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Hank Greenberg’s Self-Serving, Largely Off-Base Salvo at Goldman

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Wow, has someone declared “Forced Out CEO Tries to Salvage His Reputation Month” when I wasn’t paying attention? Or was I just not on the distribution list? Last week, we had Sandy Weill telling us how the Frankenstein of the Citigroup he created was really a fine business; the only mistake he made was pushing Chuck Prince as his successor, who was obviously incapable of filing Weill’s shoes. If you believe that is why Citi went so spectacularly off the rails, I have a bridge I’d like to sell you.

So this week we have Hank Greenberg trying to rewrite the record in the weekend Wall Street Journal Who comes next? Dick Fuld? The ex-CEO of Northern Rock? Jeff Skilling? The former heads of the three biggest banks in Iceland?

Big big caveat: I am most assuredly not a fan of Goldman’s conduct in the runup to and during the credit crisis. However, if you are going to attack Goldman (and its various enablers in the officialdom) you need to make credible charges. Broadsides that are off base in important aspects can and often do backfire. They allow the target to dismiss the erroneous arguments, and muddy the waters on the ones that are closer to the mark. The net result that it looks at best like a case of “he said, she said” and at worst that the critics are all wet.

And in this case, the attacker, Hank Greenberg comes off as whiny and afflicted with a major case of CEO grandiosity. The subtext of his account is that he was persecuted, he was an impeccable leader, other people screwed up his business. Yet it was Greenberg who picked Joe Cassano, a man who knew nothing about risk management, to lead AIG Financial Products, the unit that wrote the credit default swaps that were the proximate cause of AIG’s demise. This was a catastrophically poor choice, yet to hear Greenberg cavil, all the woes visited on AIG were due to the machinations of Goldman and Hank Paulson, not AIG greed and incompetence.

The worst feature of AIG FP was one Greenberg approved at its inception: it was a firm within a firm, always a bad idea, with its leaders receiving a pre-specified cut of revenues that they could disburse as they saw fit. That sort of arrangement had been the demise of Drexel. The deal also allowed bonuses to be paid immediately on certain types of transactions, with at most 50% reserved for a few years to see how the deal performed, even if the deal took decades to pay out. When the AIG FP team threatened to leave over a turf issue, Greenberg caved. He was too addicted to their profits even then to risk losing them.

So lets turn to what the Wall Street Journal article, which Dorothy Parker would have deemed nausea-making:

Mr. Greenberg, a genuine captain of industry but little known to the public, had built AIG over 30 years to become the biggest and most admired company in the global insurance industry. Then Mr. Spitzer, riding a wave of righteous distrust of business after Enron, accused him and AIG of accounting fraud. Mr. Spitzer, on national television, pronounced Mr. Greenberg guilty even before any evidence had been presented to a jury.

Yves here. A key bit of backstory: the Wall Street Journal has had a long-standing vendetta with Eliot Spitzer. And the “genuine captain of industry” with Spitzer as infidel characterization is simplistic and inaccurate. The idea that AIG was as sound as it was believed to be in Greenberg’s final days does not survive close scrutiny. Efforts to segregate subsidiaries in order to sell them have revealed some questionable inter-company transacations. In addition, David Merkel, who worked at AIG in the early 1990s, did a detailed analysis of the statutory books of AIG’s subsidiaries, and concluded that taxpayers bailed out not just AIG FP, but its life insurance and mortgage subsidiaries as well. In other words, Greenberg’s efforts to pin the blame on AIG’s woes on AIG FP, and Goldman in particular, is a convenient distraction from significant but well camouflaged problems elsewhere at AIG.

Merkel also recounts dubious practices which were part of the AIG culture nearly 20 years ago:

 “Dealing with auditors is bloodsport.”
 “I drop my deficiency reserves in the Atlantic Ocean.” (via reinsurance)
 “I like the pension and annuity businesses because they give some bulk to our balance sheet.” (Reputedly M.R. Greenberg said this to a colleague of mine. We scratched our heads over that one, because it was so anti-AIG philosophy.)
 Heavy reliance on surplus relief reinsurance in order to front statutory earnings into the present, and reduce capital needs.
 My boss found two centimillion-dollar reserve errors also.
 “Dealing with reinsurers is bloodsport. Never give them an even break.”
 Clever use of transfer pricing to get money out of blocked currencies.
 Arrogant guys at AIG Financial Products that would hardly acknowledge you as part of the same team at conferences.
 And, a $1 billion GAAP reserve understatement at Alico Japan in 1992.

