The Wall Street Journal’s leder this morning explores why the government dropped its criminal fraud investigation of AIG’s Joseph Cassano, the guy who let banks create all those toxic securities by taking on so much of their risk via credit-default swap.

It’s the most detail we’ve seen yet about the investigation, but even after all that I can’t quite figure out why the prosecutors dropped the case.

Here’s a Cassano deputy talking on the phone at some point in 2007 (the Journal doesn’t tell us when—a timeline would have been helpful):

In one call, Andrew Forster, an AIG executive, added that they would likely have to mark down the value of their $75 billion portfolio of swaps.

“It’s going to get very, very, very ugly,” Mr. Forster said in one call. “We’re f—ed, basically.”

But it’s worth remembering what else was going on during 2007, much of which the WSJ doesn’t mention.

Here’s Bloomberg from 2008:

Nov. 7: Third-quarter profit falls 27 percent to $3.09 billion on housing-related costs, including a $352 million decline in credit-default swaps, which AIG sold to protect debt investors from losses. AIG says it is “highly unlikely” that the firm will be required to make payments on the derivatives.

Nov. 8: AIG says in a conference call it is “comfortable” with businesses and investments tied to U.S. housing…

Dec. 5: Then-Chief Executive Officer Martin Sullivan says writedowns from the U.S. housing market are “manageable,” sending shares up more than 4 percent to $58.15.

“The effectiveness of our risk-management efforts will show through in our results,” Sullivan says.

The same day, as the WSJ reports, Cassano told investors that writedowns on his derivatives would be an estimated $1.5 billion:

There was a big caveat, however. The loss would have been much closer to $6 billion, if not for two major accounting changes that Mr. Cassano didn’t mention during the call. The changes meant the credit-default swaps weren’t marked down to fully reflect the shattered value of mortgage securities that were barely trading.

PwC two months later reversed these accounting moves. AIG’s disclosure of that decision helped trigger the firm’s bailout seven months later.

What else did prosecutors have? Cassano’s auditor at PricewaterhouseCoopers “he sometimes couldn’t get straight answers from Mr. Cassano when he asked him to justify how AIG accounted for the swaps” and “Senior executives at AIG’s parent company voiced similar misgivings to prosecutors.”

On top of that, Cassano allegedly blocked an internal AIG auditor named Joseph St. Denis from doing his job. St. Denis told Congress, “I resigned because on multiple instances beginning in the late summer of 2007, Mr. Cassano took actions that I believed were intended to prevent me from performing the job duties for which I was hired.”

Let’s remember that AIG Financial Products was no stranger to accounting fraud. Cassano’s division, paid a then-huge $126 million to settle federal fraud charges against it in 2004 for helping PNC fudge its books.

And then there’s this:

Trawling through hundreds of hours of phone conversations recorded by AIG because the calls involved traders, prosecutors heard Mr. Cassano’s subordinates discuss the multibillion-dollar losses they were facing. Government investigators believed the phone calls showed that employees of Mr. Cassano’s unit knew their business was failing even as they publicly assured investors their losses were manageable.

The exculpatory evidence came down to some notes taken on a spreadsheet at a meeting in 2007 that nobody can remember taking.

Some of the broken phrases that could be made out: “Cash/CDS spread differential,” “need to quantify” and “could be 10 points on $75 billion.”

Prosecutors realized the notes were disastrous to their case. Along with other documents, they could be used by the defense to support its contention that Mr. Cassano had in fact disclosed the size of the accounting adjustments to both his bosses and external auditors.

But either Cassano and/or his superiors at AIG were saying one thing to themselves while telling investors another, or they weren’t. From this story, at least I don’t see anything that shows that they weren’t doing that.

For more on that check out this Talking Points Memo timeline from last year.


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Ryan Chittum is a former Wall Street Journal reporter, and deputy editor of The Audit, CJR's business section. If you see notable business journalism, give him a heads-up at rc2538@columbia.edu. Follow him on Twitter at @ryanchittum.