interview of Gary Gorton, May 11, 2010
remember what happened.

I mean, I don’t remember

whether there was some agreement, you know, in the
world, either.

So I don’t know how that finally played

out.
MS. NOONAN:

Hold on one second.

There are a

couple of other things I just wanted to ask you about.
Sorry, just give me one second.
Could you get this one Clara?

I think this --

actually, I think there are just two that I’m just sort
of curious about.
And this is the other one.
If you want to make copies, then let me let
her get this other one.

There are only two that I

really think are really going to -- thanks.
Okay, what can I ask you about in the
meantime?
Oh, I know.
Could you tell me a little bit about your
compensation at AIG?
MS. HEYL:

Andy?

MR. TOMBACK:

Actually, our view on this is

because of all the threats, a number of clients jave
actually been threatened with violence on the payments.
A number of clients actually did not -- they turned back
some of their payments.
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FCIC Interview of Gary Gorton, May 11, 2010
MS. NOONAN:

Uh-huh.

MR. TOMBACK:

But --

MS. NOONAN:
MS. HEYL:

Do you represent Jake DeSantis?
No.

MR. TOMBACK:
MS. HEYL:

No.

He had a lot of problems.

He’s the one that wrote the letter?

MR. TOMBACK:
MR. GORTON:

Yes, right.
I had a lot of death threats from

the Wall Street Journal article.

And I’m the one who

asked for there to be more security at the FCIC
hearings.
MS. NOONAN:

Really?

MR. GORTON:

Yes, really.

I also had Yale security -- it was really a
terrible thing, right?

You know, I had to tell people

in my building not to open packages.
MS. NOONAN:

Huh.

MR. GORTON:

You know, and then over Cuomo, I

made plans for my family to move to Boston.
No, I mean, I’m serious -MS. HEYL:

So bottom line is, we don’t want to

get this on this tape.
MR. GORTON:
MS. HEYL:

You only need one nut.
We don’t want this out in the

public record at this point.
137

FCIC Interview of Gary Gorton, May 11, 2010
MS. NOONAN:

Okay, okay.

Well, this will not go in the public record at
this point.
MS. HEYL:

No, but it might go in the report.

And at this point, we just don’t want to have it given
to you in a form that it would end up in the public
unless we talk about it a whole lot more than we’ve
already talked about it.
MR. GORTON:

My problem is, I’m sort of very

publicly visible, right?

Most people work at FP, nobody

knows who they are, where they live, unless their names
were leaked by Cuomo.
But that’s not my situation.

Everybody knows

where I am, right, which is why it’s easy to write me a
death threat in a letter.
MS. NOONAN:

Well, and just so you know, this

is not unique to you.

This is something that we, quite

frankly, ask everyone.
MR. GORTON:

Yes.

MS. NOONAN:

And the issue of incentives and

compensation are something that we’re looking at.
Something that is actually, I’m pretty certain, is in
the statute, that we’re supposed to look at the issue of
how people were incentivized and how they were
compensated and how has that sort of played a role, if
138

FCIC Interview of Gary Gorton, May 11, 2010
at all.
And so this is not something that is – this is
just standard.

I just wanted to put it on record.

We can discuss it at some point offline.
MS. HEYL:

Yes, we can do it offline.

MS. NOONAN:
MS. HEYL:

Okay.

That’s fine, that’s fine.

Because whether he has a good

memory of it or not and has all the numbers -- certainly
Weill does, but my understanding is that Weill hasn’t
given you that information yet.
MS. NOONAN:
MS. HEYL:

No, they haven’t.
So --

MS. NOONAN:

Or at least to my knowledge.

I haven’t been through every last document
that they’ve given us.
MS. HEYL:

I think they were under the

impression they had not given out information about our
client’s compensation, either to you or to anybody.
MS. NOONAN:

Right.

Although I think it has

been requested.
MS. HEYL:

Okay.

But I’m just saying that

given the fallout that was so -MS. NOONAN:
MS. HEYL:

Sure.

MS. NOONAN:

-- massive last time.
Right.

No, I understand it’s a
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FCIC Interview of Gary Gorton, May 11, 2010
sensitive issue, and we’ll –
MR. TOMBACK:
MS. NOONAN:
MR. TOMBACK:

We can come back to it.
We can deal with it later.
We can come back to it.

I mean, I think we can agree that he earned
more per hour at AIG than he did, first, at Wharton, and
then at Yale.

And let’s work on the details later.

MS. NOONAN:

Okay, okay, that’s fine.

Let me see if there’s anything else on my
list.
So I don’t know if you’ve read the Michael
Lewis book or not.
MR. GORTON:

No, I have not.

MS. NOONAN:

“The Big Short.”

MR. GORTON:

Yes.

MS. NOONAN:

So there’s a passage in it where,

I believe, it’s -- I believe the way that the story is
written, it’s that Gene Park comes to you and some other
people at AIG-FP and asks what percent of the deals you
think are subprime.
MR. GORTON:

Right.