Merkel left because he was uncomfortable with his conscience working there (!) and contends the firm has long run with hidden leverage and losses. And lest you think this is an isolated account, a friend who joined AIG at an executive level shortly before Greenberg’s departure (he is now the CEO of a large foreign insurer) was horrified at what he saw: a lack of normal systems and procedures, far too much decision-making in Greenberg’s hand for a company as big and sprawling as AIG. Thus the perception that it was successful appears to have much to do with its aggression in the marketplace and creative accounting, a rather leaky ship for a so-called captain of industry.

But let’s return to Greenberg’s efforts to rewrite history:

In the months after he left, AIG amped up its bets on the housing market by writing what where, in effect, insurance policies on derivative securities backed by subprime mortgages. These securities were created by Wall Street firms, notably Goldman Sachs, and held on their own books or sold to investors. AIG, in turn, had committed not only to insure them again eventual loss, but to make cash payments in the meantime to compensate for any drop in price or downgrade of their Triple-A ratings by credit agencies—both of which promptly happened as housing collapsed and panic spread about the possible failure of large financial institutions.

Yves here. This account cheerily assumes that AIG would have written fewer CDS guarantees had Greenberg been in place. Do we have a single shred of evidence to support that flattering notion? In fact, a three-part Washington Post story on the rise and collapse of AIG FP makes clear that AIG was writing CDS on mortgage exposures at a furious pace prior to Greenberg’s departure. Indeed, the piece also points out that Fitch downgraded AIG to AA upon Greenberg’s exodus in March 2005; S&P and Moody’s followed suit shortly thereafter. Those downgrades not only led AIG to post over a billion dollars of collateral, but reduced its competitiveness in the business (insurance from an AAA counterparty was given particularly favorable treatment in certain circumstances). With its AAA intact, it is entirely plausible AIG would have written as much, if not more CDS before it pulled back at the end of 2005.

But let us continue with Greenberg’s version of events:

Here are the pieces Mr. Greenberg says he sees falling into place. In 2005, a trade group called the International Swaps and Derivatives Association got together and drafted new standards for the kinds of credit default swaps AIG had been writing.

Previously, Mr. Greenberg explains, losses to the underlying securities were paid off at maturity. Now, cash payments would have to be forthcoming to cover any drop in value or credit downgrades even before any losses were realized.

“I don’t know whether Goldman Sachs was the force behind the ISDA change or Deutsche Bank,” Mr. Greenberg concedes. “That’s something investigative reporters are going to have to spend time digging out.”

Yves here. This is utter rubbish. “Oh, ISDA created this new protocol and we had to go along. Goldman and maybe Deutsche did it to us.” Guess what? AIG was the only insurance company that complied. CDS that were written on subprime (say on the ABX, or on individual MBS that might become sold singly or be part of a CDO) did conform to the new protocol. But monolines who were far less powerful firms than AIG, continued to write only CDS that did NOT provide for collateral posting but payment on maturity (this was one of the reasons the monolines howled when short seller Bill Ackman had them in his crosshairs: even if their contracts were total turkeys, it would be an eternity before the insurers would have to pay out a dime on them. But the monolines forgot one thing: those agreements were still marked to market, and the accounting losses on such thinly capitalized balance sheets gave investors and rating agencies pause).

Moreover, AIG marketed the difference between its contracts (which required collateral posting in the event of a downgrade) versus those of a monoline (which did not) aggressively, as an important reason to prefer AIG’s offering.

