The problem with a population that doesn’t read widely is that they take whatever they hear on the news or read from their favourite columnist and repeat it verbatim. There is no critical examination of the facts, and because hardly anyone reads widely, they cannot plug new information into a matrix of what they have already learned and retained.
American Insurance Group was one of the most savaged brands in the aftermath of the global financial crisis. The New York Federal Reserve and US Treasury, with Tim Geithner and Hank Paulson at the helm decided to use AIG as a way to transfer tens of billions of dollars to Wall Street banks and other counterparties of AIG’s Financial Products division.
The popular narrative is that AIG was a corrupt company. This book is an attempt by the CEO and man who grew it from $100 million in revenue in the 1960′s to over $800 billion in assets in 2008 – Maurice “Hank” Greenberg – to set the record straight. It is written by Lawrence Cunningham after a lot of research and interviews. As always, it is more revealing when you learn who did not want to give an interview to an author than who actually did.
The book starts from the beginning with a clear explanation of how AIG played an important role in the globalisation of financial services and had a “profit center” mentality. Each individual underwriting unit was expected to earn a profit on its own. This was distinct from many insurance companies that simply lowered their premiums below the market rate to gain market share at the expense of higher loss rates.
Greenberg and his executives achieved very low expense ratios and loss ratios relative to the rest of the insurance industry. After he was forced to resign profit margin went from 16% to below 4%. Under his leadership AIG became a behemoth because they really were the best. They were using advanced actuarial stuff before anyone else, their senior executives had no employment contracts so were always incentivised to outperform and their long-term interests were tied to AIG because a separate company, SICO, owned a massive chunk of AIG shares that eligible AIG employees only received when they hit 65.
I am familiar with how the derivatives market works. When financial institutions trade between one another, many can do so on the back of their AAA or AAA- credit rating. They don’t even need to post collateral. The downfall of AIG came from a reduced credit rating and abandoning a policy under Greenberg of always “laying off the risk” in derivatives trades by hedging each position and therefore making a margin on what they received in premiums on a product and paid out in premiums to other firms.
In essence, before Greenberg’s departure, AIG ran their derivatives business properly with strong risk management controls. But after his departure they entered into more than $80 billion dollars of unhedged exposure. There was a massive legal wrangle over accounting inanities and at the heart of it all was former New York governor Eliot Spitzer. Yeah, that hypocrite who went after Wall Street while simultaneously engaging in (at least in the USSA) illegal activity with high end escorts.
Then, a phrase came up that immediately gave me flashbacks to a book I read about Conrad Black. The “corporate governance” mafia were responsible for the downfall of AIG. Experienced insurance and banking industry stalwarts were forced off the board in the name of “independence” and effectively hijacked a successful firm from people who knew what they were doing to people with no insurance or even financial experience.
This “corporate governance” scheme involves reforming management and the board of directors of a corporation to serve the interests of the independent directors. The interests of the shareholders, executives and employees are tertiary. The primary goal of the corporate governance movement is to enable a cottage industry of law firms, “corporate governance experts” and accountants to make enormous sums of money leeching off successful corporations.
Immediately, I plugged what I was reading into the matrix of what I have read about “corporate governance” over the years. The downfall of AIG all made sense. When you replace people who managed risk for a living, with people whose biggest risk in life was whether to attend Harvard or Yale for law school, you sure as hell will have poor oversight.
And at AIG that’s exactly what happened. The executive committee of 4 top directors that met almost weekly as a way of ensuring oversight of big decisions and risks in between full board meetings was abandoned. There was “no one in charge” and the corporation devolved into factional infighting. The board of directors was so concerned with destroying Hank Greenberg it did not take any steps to monitor risk at AIG Financial Products.
While at some points in the book it was clear that Hank Greenberg is a very American-style CEO, the parallels with Conrad Black (charged with $400M embezzlement, convicted on $285,000, destroyed in order to let corporate governance types bilk Hollinger International) were completely uncanny. The pettiness and immorality of these leeches of the boardroom is amazing.
What is even more disturbing is that basic economics tells us that Greenberg, as largest shareholder of AIG and heir of C.V Starr, had the strongest incentives to protect AIG shareholders, employees and customers. The directors that were not former executives of AIG and associated companies had tenuous incentives – their fees, some restricted stock and “prestige”. They were “captured” by outside counsel that saw a massive opportunity to bill AIG tens of millions of dollars in legal fees.
When all of the AIG legal and accounting fees are added up, over $1 billion was spent sacrificing AIG at the altar of corporate governance. And this was before the US used AIG as a bailout conduit where derivatives counterparties were paid out at 100 cents on the dollar when market conditions made it obvious that discounts were acceptable settlements of AIG Financial Products’ liabilities.
I recommend you read this book as an antidote to the anti-AIG propaganda that the media have repeated ad-nauseam. The dodgy executives at AIG were only enabled to do what they did because the corporate governance movement hobbled their in-house risk control mechanisms in the pursuit of “good governance practise”.
If that hadn’t happened, all of the losses would have been borne by those who knew the risks – the shareholders. Instead, a weak board of directors let the Fed and the Treasury hijack their company and use it as a bailout conduit. You should buy a copy of The AIG Story this weekend. It’s a compelling tale of what happens when people don’t stand up to legalistic bullies.
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