The indispensable Carol Loomis takes on AIG in Fortune. Having an overview of the government’s bailout (and re-bailout) of AIG is value enough to recommend the article as required reading. Read a little deeper and you’ll see a fascinating narrative line about Hank Greenberg and his role in creating the mess at AIG. First, there is Financial Products, the Connecticut-based division that generated derivatives. Greenberg created it and used it as a cookie jar for earnings.
For most of its history, FP gave longtime CEO Hank Greenberg profits on cue, helping him build a great record of earnings growth – until this streak was rudely smashed several years ago by earnings restatements that involved practically every corner of the company, FP included. Worse, even as those humiliations were surfacing (and leading as well to Greenberg’s departure), AIG got deeply involved with mortgage securities that all too soon were identified as toxic. A nutty investment policy at the company’s insurers helped create this problem. But the true agent of doom was FP, which wrote close to $80 billion of credit default swaps – contracts that insure investors against losing principal and interest – on super-senior tranches of collateralized debt obligations (CDOs) that were loaded with mortgage securities, some of them subprime. A financial tsunami then engulfed AIG, which is structurally a holding company – the parent of a webwork of operating insurers. The CDOs fell in value, and credit ratings for the parent company went down with them. This drop in AIG’s creditworthiness triggered clauses in the credit default swaps (CDS) that allowed AIG’s counterparties to demand collateral, and those calls for cash put the parent in a vise. There you have the internal situation that, in time, shoved AIG into the arms of the government.
Both government bailouts were predicated on the idea that FP needed to be de-coupled from AIG’s healthy insurance businesses, which could then be sold for enough money to repay the taxpayers. Again, Greenberg’s legacy is standing in the way:
Through it all, the specter of Hank Greenberg, CEO of AIG for 37 years, haunts the job of redoing the immensely complex company he built (see “Hank’s Last Stand,” on Fortune.com). A special sales obstacle, says Reynolds, is that AIG has 4,000 subsidiaries and other legal entities, with all manner of cross-ownership among them. “With all due respect to our former chairman,” she says, “a lot of things were done around the 1986 tax act.” This is a U.S. law that tightened up tax rules applying to financial services income earned overseas. Reynolds says that while the law’s provisions were later effectively repealed, a lot of ownership structures that AIG had built weren’t taken down. So simplification is today badly needed, she says, and a big team of lawyers is on the case.
That’s not Greenberg’s only legacy. The complex company has a shallow bench when it comes to managers who understand more than their specific silo. Greenberg left his successors flying blind:
He ran AIG out of his head, seemingly unfazed by an accounting system so inefficient that AIG is notorious among ex-executives for always getting just under the wire when making its SEC filings. The accounting systems plagued the CEOs who followed Greenberg – Sullivan and Willumstad – and remain a trial today. Says Reynolds: “The best businesses are run by people who kick their tires every day. We don’t even know where the tires are, much less get to kick them. If we can get back to the size of a company where we can intelligently kick our tires every day, that would be a wonderful outcome.”
Without instruments or metrics to understand their business, Martin Sullivan and Willumstad (not to mention Liddy today) couldn’t manage something they couldn’t understand. This puts a new complexion on Greenberg’s repeated claims that Sullivan wasn’t qualified to run the company. No one was qualified to run the company because Greenberg had set it up to be entirely dependent upon his knowledge and control:
The misadventures that AIG’s silo architecture can create are sharply illustrated by the company’s disasters in mortgage securities. These problems certainly were spawned in AIG Financial Products. But the fact is that FP had a moment of enlightenment in late 2005, when it began to believe that the housing boom was nearing an unfortunate end and decided to stop selling credit default swaps on super-senior tranches of CDOs. It had a few deals in the pipeline, however, so total “multisector” CDS – AIG’s name for these spiffy items – climbed a bit further in early 2006, to a total of nearly $80 billion. Later, as 2006- and 2007-vintage mortgages turned toxic, AIG talked proudly to analysts about its wise decision to pull out before trouble hit. The company proved to be excruciatingly wrong in thinking it was safe, of course, since earlier vintages have been creamed too. But the point is that by August 2007 – the start of the credit crisis – CEO Martin Sullivan and FP’s boss, Joseph Cassano, were saying to everybody who’d listen that FP had ducked the mortgage bullet by avoiding the 2006 and 2007 securities that were by that time viewed as poisonous.
And, of course, Greenberg remains a constant gadfly on the whole process using his stature and access to hector the process. Greenberg’s absence from the firm for the last few years has allowed him to benefit from a clever sleight of hand where all of AIG’s woes are the product of Sullivan’s mismanagement and Greenberg tries to remind everyone of the glory days under his watchful eye.
Among the less sanguine AIG experts around is Hank Greenberg, who hangs on every move the company makes. Speaking recently in the quiet Park Avenue offices of C.V. Starr & Co., which he heads and which is AIG’s largest shareholder after the government, he talked about the people who call to tell him they are leaving AIG and about the poor insurance results it reported in the third quarter. The unspoken subtext in everything he says is that things would be different if he were there.
AIG’s Rescue Has a Long Way to Go
Fortune; December 24, 2008