Now you do have the rather interesting fact which has not gotten enough play, that Goldman apparently obtained its insurance on its CDOs largely if not entirely through AIG (it is difficult to be certain but former monoline employees report they never saw Goldman seeking insurance coverage from them, and were surprised when AIG went down to learn how active they had been with AIG). One can argue from a risk management standpoint that it is a pretty poor choice to concentrate one’s counterparty risks so heavily. On the other hand (and I am not saying I buy this view, but it is arguable), Goldman can contend that it understood that this sort of insurance was likely to prove to be a non-performing airbag (the term of art is wrong way risk) and the only protection against that was CDS that had collateral posting requirements.

Now in fairness, among all this blather, Greenberg levels a charge against Goldman which is substantive, serious, and tallies with other reports that we have received: that Goldman, once it was net short, was more aggressive than other firms in marking down collateral. In other words, once the housing market started to burn down, Goldman poured gas on the fire:

When the housing boom imploded, Goldman demanded giant cash collateral payments from AIG on a “mark to market” basis for housing-backed securities whose price was plummeting even if the underlying payment streams were intact. True, Goldman was hardly the only one demanding cash, but Mr. Greenberg is suspicious about the size of the payments Goldman demanded based on Goldman’s own “marks” (i.e. estimate of the securities now-depressed value). “Goldman had the lowest marks on the Street by everything I hear,” he says. “There was no exchange. Where was the price discovery? It was all in the eye of the beholder.”

But then we go back to conspiracy theories:

When the government took over AIG, why did it insist that Goldman and other firms receive 100 cents on the dollar on their AIG exposure, while the terms of AIG’s own bailout were so onerous as to force the firm into slow-motion liquidation? When the government’s bailouts of Citigroup, Bank of America, GM and Chrysler were clearly designed to restore the firms to health, why was AIG’s apparently designed to create a wasting asset that would wither and die in taxpayer hands

Yves here. Most readers of this blog are probably in the camp that is mighty unhappy about the 100% payout to the AIG counterparties. So Greenberg is, in effect, trying to argue that a second wrong, throwing even more money into the AIG black hole in the hopes of bringing it back from the dead, would be a good idea. Well, it might be good for Greenberg, who prior to the government rescue, controlled the biggest block of AIG shares, between his personal stake and that of C.V. Starr.

The deal from the very outset was envisaged as a dismemberment. Lest we forget, AIG, was about to go bankrupt. It was so badly managed that it wasn’t even sure of its cash needs (the Sorkin book has its estimates of its shortfall growing by billions on a daily basis because it keeps finding new obligations. It was evident that the insurer’s controls were grossly deficient).

When you are on death’s door, you are in no position to dictate terms, so Greenberg’s indignation is wildly misplaced:

Mr. Greenberg has no doubt the destruction of AIG was the politically-dictated goal at the time. He points to Treasury Secretary Hank Paulson’s statement on Sunday morning television shortly after the rescue, saying the purpose was to “allow the government to liquidate” the company.

Mr. Greenberg invokes the loaded constitutional word “takings” for the government’s seizure of a 79.9% stake in AIG as part of the package dictated to the company’s board. “They just took the goddamn thing. What’s the basis for taking it? You gotta explain, How did you get to 79.9%? I’d be curious to know.”

Yves here. It was 79.9% because the more logical number, 100%, would produce more headaches than it was perceived to be worth to Uncle Sam, as we discuss shortly.

AIG got a very costly loan and promised to sell assets to repay the loan, which was in effect an orderly liquidation The fact that AIG survives as AIG is due strictly to the fact that the government has blinked and retraded the deal four time. Greenberg thinks AIG deserves better? AIG has gotten vastly more than it deserves. And let us recall that the only “rescue” of a firm about to collapse prior to AIG was a shotgun marriage of Bear with a big dowry paid to the groom. JP Morgan, to take on a presumed garbage barge. And lest we forget, Bear did not survive. But we get another dubious idea from Greenberg:

Washington could simply have ordained that AIG’s debts were the government’s debts and so no collateral was due give Uncle Sam’s bulletproof credit rating.

