AIG rescue and the Goldman connection

The seeds of much of the financial chaos engulfing America were sown in London, by a single unit of AIG, the financial services firm recently bailed out by the US Treasury. The New York Times reported yesterday that this 377-person unit "flourished in a climate of opulent pay, lax oversight and blind faith in financial risk models" which resulted in the near-collapse of one of the world's most important firms.

The newspaper also suggested that the US government's decision to bail out AIG, within hours of letting Lehman Brothers go bankrupt, owed much to the risk posed to Goldman Sachs - the firm run until two years ago by Hank Paulson, the Treasury Secretary.

Unknown to many, Goldman had become AIG’s largest trading partner according to six people who spoke to the New York Times anonymously. If the insurer collapsed, they told the Times, Goldman stood to lose $20bn.

When federal officials - who let Lehman Bros die - decided to bail-out AIG at a cost of $85bn, Lloyd Blankfein, the CEO of Goldman, was the only Wall Street chief exec present.

The impression that Goldman Sachs has received preferential treatment during this crisis will increase political pressure on a firm once regarded as bullet-proof.

The revelation that AIG's problems lay with a unit in London will surprise no one who has watched London's evolution as a hub for the world's most innovative - and murky - financial institutions.

Joseph Cassano, the executive who ran the unit, joined AIG in late 1987 from Drexel Burnham Lambert, a notorious firm which collapsed amid charges of fraud. He left AIG in February, but continues to live the archetypal London banker's life, in a three-story house in a garden square close to Harrods.

Cassano's main line of business was selling insurance policies to people holding packages of debt, including mortgages, known as 'collateralized debt obligations' or CDOs. If any part or all of these debts defaulted, AIG would pay out to cover the shortfall. As