The Most Stunning (and Uncommented on) Revelation in Too Big Too Fail

Although I read it two months ago, I haven’t made much in the way of comments on Andrew Ross Sorkin’s Too Big Too Fail, figuring the ground was well plowed by others. However, the bit that I found the most shocking has not gotten the notice it deserves, so I am writing it up now.

The book present a number of truly remarkable incidents from the crisis, so it might seem surprising that one stands out among the revelations and juicy tidbits. For instance, in what amounts to a bit of Treasury defending its record, the book recounts how Neel Kashkari developed a “break the glass” memo, so the powers that be allegedly did plan for an emergency. But anyone who has done real business planning or project management would recognize this document was useless, that it was at far too high a level of abstraction to be helpful when the shit hit the fan.

Similarly, it was an eye-opener to read that absolutely no one in the officialdom had the foggiest idea of the legal and practical implications of putting Lehman into bankruptcy. Lehman had engaged Harvey Miller, the preeminent BK lawyer, and no one bothered to talk to him. In fact, Miller’s highly developed deal sense told him Lehman was going to be rescued precisely because he was so removed from the discussions.

But there is one particularly striking tidbit that I though someone would have picked up on by now (and hopefully add their own commentary). But since (to my knowledge) no one has done so, let me point it out.

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. Given AIG’s history, there is every reason to believe this is what is appears to be: a slush fund created for Greenberg’s personal use that was never accounted for properly.

The simple test of whether this arrangement is proper or not is whether the cache was fully accounted for on AIG’s balance sheet. If not, no wonder Greenberg had to go to such lengths to boost reported earnings. He would have needed to hide the truly remarkable amount of skimming needed to put these reserves aside.

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  1. Francine McKenna

    I guess I should finish the book. It’s been a treasure trove of leads for me, even without hardly a mention of the auditors of these institutions. It’s exactly this – lots of accounting manipulation and discussion of accounting principles like mark-to-market with no mention whatsoever of the audit firms anywhere in the foreground, background, on the stage or at the table – that lends credence to my contention that the Big 4 audit firms were no where to be found. And, therefore, there is no one to look out for the shareholders.

    Maybe we should ask AIG’s long-time auditor about this story of a treasure trove of bonds in the basement vaults. Dare I suggest that they should have known – as providers of a clean audit opinion on the balance sheet – to what ends these assets were used?

    1. tim

      you should pursue that and shine the light at your excellent website! glad i found another site to read daily francine. :-)

      the light needed to “help” the fiic apparently needs to be a super nova.

    2. Ursula Fogle

      Ok, call me naive, but wasn’t that hot-stuff Sarbanes-Oxley law supposed to catch issues like this after Enron or was that just another big load of bull?

      1. Francine McKenna

        Sarbanes-Oxley is only as good as the auditors who test management’s assertions. If you follow the history of AIG’s relationship with PwC (and I have written umpteen posts about their co-dependent, dysfunctional coupling) you will see that PwC let them get away with murder for a long time, finally said the buck stopped when AIG’s own executives pushed them to (or maybe it was their other client GS) and is still in place enabling AIG’s sins in spite of being sued by AIG’s own shareholders.

        The law doesn’t work if the watchdog has no teeth and instead licks the client’s…

  2. Siggy

    I have just begun to read TBTF and am only at page 115. As far as I am in the book, I firm in my belief that there is ample cause for action on the part of the Justice Department. “Unofficial Vaults” is a very curious label. $14 billion is a bit more than a slush fund.

    I have a growing sense that we are at the effect of people who are clueless as to their legal responsibilities and absolutely unethical in their conduct. Greenberg is mad because of the ‘taking’ by the Fed. Geithner is doing a white knight to save AIG from bankruptcy; yet, the effect of the rescue is to support 16 or so ‘primary dealer’ banks.

    The public is outraged over the rentention payments and the bonuses being paid by Wall Street firms. For the most part the bonuses are chump change. ‘Unofficial Vaults’ are the issue. Unofficial Vaults are the stuff of fraud. Somewhere, at some point, a lot of money ran thru AIG and evaporated. What you are pointing to is $500 to $700 million in annual income that probably has not been reported.

    Now, what if the ‘Unofficial Vaults’ cache was, in fact owned, or pledged to other parties; then, someone committed a felony!

