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

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.