MS. NOONAN:

And in the book, it says that you

responded, “Maybe 10 percent.”
MR. GORTON:

Right.

MS. NOONAN:

Now, the book also goes on to -140

FCIC Interview of Gary Gorton, May 11, 2010
I can’t remember whether the book says what the actual
percentage was, and I’m not clear on whether that’s
right or not.
But do you remember that -MR. GORTON:

I remember that --

MS. NOONAN:

-- happening?

MR. GORTON:

-- from the Vanity Fair article.

I don’t remember that happening -MS. NOONAN:

You don’t remember –- well, my

question is, do you remember it happening?
MR. GORTON:

No.

But I can easily imagine

that, you know, because I wasn’t involved in the
business for the last four years, that I was thinking,
before I moved over to commodity futures, that’s
probably what it was, 10 percent.

And then later, it

evolved somewhere else, so…
MS. HEYL:

Well, do you remember coming up

with that –MR. GORTON:
MS. HEYL:

I don’t know.
-- number for Gene Park?

MR. GORTON:

I don’t know.

MS. NOONAN:

Okay.

I don’t remember

that, no.

MS. HEYL:

And did anyone ask you to verify

that for the book?
141

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MR. GORTON:

No, I didn’t talk to Michael

MS. NOONAN:

No, these are extra copies.

Lewis.

MR. TOMBACK:

With respect to the available

people at AIG FP, both in London and Connecticut at that
time, were you a good choice to ask for current
information on the percentage of subprime in the book?
MR. GORTON:

No, I wasn’t good person.

I

refused to talk to Michael Lewis; and Gene later
apologized.
MS. HEYL:
MR. GORTON:

Apologized for what?
Well, he was very -- he -- I

mean, he just felt bad about the whole thing.

But he

was kind of naive.
MS. NOONAN:

I just wanted to get it on the

record.
Okay, so two e-mails.

One is -- the first one

that I want to talk to about is dated February 16th,
2006.

It’s Bates number AIG-FCIC-00109416 to -419.

And

it’s sort of a long chain of e-mails.
If you flip sort of to the last -- page 3 of
4, at the very bottom; and then on the fourth page, it
starts out with an e-mail from Andrew Forster to you and
Gene Park and others.
thoughts.”

And the subject is, “Subprime

And it’s just talking about concerns the way
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FCIC Interview of Gary Gorton, May 11, 2010
that the market is developing.

Specifically, declining

underwriting standards, et cetera.
So then if you go to the bottom of page 3, you
respond, and you said, “I think the really bad scenarios
have Bbb-rated bonds being hit and possibly suffering
significantly.

Are we being a bit paranoid about the

other situations?”
So I just wondered, what was your view at the
time of the idea that AIG-FP should get out of this
business?
MR. GORTON:

I mean, I don’t remember exactly

what it was at the time.

I also -- I vaguely remember

this happening earlier; but, you know, there was a -there were deals -MS. NOONAN:

You remember a similar discussion

taking place earlier?
MR. GORTON:

Yes, I thought this whole

discussion happened earlier, but, you know, maybe just
my memory’s wrong.
I think the question -- there was a long
discussion in the group about the whole issue of the
business and subprime and CDOs.

And we all thought

that, you know, house prices aren’t going to keep going
up; they’re going to go down.

And the question is, how

bad is it going to be?
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FCIC Interview of Gary Gorton, May 11, 2010
And there were deals called “high-grade
deals,” where the underlying bonds were mostly Aaa and
Aa.
So the question was -MS. NOONAN:

Okay.

MR. GORTON:

-- would we be willing to do

those deals and not the deals that had all these Bbb’s.
I think everybody agreed that the Bbb’s were in trouble.
And in the end, we all agreed to just get out
completely.

And this is sort of somewhere in the middle

of this big discussion.
MS. NOONAN:

Were there others that -- because

it seems at this point that you’re sort of trying to
make some case for, “Maybe we could stay in part of this
business.”
MR. GORTON:

Yes, I mean, I was thinking about

it.
In the end, as a group, we were unanimous and
recommending exit from the whole thing.
MS. NOONAN:

Okay.

MR. GORTON:

But, you know, we went through a

long discussion and a lot of meetings and research to
get to that point
MS. NOONAN:

So is this -- would that have

reflected sort of a change of opinion on your part or
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FCIC Interview of Gary Gorton, May 11, 2010
was that just a -MR. GORTON:

I don’t know.

I don’t remember,

MS. NOONAN:

I mean, Alan Frost, for example,

really.

if you look on page 2 at the bottom, like the third
sentence, “I think we’re being a bit extreme about
theses risks, and the consequence of the changes in our
approach will fundamentally shut us out of the entire
market very quickly.”
MR. GORTON:

Yes.