Yves here. Right. First, the reason Freddie and Fannie were done as conservatorships were to avoid consolidating their debt on the Federal balance sheet, so the idea of having the Treasury make AIG a full faith and credit obligation was a non-starter. Having the government own 79.9% is a dysfunctional arrangement, as we have seen with Freddie, Fannie, and now AIG. But if the government assumed the debt, there is no reason not to wipe out the equity holders. And then Greenberg would be enlisting the Wall Street Journal to complain about nationalization.

This interview is a lead in to a truly offensive proposal: that the AIG deal be retraded yet another time, yet again to the advantage of the shareholders (Greenberg, of course) and the taxpayer be damned. Predictably, he tries to present this self-enriching plan as best for the dumb chump public. I won’t dignify it by going through the details.

This whole interview amounts to what I call the shitpile school of argumentation, which sadly has become prevalent in America: produce a whole heap of crap, and declare, “See, there is lot of shit, surely there is a pony!” The assumption is that no one has the fortitude to do forensic work on the, um, evidence. But these dung hills, upon inspection, seldom prove the existence of a pony. Indeed, they usually consist of non-equine output, like old zoo doo and garden variety dirt. But guys like Greenberg are happy to produce volumes of rubbish on the cheery assumption that no one dares question a con artist captain of industry like him.

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23 comments

  1. attempter

    This whole interview amounts to what I call the shitpile school of argumentation, which sadly has become prevalent in America: produce a whole heap of crap, and declare, “See, there is lot of shit, surely there is a pony!” The assumption is that no one has the fortitude to do forensic work on the, um, evidence. But these dung hills, upon inspection, seldom prove the existence of a pony. Indeed, they usually consist of non-equine output, like old zoo doo and garden variety dirt. But guys like Greenberg are happy to produce volumes of rubbish on the cheery assumption that no one dares question a con artist captain of industry like him.

    That’s pretty much true of the MSM coverage in toto of the Bailout, and everything else.

    Although the deplorable fact that con artists are turned in to celebrities and actually considered to be heroes by a broad non-rich public seems to be a long-standing, truly bizarre American disease.

    Even to this day people still want to admire the likes of Buffett, Gates, and god help us even Trump.

    Why? It’s truly demented.

    Mr. Greenberg invokes the loaded constitutional word “takings” for the government’s seizure of a 79.9% stake in AIG as part of the package dictated to the company’s board. “They just took the goddamn thing. What’s the basis for taking it? You gotta explain, How did you get to 79.9%? I’d be curious to know.”

    He wouldn’t have had any problem with me. I would’ve taken zero, nothing, not one cent for any of them.

    And we’d all be much better off.

  2. Vespasian

    Brilliant analysis, Yves. Your writing, knowledge, and analysis shines brighter than anything I read at WSJ (and is a bright star against the dark moon of a far-orbit planet that is the mainstream newspapers or black hole of TV news).

    Editing-wise (I see this was posted late at night), the last paragraph “of the school that Goldman’s conduct….” seems out of place … like a thought tapped into the PC that doesn’t fit the rest, is pushed to the end of the text, forgotten about… and not deleted at 3am posting time!

    1. Yves Smith Post author

      Vespasian,

      Thanks for the kind words, and for pointing out the glitch! Have deleted it.

  3. Vespasian

    yargh, I just recognized the posting time stamp is MY time, and I’m in eastern EUR right now … nevermind that blurb about 3am….

  4. David Merkel

    Glad to be of service to you, Yves. As an aside, no one forced AIG to write so much default protection naked. They did it because they were yield hogs, and addicted to the seemingly easy income.

    Good post.

  5. bob

    Greenberg for T sec.

    You know he’s got the balls to ask for it, and he can join the other majority shareholder so we can finally get all of these assholes on one side of the table.

    Who do you throw shit at then?

  6. Robespierre

    Yves, I like your articles very much and learn a lot from them. I disagree, however, when you said: “However, if you are going to attack Goldman (and its various enablers in the officialdom) you need to make credible charges.”