    You are on point here, this is a genuinely meaningful story not just salacious financial shenanigans that make for amusing theater. The more I consider this the more I understand why the Fed is so intent in not wanting AIG to publish where the bailout monies went.

    By the by, how or will it be possible to get a signed copy of your book?

  3. LeeAnnea

    Thank you Yves for ending the confusion around just who these people in charge are; your article pulls the mask off finally. The American people have not acted against the powers to be until now because our corporate government have so successfully sown confusion among the American people through their corporate owned media; the loudest if not the biggest culprits being those oafs ‘interviewing’ and shouting on the TV.

    It looks like we need Eliot Spitzer to be appointed or reelected so that he can continue to prosecute his case against AIG principals. And we need to honor Ron Paul, award a medal for heroism for his relentlessly sounding the alarm on behalf of the people of this country about the FED; that organization of stupid, double-talking, greedy traitors who are at the center of the biggest criminal heist in the history of the world. We’ve suspected it; but there is no longer any doubt about it.

    Backing up your thesis this from Daily Kos September 20, 2009:

    “I have come to suspect that the Lehman bankruptcy was a highly risky strategic act carried out by the world’s biggest banks through their control of the New York Fed, an act which succeeded brilliantly in literally “scaring up” trillions of taxpayer dollars to save the very financial institutions which had caused the meltdown.”

    “Jamie Dimon, the CEO of J.P. Morgan Chase who actually negotiated the last minute deal with the New York Fed over a single weekend, that he himself sits on the board of directors of the New York Fed, as a Class A director representing the banks. We have no idea whether Dimon recused himself from the discussions at the New York Fed concerning the Bear Stearns deal, because Dimon’s dual-hatted role has remained all but invisible to the press and public.”

    It looks like Eliot Spitzer needs to be appointed or reelected to continue to prosecute his case against AIG principals.

    Daily Kos: ” …Eliot Spitzer, a man who personally sued the New York Fed, and who is intimately familiar with its personnel and workings. Writing earlier this year in Slate magazine, describing the dramatis personae of the New York Fed, beginning with the selection of its bright new president in 2003, Timothy Geitner. Spitzer wrote:

    ‘So who selected Geithner back in 2003? Well, the Fed board created a select committee to pick the CEO. This committee included none other than Hank Greenberg, then the chairman of AIG; John Whitehead, a former chairman of Goldman Sachs; Walter Shipley, a former chairman of Chase Manhattan Bank, now JPMorgan Chase; and Pete Peterson, a former chairman of Lehman Bros.’

    Furthermore, the CEOs and board members of these same institutions repeatedly are to be found among the nine governors of the New York Fed itself. There are nine such governors, three elected by the owner banks to represent their own interest.I have already mentioned that Jamie Dimon was one of these, …”

  4. Dave

    This was fraud on a massive scale, known by many, and taken full advantage of by the players (GLD) to maximize returns. On the money trail of every off-balance-sheet slush fund are executives, accountants, regulators, and legislators well enough compensated to overlook plenty of sins, and plenty of leverage for anyone with that knowledge to hold AIG by the b—s to do what they pleased and take what they could (Cosimano?).

  5. DoctoRx

    When I heard about it, the revelation of vast bond values just sitting around to be “remembered” at a propitious time struck me as so odd as to be unbelievable. What if this story is, simply, a lie?

    1. IF

      I had the exact same thought when I heard this story, and thus discounted it as a pile of shit. Of course it could be there as a distraction. Yves takes it at face value to motivate readers to follow the leads. I agree with her, it needs investigation. The question remains, why do we pay for an expensive legal system, if it seemingly does nothing? Maybe we just don’t see yet all the cases that investigators are preparing and are currently moving down the pipeline to the courts? How would we be able to figure out how much is coming, just wait and see seems too risky as an approach.

  6. Uncle Billy Cunctator

    A quick news and blog search reveals that you are probably the only one who is talking about it.

    $14 Billion is what AIG paid to Goldman. Maybe the unofficial vault wasn’t actually downstairs at AIG?

  7. Michael M Thomas

    When I read this, I was incredulous. Wasn’t sure I believed it then, still not sure. Wonder what the auditors are going to say?