MS. NOONAN:

I mean, it sounds like a

consensus was reached at the end, is what you said.
I mean, were there others that sort of had the
view that Frost sort of makes here?
MR. GORTON:

I mean, I don’t remember

everybody’s view.
I remember there was -- you know, there was a
significant investment in spending –- in getting a lot
more information about this market, and a lot of
discussions.
And when we finally talked to Cassano, you
know, nobody -- there was no minority view.

All right,

everybody said, “We’re out.”
MS. NOONAN:

Was Andrew Forster the person

that really prompted this discussion or was someone
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FCIC Interview of Gary Gorton, May 11, 2010
else?
MR. GORTON:

No, it was Park.

It was Park.

MS. NOONAN:

Park?

MR. GORTON:

Park was really the trigger for

Okay.

really thinking a lot more about it.
And, you know, I had been working on commodity
futures, so I didn’t realize that we were being shown a
deal -- in fact, I was even surprised at some of the
deals that we did.

I don’t know how -- you know, I

don’t know.
MR. TOMBACK:

Let me just mention because

Alan’s not here but he’s quoted in Gary’s interview.
But that same e-mail, Alan goes on to say, and I quote,
“I don’t think we can just look at this as
just an exiting the mezz – mezzanine -- subprime CDO
market even though that’s the driver.

Maybe we should

spend some more time working on some revised rules so
that we don’t shut it down completely.”
“Having said all that, I do not have a very
robust rebuttal to the concerns that people have,
although I am probably more of a buyer of the
soft-landing expectations -- expectation.”
So -MR. GORTON:
MR. TOMBACK:

I mean, it was a very --- he’s not a wide-eye, “Let’s
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FCIC Interview of Gary Gorton, May 11, 2010
keep going” guy, that first quote would lead you to
conclude.
MS. NOONAN:
whole document.

Right.

I mean, I’ve read the

I appreciate that.

MR. TOMBACK:

Okay, I just wanted it tape

recorded again.
MS. NOONAN:

I appreciate that.

That’s just

fine.
I -- I mean, this -- this string of e-mails
appears to be a robust conversation about whether or not
AIG-FP should stay in the business or not.
I’m trying to get a little bit of more sense
of what was taking place offline, off-e-mails, in
discussions and phone calls.
MR. GORTON:

It’s no different from this.

This is -- this is a kind of accurate sampling, right?
I mean, we went to see a number of economists
at investment banks and I think the rating agencies and
a lot of people, you know, asked them a whole bunch of
questions.

So we -- this was -- you know, the guys came

from London and New York, we had all these meetings.
And, you know, over this time, so there’s this
discussion.

And, you know, in the end, there was this

conclusion to get out.
MS. NOONAN:

Were you involved in any of the
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FCIC Interview of Gary Gorton, May 11, 2010
discussions with the external people?
MR. GORTON:
meetings.

Yes, I went to some of these

I mean, I’m not sure if I went to all of

them, but I went -- I remember spending, you know, a
couple days in New York, going from meeting to meeting
to meeting.
MS. NOONAN:

So what investment banks?

Would

it have been a lot of AIG’s counterparties on deals or…
MR. GORTON:

I’m not sure how they were

picked.
I mean, one of the ways they were picked was,
we picked firms where they had research analysts or
economists who seemed to write the best stuff about the
housing market.

So that was one criteria.

I mean, our counterparties -- you know, the
actual people on the other end of the phone would have
no idea about this.

So you don’t need to talk to them.

They want to keep going.
So, you know, the question is, what are the
research people, in the research departments, those are
the people you want to go talk to.
MS. NOONAN:

Okay.

So then if you go up to

Andrew Forster’s response at 9:03 a.m., the last
sentence of the first full paragraph -- or just the last
part of it -- he says, “If we think there’s a softer -148

FCIC Interview of Gary Gorton, May 11, 2010
more likely to be a softer landing, I prefer we took
that view directly by investing in the underlying deals
and then earning some real spreads since we are taking
pretty much the same view in my mind and since we lack
any feel for correlation across deals, so we have no
idea if the subordination we have is worth much.”
I’m just curious whether you agree with that
statement, the part about, “We lack any feel for
correlation across deals and don’t have any idea if the
subordination is worth much”?
MR. GORTON:

Right, that’s exactly what we

were discussing before, when you pointed to that table
about 2006.
MS. NOONAN:

Okay.

MR. GORTON:

That’s the same -- he’s

articulating the same thing, right?
MS. NOONAN:

Okay, so then the question that

jumps out to me, and sort of something that I thought
about when we talked about it earlier as well is, does
it at all sort of -- did it make you think or revisit
the information you had using the model for the prior
deals?
MR. GORTON:

No, because there was -- the

information, again, that we looked at were the 2005 and
earlier vintages were much different, right?

