Hubris knows no bounds. AIG’s former CEO Hank Greenberg, who was a significant shareholder of AIG stock via C.W. Starr (which was basically an executive enrichment vehicle) is suing the Treasury and Fed over its rescue of AIG. He has hired litigation heavyweight David Boies, who famously made Microsoft CEO Bill Gates squirm when he put him on the stand in the Microsoft antitrust case.
based on the report from Gretchen Morgenson, the argument seems to be that AIG got less good terms that Citigroup did, ergo the bailout “discriminated” against AIG.
While the public might similarly enjoy the spectacle of Timothy Geithner, Hank Paulson, and Ben Bernanke through the wringer, and I’m looking forward to reading the actual claim, but this reads like a stretch. The government stepped into a rescue when private sector rescue efforts failed. A team headed by Bob Scully of Morgan Stanley had put together a term sheet and tried raising funds for the floundering insurer, but they could not secure enough money. If my recollection of the Sorkin book Too Big to Fail is correct (I’m on the road and don’t have a copy here), the Fed and Treasury used the same termsheet as the private sector deal (although, as I recall, the amount to be funded also rose as AIG revealed late in the game that it needed an additional $20 billion dollars in addition to its guesstimated $40 billion in CDO losses due to problems in securities lending portfolio). Note also that the AIG CEO came to the government, provided the collateral for the initial loan, and AIG proved to be in worse shape than it initially told the authorities. It’s hard to argue either coercion or unjust enrichment. As we wrote, it was outrageous that the deal was retraded repeatedly, with the terms becoming more favorable each time.
A big issue, per the Sorkin account, was the embarrassingly bad state of AIG’s records. The Wall Street firms involved in the failed rescue were alarmed at was the fact that AIG did not have a good handle at all on its financial exposures. Similarly, your truly saw a huge red flag in a disclosure in the first edition in Sorkin’s book:
Readers of TBTF may recall that the book gives the travails of Lehman center stage, with the AIG unravelling a secondary but parallel story. Sorkin drops in the proximate cause for the AIG rescue: the magnitude of its credit default swaps portfolio: $2.7 trillion notional, with $1 trillion of that concentrated among 12 financial institution (p. 236). We get a flavor of how badly run the place is: management admits to having “antiquated systems” (p. 364) and is not able to get a estimate its cash needs (p. 365). Amazingly bankers poring over its financials in the course of trying to raise funds discover a $20 billion sinkhole that was somehow overlooked by the AIG top dogs, the result of losses in its securities lending business. That increased the amount of money needed at that juncture from $40 billion to $60 billion (p. 337). Ouch.
So the story thus far is that AIG is a great big mess that will bring everyone down if it goes. Got that. Geithner accepts that picture, persuades Bernanke. AIG is on the verge of bankruptcy, according to Sorkin, mere “minutes away” (p. 399). The Fed agrees to extend a $14 billion loan to get it through the trading day but it wants collateral. Collateral? From a broke company? How is that going to happen?
Then we get this bit:
Wilmustad understandably wondered how they were supposed to come up with $14 billion in the next several minutes. Then it dawned on them: the unofficial vaults. The bankers ran downstairs and found a room with a lock and a cluster of cabinets containing bonds – tens of billions of dollars’ worth, dating mostly from the Greenberg era. They began rifling through the cabinets, picking through fistfuls of securities that they guessed had gone untouched for years. In an electronic age, the idea of keeping bonds on hand was a disconcerting but welcome throwback. (p. 400)
WTF? This is a company about to go out of business, then it suddenly remembers it has a secret stash….worth at least 1/6 of the initial government rescue commitment? $14 billion was only what they coughed up to satisfy the Fed. How much more was left in those cabinets?
And more important, WHO SUPPOSEDLY OWNED THIS PAPER? This wasn’t held by the subsidiaries; otherwise, AIG would not have been able to pledge it to the Fed. And if it was a parent company holding, why wasn’t it repoed or sold earlier? What entity took the semi-annual interest payments? Take the $14 billion we know about, and assume a 5% interest rate. That’s $700 million. Where did it go? Was it reinvested? Disbursed?
The language further suggests that bonds in this secret trove, while mainly accumulated under Greenberg, had more recent additions, presumably under Martin Sullivan, perhaps Wilmustad. This “unofficial vaults” designation strongly implies this was a secret, off balance sheet cache that threw off a hefty amount of annual income by virtue of its staggering size. That would mean it could be used by the CEO at his sole discretion, for anything from bribes to unreported executive payments that might then be used to open foreign bank accounts or pay for personal or business expenses.
And these “unofficial reserves” continued AFTER Greenberg was ousted over accounting improprieties. Business Week gave a short summary:
Investigators believe that AIG may have goosed its financial performance with dubious transactions and improper accounting. Last fall, the insurer paid $126 million in fines to the Securities & Exchange Commission and Justice Dept. for deals it structured for outside clients that allegedly violated insurance accounting rules, although AIG admitted no wrongdoing. The company also came under the glare of New York Attorney General Eliot Spitzer for its role in bid-rigging with broker Marsh & McLennan Cos. (MMC ), which led to the ouster of Hank’s son Jeffrey as CEO there. AIG admitted no wrongdoing, but two of its executives plead guilty and left the company.