  8. Uncle Bill

    Where do you think Sorkin got the info on this? If it was a law enforcement source, you’d like to think they’re looking into it. If from a participant or knowledgeable source, the info begins to look specious and/or self-serving. Of course AIG was a criminal outfit — legally domiciled in Panama, where they bought the brand-new legislature to write rules they dictated after “we” took out Noriega. Talk about a nice conspiracy theory….

  9. Moopheus

    I think everyone who reads this blog should print out this page and mail it to their congressthing. Not that it would do much good, but clearly somebody needs to be put on the hotseat to answer some questions.

  10. Ishmael


    In way of background I was with a Big 5 firm and my clients included some of the largest nonfinancial companies in the world. I also was the CFO for 4 public companies including one multibillion dollar company and another NYSE company. In addition for the last few year I have had my own corporate governance and advising company and perform a lot of subcontracting for a large international accounting firm.

    When I read the comment, “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” I will have to say that sounds like a story from someone who really does not understand accounting and custodian of assets. Never in all of my 30 year career (including being brought in on some of the largest BK’s and frauds in the US over the last 30 years) have I heard of such things. Now I will tell you Penn Square Bank’s records were atrociously bad but they did have all of their loans on the books even though the underlying records were in banker’s boxes stacked to the ceiling.

    I could not imagine any half-way decent finance person not having a list of collateral that was unencumbered and could be used to obtain new financing. This would be especially true for a company in the financial condition such as AIG.

    I also have to admit that the picture of the CEO running willy nilly around like a character in a Buster Keaton movie and they run down to the “unoffical vaults” and find the hidden treasure just strikes me as unbelievable. Even with companies near BK, usually the CEO turns such things to the finance staff (who know where the cookie jars are) and goes home telling the staff to call him and keep him appraised.

    Considering that AIG was one of the largest companies in the world, if the above was true it would also have had the worst financial controls in the world. On the other hand, they did have the FP division underwriting massive amounts of CDS and did not set any reserve away. Of course this was supposed to be a rogue part of AIG.

    I just find the above comment unbelievable, but the last 5 years would have been unimaginable 30 years ago.

    1. WRC

      Most likely the bonds were available for physical audit by various state insurance regulators and auditors. AIG records were always a dusty labrinth probably intentionally.

      But many insurance company frauds in the past have utilized double or more counts of the physical bonds on hand.

      Note: First time responder, long time reader of this blog. Thank you Yves.

    2. Moopheus

      But if the company had a huge stash of bonds that it owned free and clear, that were its legal assets, then why did it need a bailout from the Fed? It’s like, gee, we’re broke, except for all this money. Or some private entity would have been willing to lend against that collateral. It does seem that something fishy is being glossed over here.

    3. Steve

      I imagine a very FEW AIG execs knew about the existence of the stash, and informed others only when it was absolutely necessary.

  11. Hugh

    Great catch. It wasn’t just the accounting scandals AIG had. Remember too it was re-insuring internally. And of course there is AIGFP. So there really is a pattern of cooking the books across the board and for a substantial length of time at AIG. It makes me wonder what a forensic audit of the company (or any of the financial corps would show since there are plenty of indications that they were monkeying around with their books too). For instance, what did AIG do with all the money coming into it from its insurance companies? How much of it was used for gambling or purchase of illiquid and overpriced assets?

    I really have no feel for how its portfolio was structured. But there are red flags everywhere. I would simply point out that one of the reasons put forward for why healthcare insurers pressed so hard for a healthcare bill only insurance companies and bought politicians could love was that they needed a way to recoup losses from their bad investments in the bubble burst and meltdown. But as it is now everyone is being allowed to cook their books. Rather than inspire confidence I think it should be a cause of concern to us all.

  12. Jim in MN

    Wow. So bonds are good for something after all? Who knew.

    The secret: they’re ONLY good if you hold the actual bond! Now, try to go buy one at retail. I bet you can’t. Ha ha. The only decent investment the ordinary person can make–corporate bond coupons at 5% or better–and YOU CAN’T HAVE ANY. Bond funds are, of course, a sick joke. One interest rate twitch and poof.

    But AIG overlords can dive around in a vault full of actual, interest bearing bonds like Scrooge McDuck in gold coin.

    Really, this makes me sick on several levels.