And,
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FCIC Interview of Gary Gorton, May 11, 2010
again, as far as I know -- I may be wrong, but at least
as of two months ago, we didn’t even have losses on the
really terrible 2006 deals.
So I think -- I mean, I think in all this
regard, we made the right decisions.

But the problem,

as you indicated earlier, was all this collateral that
was based on prices, and the prices suddenly plummet.
And, you know -- you know, this part, I think we
actually got right.
MS. NOONAN:

So then the last part is just

flipping it to the front page, and then you respond,
“On Aa and Aaa tranches, I think we should distinguish
between taking them and controlling how much we would
take.

This is important because I think the distinction

is between shutting down a business completely versus
making an attempt to get some deals and influence the
street.”
I’m sort of curious about “influencing the
street,” that part of the sentence.
MR. GORTON:

Yes, I’m not sure what I meant,

other than the fact that we -- you know, we might be
able to say to counterparties, “We only want deals that
have Aaa bonds in them,” right?

If we just said that,

the question is, you know, could we -- you know, would
they do that?

I don’t know.

But in the end, we decided
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FCIC Interview of Gary Gorton, May 11, 2010
not to do it.
MS. NOONAN:

Do you know or think that -- it’s

probably the wrong way to ask the question.
So, first, do you know whether AIG’s decision
to exit the business entirely did, in fact, have an
influence on the street?
MR. GORTON:

No.

I was --

MS. NOONAN:

Or would you have been aware of

any feedback from counterparties?
MR. GORTON:

Well, I was, frankly, pretty

stunned because, you know, I thought our exit would be
kind of a red flag to others; but most of our
counterparties did twice as much in 2006 as in 2005.
And, you know, I remember saying, “I don’t understand,
like, aren’t they getting the same information we’re
getting?

What are they doing?”

You know, these turned

out to be UBS, Merrill Lynch, Citibank, and so I don’t
know.
MR. TOMBACK:

You said counterparties.

But

were really people that -MR. GORTON:

Yes, they were not counterparties

MR. TOMBACK:

Effectively, your competitors,

but --

entities that are selling protection?
MR. GORTON:

Yes, entities that are selling
151

FCIC Interview of Gary Gorton, May 11, 2010
protection.

Or what they did was they kept the bonds.

MS. NOONAN:

They may have been buyers of

protection from AIG in previous deals?
MR. GORTON:
were.

Some of them -– some of them

But the main point is that the street, as a

whole, did twice as much in 2006 as 2005, independent of
us.

I mean, I found that -- that just seemed kind of

odd, given everything that we had seen and what we had
concluded.
MS. NOONAN:

Were you thinking about at the

time or is this sort of looking back on it, being
surprised?
MR. GORTON:
were surprised.

No, at the time.

At the time we

At the time we were surprised.

And at the time, you know, I was very
convinced when, you know, we had this meeting with Joe,
and I said, “You know, we should go short.”
And he said, “How much?”
I said, “A billion,” right, which wouldn’t
have made a difference in the end.

But we before pretty

sure this was going to be -- we didn’t realize how big
of a blowup it was going to be.
was going to be pretty bad.

But it seemed like it

And so we were really

surprised.
MS. NOONAN:

So what was -152

FCIC Interview of Gary Gorton, May 11, 2010
MR. TOMBACK:

Just to be clear about that, so

you were really surprised about the lack of response by
the rest of the street?
MR. GORTON:

Yes.

MS. NOONAN:

And so when you recommended to

Cassano going short -MR. GORTON:

Yes.

MS. NOONAN:

-- could you tell me a little bit

about the discussion?

Was that something that Cassano

had asked you to think about or was it something that
you -MR. GORTON:

No, we just -- we should not only

stop -- the reasons we’re stopping are so good, we
should go short.
You know, and with credit derivatives, it’s
not like stocks, right?
to pay, right?

You know how much you’re going

Stocks, you don’t know.

So -- but this

wasn’t -- this was really not the kind of thing we did.
And in the end, you’d have to -MS. NOONAN:

Going short was not the kind of

thing you did?
MR. GORTON:
not very much.

Yes.

I mean, we did go short but

I forget how much.

Like, 250 million or

something.
MS. NOONAN:

And how did you go short?
153

FCIC Interview of Gary Gorton, May 11, 2010
MR. GORTON:

I don’t know.

You’d have to ask

MS. NOONAN:

Forster?

MR. GORTON:

Maybe we did the ABX index.

Forster.

don’t know.

I

I don’t know.

MS. NOONAN:

But Cassano was not interested in

going short or -MR. GORTON:

No, he was, to some extent.

But,

I mean, he was happy to get out when all of us said we
all agree.

You know, that’s compelling.
So he said, “Why?”

We explained, and he said,

“Fine.”
Then we said, “We should go short,” and that
was less -- he was sort of less interested in that.
MS. NOONAN:

When the decision was made to

exit the business, did that cut off a significant
revenue stream for the unit?
MR. GORTON:

Yes, you would have to ask Al.