    The reason that various players have to make charges as they can is that the government refuses to investigate for wrong doing so what is left? You would think that an administration that promised change would had assembly not only a strong economic team but also a prosecutorial team as well. Much has been said about “putting out fires” first during the “crisis”. How about looking for arsonist now that the crisis has ended? While I agree AIG was at fault its CEO coming out publicly increases the pressure on public officials to at least make an effort to look into this.

  7. Siggy

    Nice post. I read the Greenberg assertions as reported on Bloomberg and concluded that it was a self serving exercise on the part of Greenberg.

    It’s really pretty simple, AIGFP did not have to enter into all those contracts with GS. So, while it may be true that GS was exploiting AIGFP, it is equally true that AIGFP was in the position of believing that it was exploiting GS.

    MSM has not covered this sad story very well at all. The issue I have with MSM is that I see the sale of contracts that could not be honored as a massive tort and quite probably a fraud. MSM seems to be avoiding this elephant.

    I’m not a fan of Elliot Spitzer, yet I must say his call for the publication of the email traffic and the resulting contract documents in this matter would be a great public service. This gets me back to the idea that AIGFP should have been segregated and AIG itself sold off to NEW Ownership.

    I rankle at the continuing representation that derivatives are ‘too complex’. Rubbish, there may well be a lot of legalese to read thru; but, publication of a Term Sheet would go a long way toward helping the public understand what transpired. Such an act, however, would undoubtably expose the fact that the Treasury did more to protect a selected few ‘primary dealer’ banks than AIG, ergo – Follow the Money.

    I think it is very instructive that AIG has been unable to successfully sell any subsidiary business where the funds might be applied to the repayment of the bailout monies.

    I hope the upcoming hearing will begin to look into this CDO – CDS derivatives business in depth.

    Again, enjoy your work and I marvel at your ability to get to crux of issues with considerable clarity.

  8. maynardGkeynes

    I think Greenberg has a valid point on the Fifth Amendment Due Process “taking” issue, and since his lawyer is David Boies, I doubt that Greenberg just pulled this out of his “bonnet.” The FDIC takes over banks because of the preexisting authority granted to the agency by the banks under the FDIC agreement, under authority granted to the FDIC by the Congress. AIG had no such preexisting legal relationship with the government. It was a totally unregulated private entity at the federal level. The only case I can think of where a seizure of a wholly private company was declared lawful was Truman’s seizure of the Steel companies during the Korean War, and that case went all the way to the Supreme Court. It was declared legal only under the President’s extraordinary authority under the War Powers clause of the constitution. I don’t think we should concede that the Fed’s so-called extraordinary power is some kind of equivalent to the War Powers act. The reason that the War Powers authority is recognized is that war involves the very survival of the Nation. The survival of Goldman Sachs is not the moral equivalent of the survival of our Nation, a point that seem to have been lost on Geithner, Bernanke and Paulsen throughout this sordid episode.

    1. Siggy

      A very good observation and point. Ad Hoc, neither Treasury nor the Fed had/have authority to directly takeover AIG. But then, AIG was looking for a loan and it was the Treasury terms of the granted loan that amounted to a defacto takeover. That is where the water muddies. Its Federal money granted as a loan on terms that effect a takeover of the enterprise. That may, or may not be legal. On reflection it seems to me that the statutes should proscribe the takeover of an unregulated enterprise by any device wherein the object of the takeover is denied or obstructed from due process.

      Willing partner point: AIG did not have to accept the loan and its terms. They could have filed for Chapter 11.

      If Boies and Greenberg have partnered up to file suit, then I see Greenberg’s efforts as self serving in that he is trying his case in the public opinion court. I wonder if he is doing this on the advice of Boies who may have the view, ‘lets run it out there and see how it plays’. Net, Boies gets a nice fee for consultation, probably never goes to court and Greenberg continues to scurry about trying to rehabilitate his ‘captain of industry’ persona.

      This is almost as good as Shakespeare. Now, just who is Shylock?

    2. Yves Smith Post author

      I’m not a lawyer, but I don’t see how the “taking” can hold up. Unlike Fannie and Freddie, where the government said “you accept this or we make this happen without you”, AIG sought out the government and could have filed for Ch. 11. It did have an alternative which it chose not to pursue. And shareholders would most assuredly have been wiped out in that scenario. Hence no “taking”.