  13. dianeb

    I haven’t reached that part of TBTF yet, but from what I have read (through Sunday, September 14, the day before Lehman croaked) just takes my breath away. These guys from Paulson on down seem to be rank fools and idiots, intent on forgetting the most basic points. Did it take genius IQ status to know that someone (anyone!) should have called the FSA to get an immediate and informed read on what their position would be regarding a Barclay’s buyout of Lehman? Paulson had to find out at the last minute, then ordered Cox to call and see if there was any wiggle room? No one had that on their check list to begin with, just took what Barclay’s told them at face value and then blubbered when big bad FSA said no?

    All the players just seem to be little more than toddlers, with an attention span of three seconds and little more in the way of brain power than lettuce.

  14. Ultimate Janitor


    Further evidence that the public accounting function is extinct.

    Internal auditor? WTF is that??!!?~!

  15. David Merkel

    Fascinating, and not improbable for a company led by two very strong figures. The excess assets would be consistent with my experience. The trouble with them is, if they really existed, they would be hard to use to aid AIG because of the accounting trail that would happen at the moment they were booked. Maybe they were on balance sheet, and it was AIG’s equivalent of Goldman’s “BONY box.”

    PS — the $20B+ of securities lending losses were buried in the life companies, and came from a substitution of AAA subprime RMBS for the clean T-bills that most would have to post. AIG was “Texas hedged” on subprime RMBS — the ultimate patsy that took all the losses. Those losses now belong to the taxpayer.

  16. MichaelC

    When I read that bit I assumed Sorkin was using ‘unoficial vaults’ as a literary device and interpreted it to mean that the desperate accountants had found a loophole in the rules to reclassify the amount as available for use as collateral.

    Sorkin should be called on it to explain what he meant. Thanks for shining a light on this.

    If they really do have secret vaults, then that’s a blockbuster which I assume Sorkin would have trumpeted.
    If the ‘secret vaults’ are further evidence of AIGs astounding accounting abuse that’s also worth exploring.

    Either way how did AIG/Treas/Fed respond to this newfound goldmine at the time. We won’t have any idea till we see more disclosure from the Fed, so asking this question now further weakens Geithner’s secrecy position.

    Great timing Yves.

    1. Chris

      I wonder why Sorkin didn’t elaborate – surely he would have been aware of the implications. Maybe anything more explicit would have tied the book up in litigation and delayed publication, so he left it in there as an Easter egg and trusted that someone would connect the dots. Or maybe there is a less sinister explanation.

      I wish I had $14B under my mattress. On second thoughts, maybe I don’t (look up “Shallow Grave” on IMDB if you haven’t seen it).

  17. Robespierre

    Easiest way to land these gangsters in prison is via tax evasion. Just audit the bunch and make them justify their standard of living and wealth to whatever they report. What worked with Al Capone will work here again.

  18. Another Joe

    “Easiest way to land these gangsters in prison is via tax evasion. Just audit the bunch and make them justify their standard of living and wealth to whatever they report. What worked with Al Capone will work here again.”

    I hate to point out that Geithner admitted to tax evasion and they made him the SecTreas.

  19. avrymann

    Wait a minute! Hold the Phone! Stop the presses!

    How could he/they all of a sudden “dawn on them” that these bonds existed if they didn’t already know about them to begin with. They didn’t discover that these vaults existed, they knew about them and classified them as “unofficial”. Could they not have know just how large they really were? If they knew about their existence, they must have had some idea of their size otherwise they never would have been scampering down to the vaults to count their money.

    Its like saying that average Joe is at home meeting with his mortgage lender to keep from foreclosure. He is told he needs to come up with 20 grand in collateral. All of a sudden he realizes that he has that much stuffed in coffee cans in the basement. He runs down to check and finds that he has 40 grand which saves the day.

    Which scenario is more outlandish?

  20. dd

    It must be assumed that every factoid about AIG is suspect until verified by independent processes. Did the Fed really make AIG post worthwhile collateral or is this more misdirection? There is nothing but misdirection where AIG is concerned and one assumes the “AIG never assumed any of the risk associated with insurance underwriting” likely applies to the CDS as well. That would explain the heavily redacted term sheet and the par payments on unspecified CDO.

  21. bob

    This does not play.

    I would point out that if one were likely to have 14 billion in physical bonds, they would not all be in the same place, unless there was at least one other stash somewhere else.

    Putting all of your eggs in one basket, or vault, is very bad risk management.

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