I’d say it’s 50 to 80 million a year, something like
that.
MS. NOONAN:

Was there any discussion -- was

there any pushback on that, like, losing that revenue
stream?
MR. GORTON:

Yes.

You know, you hate to close

a business like that; but, you know, nobody -- there was
154

FCIC Interview of Gary Gorton, May 11, 2010
no pushback from Joe or -- I mean, Al was basically -you know, the whole business was being shut, you know,
so…
But he had already been moved on to something
else.
It was Gene’s -- Gene said that –- Gene was
told, “Go take over that business.”
He comes back and says, “My God, we should
shut this down.”
We all look at it for six weeks, and we go,
“You know what?

You’re right.”

MS. NOONAN:

So since you were in the

commodities -MR. GORTON:

Yes.

MS. NOONAN:

-- mostly working in commodities

at that point, did it affect your day-to-day activities
significantly for this business, too?
MR. GORTON:

No, no, no.

MS. NOONAN:

Loud.

MR. GORTON:

No.

MS. NOONAN:

And so the last e-mail that I

have was this one dated February 28th, 2006, from Gene
Park to Joseph Cassano, copying you and others, and the
subject is, “CDO of ABS approach going forward, message
to the dealer, community.
155

FCIC Interview of Gary Gorton, May 11, 2010
The Bates is AIG-FCIC-00109490.
Have you -- take a minute and look at it.
Do you remember this?
MR. GORTON:

Not really.

But I remember sort

of the gist of it.
MS. NOONAN:

Okay.

Do you agree with it,

MR. GORTON:

Yes, I agree with it.

basically?

I mean, you know, in the end, it was just
we’re out.

It didn’t -- this idea of working with the

street just never got anywhere.
MS. NOONAN:

Do you know if this was -- were

you cc’ed or do you know if this was actually sent to
the dealers?
MR. GORTON:

Oh, no, we’d never send this to

the dealers, no, no, no.

You just talk to them on the

phone.
MS. NOONAN:

I see.

So these were like

talking points?
MR. GORTON:
to Joe, right?

No, this was -- this was a memo

So this is -- this is --

MS. NOONAN:

The first sentence says, “The

list summarizes the message we plan on delivering to the
dealers.”
MR. GORTON:

Yes, but that would be -- that
156

FCIC Interview of Gary Gorton, May 11, 2010
would be -MS. NOONAN:

Verbal?

MR. GORTON:

-- over the phone.

Verbal, yes.
MS. NOONAN:

Okay, okay, okay.

Were you involved in -- okay -- in delivering
the message?
MR. GORTON:

No.

I was never involved with,

you know, very -- any direct contact.
I mean, sometimes I would go to a meeting
with, you know, somebody.

But, in general, I was

never -- I mean, I didn’t have a license to trade, and
it wasn’t my job, so…
MS. NOONAN:

Give me one second.

Do you have anything -MS. MORAIN:

Sure.

I was wondering if you

could give us a little bit more information about this
tour you went on when you talked to economists at the
rating agencies and investment banks, and ultimately led
to your -MR. GORTON:

Yes.

MS. MORAIN:

-- your decision to stop writing

protection on -MR. GORTON:

I was trying to remember if –-

any of the names.
157

FCIC Interview of Gary Gorton, May 11, 2010
So we -- I’m not sure -- I’m not sure -- I
can’t remember any of the people; but I remember we went
to New York, and Forster and Fewings came from London.
And, you know, the group was something like Forster,
Fewings, me, Frost, and Park.

And we went to, you know,

Bear Stearns, Merrill Lynch, Goldman -- I’m not sure if
we went to Moody’s.

I don’t remember.

But the people

we met with were economists, you know, that worked in
the -- you know, on mortgages.
And the discussion was all about housing
prices and mortgages and defaults and what subprime was
and, you know, these kinds of issues.

And I don’t

remember if maybe the other people went to a separate
set of meetings when I wasn’t there.

I don’t remember.

MS. MORAIN:

Were there any sorts of reports

MR. GORTON:

Yes, I don’t think we wrote a

generated?

report, I think -- you know, other than this kind of
summary.
I mean, they gave us lots of reports, you
know, that they had written about, you know, the
California subprime market, or whatever it was.

I mean,

there was a lot of pretty impressive people study this
out there.
MS. MORAIN:

For example?
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MR. GORTON:
think.

That’s what I was trying to

You know, I was trying to think -- you know, I

sometimes picture this Bear Stearns guy who was very
optimistic, right?

And he was a very well-known analyst

in the mortgage market, but he was very optimistic.

And

he was so optimistic, that we came out afterwards, you
know, talking to ourselves like, “This guy is out of his
mind.

He must be on drugs or something.”
MR. TOMBACK:
MR. GORTON:

Remember, you’re on tape.
Yes.