      Second, and even more important, the Fed simply used the same term sheet private sector lenders had come up with independently and had gotten commitments on (Jimmy Cayne, far and away the most effective player in the syndicated loan business, had been raising money for AIG). So you can’t argue for government taking when AIG was aware of and had implicitly agreed to the very same terms from private sector lenders. See Sorkin for the blow-by-blow account.

  9. Cullpepper

    Perhaps there are a few folks trying to lay some groundwork ahead of time. If Tim Geithner goes to jail, you don’t imagine he’s going alone, do you?

  10. eurostoxx

    Yves,

    This post is the reason why I read your blog. Great job!!

    Analyzing financial companies is so hard these days, as they are such huge companies and financial disclosures are so obscured you cant really evaluate mgmt without knowing someone who is working on the inside. thanks for giving that perspective to your reads.

    Keep up the great work!

  11. sgt_doom

    A Thousand Thanks for this, Yves!!!

    Greenberg should be held accountable – and in jail – for the largest swindle in human history, zillions of CDSes written without the capital reserves on hand. Period.

    Not even taking into account the lengthy history of accounting fraud on their part, be it all those reinsurance with notes (discounting any realy risk removal) along with various other accounting fraud perpetrated over the years (that one with Brightpoint, where AIG was actually fined for once, comes immediately to mind.

    No excuses for the MAJOR EXCUSE MAN, Hanky Greenberg!

    [And I won't triviliaze this site by bringing up that insinuated involvement of AIG (remember their two subs, Marsh & ILFC - the largest commercial aircraft leasing company around) with 9/11/01. Although it is worth some reflection....]

  12. NYT

    I suspect AIG is a cesspool – not just AIG FP.
    They were found by Spitzer to have engaged in accounting fraud and they had that weird arrangement with CV Starr.
    After then 15 months of crisis they haven’t been able to sell ANY significant subsidiaries, even though prices for most financial assets have rebounded.
    Buffet was offered any subsidiary at any price, according to Sorkin, and he didn’t want to know.

  13. chicago mike

    Consider again the “anecdote” Cohan supplies in “House of Cards” involving Goldman’s Gary Cohn and KKR’s Nick Fanlo.

    http://money.cnn.com/2009/03/02/magazines/fortune/cohan_houseofcards5.fortune/index.htm

    Cohn tells Fanlo that if he (Fanlo) can generate a bid of 80 for the securities in question, Cohn will sell him $10bb at 55.

    Why would Cohn so forcefully challenge his customer’s (and the Street’s) collective belief?

    Answer: Cohn doesn’t merely want to see the collateral (that’s widely held by his peers in a so-called Mexican standoff) marked lower, as if price discovery were some kind of good deed performed by risk-taking traders, akin to a Boy Scout’s helping an old lady cross the street.

    Cohn’s objective is to “break” the quoted price; he wants to force the price down because it will benefit his firm relatively more than his competitors.

    From Cohn’s perspective (in the executive suite), a new lower valuation of the collateral would presumably trigger a series of “positive” outcomes for his firm.

    Ironically, a few months later (September 2008), Goldman Sachs itself would require governmental life-support (via the FDIC bond guarantee program, without which GS would not have been able to rollover their own corporate debt, then offered north of 16% YTM (no bid). With the FDIC insurance, the first trade GS (and their brethren) made was repurchasing their own outstanding debt, which would earn them millions as the Fed & Tsy later spent $1.5 trillion buying bonds to drive down interest rates.)

    The biggest traders don’t merely put positions on; they work actively on behalf of their net long/short position; they do what they can to make it a “winner.”

    By successfully challenging Fanlo’s (and the dealer community’s) valuation, Cohn achieved what every trader dreams of: He dropped the straw that broke the camel’s back.

    Now THAT’s trading.

  14. Joseph

    I met Mr Greenberg once a few years back. Not sure if I would describe him as a shark in a suit or a snake in a suit. A very nasty piece of work.

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