This time, investigators initially focused on two transactions involving Berkshire Hathaway’s (BRK ) General Re Corp. unit. The deals essentially amounted to a $500 million loan that was dressed up on the books as premium revenue. That allowed AIG to boost its sagging reserves at a time when investors thought they were too low. The problem: AIG never assumed any of the risk associated with insurance underwriting. On Mar. 30, the company acknowledged that “the transaction documentation was improper” and should never have been classified as insurance premiums.
Since then, AIG ‘s problems have escalated. In its Mar. 30 release, the company itself identified several problem areas. They include transactions with supposedly independent companies that were in fact controlled by AIG; bond transactions that may have allowed it to claim gains without actually selling the bonds; misclassified losses; and questionable estimates on deferred acquisition costs. Investigators and state regulators are looking into some 60 transactions involving these and other possible accounting shenanigans. “Greenberg strived for a steadily rising stock price,” says a source in Spitzer’s office. “He used mechanisms now being revealed as deceptive and improper.”
Perhaps there is an innocent explanation for this huge stash. However, but in all my years in financial services (and having had billionaire clients who would be completely within their rights to run their enterprises as personal cookie jars to the extent the law allows), I have never heard of anything remotely this suspect.
Sorkin contends (based on phone calls prompted by the focus on this paragraph) that the securities pledged to the Fed were the share certificates in the subsidiaries and changes his account to reflect that in later editions of his book. Maybe. But even so, that’s a hugely irregular practice at a company as big as AIG, and also flies in the face of the idea of an “unofficial vault”.
In addition, AIG was known to be in thick with the CIA. Its huge sprawl of offices around the world made it the perfect entity to give employment cover to agents.
This obvious lack of adequate controls would seem to set up a major defense to the suit: AIG was not regulated in any meaningful way by the Federal government, unlike Citigroup. To expect it to rescue an entity where it had effectively no oversight and therefore had no insight into the adequacy of its records is bollocks. It should properly ask for completely different and more punitive terms for rescuing a pig in the poke. And as we commented at the time, we approved of the first AIG rescue. It was along classic Bagehot lines: lend freely, against good collateral, at penalty rates.
But the premise of the first AIG bailout was proven false. The collateral wasn’t so hot. That was why the deal had to be redone repeatedly. AIG had been highly confident this was just a liquidity problem, that it could sell various subsidiaries and come out just fine. But it was only able to monetize a few of its best operations.
In keeping, I’ve been told AIG was and is DEEPLY insolvent at the subsidiary level from former state insurance regulators. Since you get the money up front and pay out later, insurance is the perfect vehicle for fraud. This is extremely significant, since if true, it means AIG was rotten to the core, not merely insolvent at the parent company level. The alleged problems are in its US property and casualty operations, which have an extraordinary number of cross guarantees, and also make use of the highly suspect “finite reinsurance” with each other, the same sort of dubious practice cited in the Business Week article above. But it is brutally difficult to prove (I had a team of four people waste the better part of a month on statutory filings. They are FULL of red flags, but even one major sub’s filing run to nearly 300 pages, and you need to go through tons of analysis across subs to get anywhere).
But any Federal case is not going to touch the issue of problems at the sub level confirming their initial call; this would call into question the quality of what is left of AIG when the Federal government still has more of that garbage barge to unload on the public.
The intent of this case is clearly to embarrass the officialdom into paying Greenberg to go away quickly. Many of their best defenses cannot be revealed due to their conflict of interest by being a continuing owner of AIG and keen to present the bailout as a success (remember the continuing “paid off the TARP” meme). And Greenberg does have a point in his favor: the way AIG was used as a vehicle to provide funding to other insolvent companies (the now notorious paying off of the Maiden Lane III credit default swaps at par, the payouts on the securities lending portfolio, and the less widely noted way in which entire portfolios of levered credit risks were unwound, purported to provide the big banks with badly needed profits in the first quarter of 2009).
Paulson is interestingly off the hook as the Treasury secretary, since the Treasury secretary was put outside the law in TARP legislation. So I’d assume the Treasury will be able to get itself removed from the case. The Fed will probably seek to have the case sealed. If it succeeds, it might pull out all the dirty laundry on what a mess AIG really is.
I love the notion of a Microsoft anti-trust-suit-like spectacle, but I don’t see that in the offing. Boies is shooting at much bigger targets at this time, and he may not realize the fact set is pretty poor (Greenberg is smart and famously persuasive). But the flip side is this is probably an effective extortion game, since senior government officials won’t be keen to spend the time needed to make an adequate defense, or go a few rounds of discovery to let Boies know they would have good case if they went to the mat. After all, one thing Greenberg has observed that the easiest course of action is to roll the taxpayer. He just wants his share.