Anyway, we just couldn’t

believe -MR. TOMBACK:

At this point, don’t remember

the guy’s name.
MR. GORTON:

Well, I don’t remember the guy’s

MS. NOONAN:

Yes, you’re on tape.

name.

MR. TOMBACK:
MR. GORTON:

That’s okay.

I’m just a lawyer.

One of the things that’s always a

bit of an issue is whether these people are sort of
marketers, right?

This is always the problem, right,

and this is with my Ph.D. students who go to investment
banks, they suddenly become marketers, right?
need numbers.

So you

It’s better to have numbers, not so much

your opinion -- or just ask for information, like, “How
does this actually work,” and this kind of thing.
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So, I’m sorry, I don’t have more -- I can’t
remember exactly where we went.
MS. MORAIN:

It’s interesting, you said that

there wasn’t really a question that housing prices were
going to go down; it was just about how bad it was going
to be.
MR. GORTON:

Yes.

MS. MORAIN:

So do you know of any discussions

within AIG-FP where that discussion went to, “Well, I
wonder if this is ever going to trigger one of these
collateral provisions that are written into all these
contracts”?

I mean --

MR. GORTON:
like that, no.

I don’t remember a discussion

I don’t remember.

Because I think -- you know, we thought
housing prices were going to go down.

We didn’t think

all bond prices are going to go down.

But that’s the

crisis, right?
The key, as I said in my testimony to FCIC,
the real question is to explain why all bond prices went
down.
When they went down, you know, it was truly
shocking.
calls.

And then that triggers all these collateral

And I can remember coming in and, you know,

people are yelling on the phone.

And I said to Tom,
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asked him like, “What the hell’s going on?”
He goes, “We have all these collateral calls.”
“Collateral calls about what?”
He goes, “The CDS book.”
I’m like, “What?”

It was like, you know -- so

not to my knowledge.
I mean, it may have happened with other people
or with the risk people, or I don’t know.

But I don’t

remember any conversation that I was involved in about
this.
MS. NOONAN:

So we know now that you have read

the ISDA master agreement.
MR. GORTON:

Yes.

It doesn’t mean I remember

MS. NOONAN:

And that you’re familiar with it?

MR. GORTON:

Yes.

MS. NOONAN:

I mean, were you familiar with it

it.

at the time?
MR. GORTON:

No.

After the crisis --

MS. NOONAN:

I’m going to go find your

students from 2002.
MR. GORTON:

No, you can ask them.

I mean, I actually read it, and I wanted to
read, you know, a CSA template afterwards because I was
writing these papers for these Fed conferences, and I
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wanted to know exactly what these things said.
I mean, I knew there were CSAs before all this
happened, I just never looked the one.
MS. NOONAN:

And is the CSA where the

collateral provisions are?
MR. GORTON:

Yes, yes.

Right, so you sign a master agreement, then
you trade under a confirm under the master agreement.
And then there’s either a general CSA or there’s one for
each transaction.

So that was the -- once I was alerted

that we had all this collateral stuff, you know, I
wanted to just see what these documents looked like.

I

never looked at any of our documents, but I looked at
the blank one.
MS. NOONAN:

And the blank one -- would the

blank one be -- I mean, I’m trying to figure out -- this
is sort of a separate question -- but were the
collateral provisions in the AIG-FP contracts standard?
Was it typical that there would be a collateral call
upon a downgrade of the parent company which -- you
know, which was the reason that the New York Fed was
working the way it worked during the crisis, was to
prevent them from being downgraded, because the
downgrade would have triggered all these other
collateral calls?
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MR. GORTON:
the answer.

Yes, I don’t know.

I don’t know

I mean, I’ve never seen an actual one.

ISDA does these surveys, but I don’t think
they surveyed that.

They don’t ask that question.

You

know, they ask, you know, “How much collateral have you
posted?”

But -- so I don’t know.
MS. NOONAN:

I don’t know.

Okay, okay.

Do you have one?
MS. MORAIN:

Well, why do you think those

conversations didn’t take place?

Or if they didn’t take

place, why do you think they weren’t about collateral?
Was this a failure of risk management?

What was -- what

happened?
MR. GORTON:
know.

You know, I don’t -- I don’t

I don’t know whether people just thought we would

never have a crisis like this or -- I don’t -- I don’t
know.

I mean, I, frankly, just don’t know.
I mean, I had sort of proceeded under the

assumption that everything was linked to the rating.
And as long as Greenberg was there, Greenberg could
always raise money in China, Greenberg could negotiate.
So when Greenberg went away, suddenly you didn’t have
your negotiator.

I still didn’t think there was going

to be a problem.

I didn’t think about it.

When the crisis happened, I was kind of amazed
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to have all this stuff linked to, you know, prices.
I don’t know.

I don’t know who knew about it.

Even now, when I ask people, you know -- I
mean, I never asked Al point-blank but I’ve asked, like,
Fewings.

You know, he doesn’t know.
MS. NOONAN:

What about Bob Lewis?

Or who is

the risk officer in FP?
MR. GORTON:

Pierre Micotis.

MR. TOMBACK:

Micottis.

MR. GORTON:

Micottis.

I don’t know.
or knew.

I have no idea what they know

I don’t know.
MS. HEYL:

Pierre wasn’t involved with the

credit for a long time.
MS. NOONAN:

Okay.

MR. GORTON:

I mean, I don’t know.

MS. HEYL:

He wasn’t the risk manager for this

business during much of the period we’ve been talking
about.
MR. GORTON:
whether Ed Diaz knew.

But I don’t know, you know,
You know, I don’t know.

MS. NOONAN:

Okay.

Do you have more?

MS. MORAIN:

You know, we’re supposed to be

studying the causes of the crisis and the institutions
that failed or would have failed but for the receipt of
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exceptional government assistance and, obviously, AIG
falls into that category.

And, obviously, AIG-FP is a

central part of the story of AIG’s failure.
And so where would you suggest we look?

Where

else would you suggest we look, I mean, to help answer
the questions of why the problems at AIG-FP took place?
MR. GORTON:

Well, I mean, other than

interviewing people like you’re doing, I’m not sure what
else you can do.
I mean, I don’t -- I mean, this is a really
good question, like who knew about the collateral.
suspect that somebody knew.

I don’t know.

I

But, I mean,

all you can do is ask, I suppose.
MS. NOONAN:

Did you ever get the sense that

people were relying on your model for the proposition
that AIG would never lose money on these deals, and that
perhaps that they ignored these other provisions?
MR. GORTON:

No, I don’t think so.

First of all, they would never say “never lose
money,” because I beat people over the head about that
for years; right?

It’s highly unlikely.

But remember, the model is actuarial, right,
so it doesn’t care about prices.
So, you know, the model could be exactly
correct -- it’s very unlikely you’re going to lose
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money, which turns out to be pretty much true -- and yet
if you have collaterals linked to prices and prices go
down, the model can be right and then you’d have to pay
out all this collateral, which is exactly what happened.
So, you know, I was very worried about the
accounting-rule change that said we were going to have
to mark this very large book.

But I didn’t know how

much collateral was going to be triggered by these
prices -- by price movements.
So, you know, that was just -- that was an
Achilles heel.
MS. NOONAN:

Did it ever cross your mind that

the sheer size of the notional amount that AIG wrote
protection on was a problem?
MR. GORTON:

No, because with derivatives,

size is very, very misleading, right?

I mean, if you

have super-senior and you have a very, very large size,
you know, that can be safer than having, you know,
500 million of the equity, right?

So the dollar amount

doesn’t tell you what you really want to know.
This is true of derivatives generally, right?
I mean, if I do an interest rate swap with you and it
has a market value of zero at day one, and it’s
a billion dollars -MR. CREGO:

Pardon, Professor Gorton, I’m
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FCIC Interview of Gary Gorton, May 11, 2010
going to disconnect now.
call.

We have another conference

Sorry to interrupt you.

And I thank you for your

time.
MR. GORTON:

You’re welcome.

You know, that -- what you really want to know
is, you know, if interest rates move by 500 basis
points, what happens.

And, you know, so the dollar

amount -- I mean, I think the dollar amount made a huge
difference if you had these collateral linked to prices,
right?

But that’s not an issue that came up.
It did come up about the sheer size of the

book.

That came up, you know, over and over again.
MS. NOONAN:

Well, but, I mean, aren’t credit

derivatives a little bit different than interest-rate
derivatives?
MR. GORTON:

Well, they’re not --

MS. NOONAN:

When you think about the amount

that’s really at risk?

I mean, you had an example of

the interest-rate swaps where you’re zero at day one,
and the movement is really just the difference of the
movement in the interest in the fixed versus the
floating.

But in a credit derivative, it’s a little bit

different, right?
MR. GORTON:

Well, it isn’t –-

MS. NOONAN:

You’re on the hook for the whole
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FCIC Interview of Gary Gorton, May 11, 2010
amount?
MR. GORTON:

No, that’s true.

But the point

here is that you’re attaching after this buffer and it’s
on a portfolio, right?

So because -- I mean, I suppose

I told you it’s a trillion dollars.
number?

Is that a big

And then before you say “yes,” I say, “But we

have $10 trillion buffer.”
MS. NOONAN:
MR. TOMBACK:

Right.

But if the --

The difference for the

interest-rate swap is immediate every day that goes on,
you’re gaining or losing real money.
I don’t know how much -- I don’t know enough
about this portfolio, but I presume they even have
[unintelligible] which haven’t triggered a loss in the
credit-default swap world their residuals that are
allowed.

You know, you get the bonds.

So it’s not an

on/off switch.
MS. NOONAN:
MR. TOMBACK:
MS. NOONAN:

Sometimes.
It doesn’t go from –
There are bankruptcy -- I mean,

sometimes -- under the straight contractual terms,
that’s true; although in bankruptcy, in the event of an
AIG bankruptcy, that would not have been true, which is
sort of news to legal.
MR. TOMBACK:

But you’re looking at it from
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FCIC Interview of Gary Gorton, May 11, 2010
the perspective of AIG, and so you get the bonds.
I presume all of the counterparties are still
alive.

I don’t know.
MR. GORTON:
MR. TOMBACK:
MR. GORTON:
MR. TOMBACK:

Well, Merrill isn’t.
That’s right.
And Lehman isn’t.
Yes, but Merrill –- Merrill was

merged -MR. GORTON:

Yes, Merrill got merged, and so

Lehman.
MR. TOMBACK:

But most, if not

all, counterparties are still on, so you’ve got that as
well.
MR. GORTON:

I guess my point is kind of a

simple one, which is that the risk depends on where you
are in the capital structure, you know, not just the
dollar amount
MS. NOONAN:

No, I mean -- I take your point.

I take your point.
MR. GORTON:

That’s my only point.

MS. NOONAN:

Yes.

MR. TOMBACK:

To summarize a different point,

I think, that Professor -- I mean, Professor Gorton
stressed that, right, the “very unlikely” as opposed to
“never will happen” nature of the model.
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And the “very unlikely,” it turns out, at
least at this point -- not that the result justifies the
model or the means or how you got there; but there is a
point where there are no losses.
MS. NOONAN:

Yes, I mean, it’s an interesting

fact about the AIG-FP story.
MR. GORTON:

Another interesting fact is that

the Fed has made, like, $50 billion or so on Maiden
Lane III, so -MS. NOONAN:

Billion?

MR. GORTON:

Yes.

MR. TOMBACK:

Many of the CDSes -- many -- I

guess virtually all the CDSes that come back -–
MR. GORTON:
MR. TOMBACK:

The prices went up, right?
So the collateral -- some

substantial amount of collateral has come back to AIG.
But it’s not AIG anymore, it’s you and me.

It’s

America.
MR. GORTON:

Also, I don’t know how the

collateral works, either.

Like, I don’t know if anybody

gave the collateral back because the prices went up.

I

don’t know.
MS. NOONAN:

That’s an interesting question.

MR. GORTON:

Well, I think so -- I don’t know

the details about Maiden Lane III; but since they bought
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FCIC Interview of Gary Gorton, May 11, 2010
a lot of the bonds, I don’t know how -- I don’t know how
the collateral -- I don’t know.
MS. NOONAN:

I actually think that the

collateral probably isn’t at play anymore because they
ripped up the –- they ripped up the swaps –
MS. HEYL:

Right.

MS. NOONAN:

-- so that the counterparties are

paid in full on the swaps; and now, they just hold the
underlying bond on Maiden Lane III.
MR. GORTON:

But do they have to give the

collateral back then?
MS. NOONAN:

No.

MR. GORTON:

Why would they have to give the

collateral back?
MR. TOMBACK:

Let’s be fair, without knowing

the instruments themselves, the collateral is not for
free.

So if you paid out collateral to a counterparty

to protect them against a loss they perceived they would
have of $10 billion, and with, say, Goldman didn’t
suffer any losses because the government filled them
100 percent, the collateral either contributed to
filling them 100 percent or went back to AIG.

But the

10 million was no longer -MR. GORTON:
MR. TOMBACK:

Billion.
-- was no longer -- billion,
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FCIC Interview of Gary Gorton, May 11, 2010
excuse me -- was no longer, quote, unquote, sort of out
there or Goldman’s just to keep, free of charge.

And --

MR. GORTON:

I mean, at this point, all I

MS. NOONAN:

It was a pay-out on their

know --

position.
MR. TOMBACK:

It was conceptually returned to

the AIG side of the ledger, and they use it to pay off
whatever obligations it had.
MS. NOONAN:

Right.

I think that’s right.

MR. GORTON:

And all I know is what I read in

the paper, and it’s very confusing.
MS. NOONAN:

This has been really helpful.

I

appreciate it.
I should ask at the end, is there -- is there
anything else that we haven’t really talked about that
you think we need to know or is critical to our
understanding, at least, from your point of view, what
happened at AIG in the Financial Products group?
MR. GORTON:

Not -- I mean, I’m sure there’s

MS. NOONAN:

Are there big things that come to

other --

mind that we haven’t really discussed today?
MR. GORTON:

Not that I know about, no.

MS. NOONAN:

Okay.
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FCIC Interview of Gary Gorton, May 11, 2010
MR. GORTON:

As far as what I know, I think

we’ve covered it.
MS. NOONAN:

Okay, thanks very much.

MR. GORTON:

You’re welcome.

(End of interview with Gary Gorton)

--o0o--

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