What Greenberg Might Have Said

It was recently reported that AIGFP began selling credit default insurance in 1998 and that the volume of this business exploded after I left the company in March 2005. AIGFP reportedly wrote as many credit default swaps on collateralized debt obligations, or CDOs, in the nine months following my departure as it had written in the entire previous seven years combined. Moreover, unlike what had been true during my tenure, the majority of the credit default swaps that AIGFP wrote in the nine months after I retired were reportedly exposed to sub-prime mortgages. By contrast, only a handful of the credit default swaps written over the entire prior seven years had any sub-prime exposure at all. Based on published information from AIG, AIG net notional exposure to Multi-Sector CDOs at June 30, 2008 amounted to $80.3 billion, of which $57.8 billion contained sub-prime mortgage collateral. The mark-to-market loss on this portfolio at that date amounted to $24.8 billion, of which $21.0 billion related to securities containing sub-prime mortgage collateral. The total mark-to-market loss on the AIGFP portfolio as of June 30, 2008, is $25.9 billion.

How did this happen? I was not there, so I cannot answer that question with precision. But reports indicate that the risk controls my team and I put in place were weakened or eliminated after my retirement. For example, it is my understanding that the weekly meetings we used to conduct to review all AIG’s investments and risks were eliminated. These meetings kept the CEO abreast of AIGFP’s credit exposure. Earlier this year, AIG’s independent auditors, PricewaterhouseCoopers, found AIG to have a material weakness in its internal controls relating to AIGFP’s portfolio of credit default swaps. It also appears to be the case that the problem created by the additional risk AIG had taken on through these new credit default swaps may have been aggravated by the fact that the new exposure appears to have been entirely or substantially unhedged.

When it became increasingly clear that AIG faced an intensifying liquidity crisis, I offered to assist the company in any way I could, including by raising tens of billions of dollars in private capital. Unfortunately, I was not able to even arrange a meeting with the company to present my proposals.

As the AIG crisis reached its apex last month, the State of New York was prepared to permit AIG to use $20 billion of excess capital in its insurance subsidiaries, and I called on the federal government to extend a temporary and limited bridge loan to AIG. Those steps would have enabled AIG to address its temporary liquidity problem and would have preserved AIG as a going concern, while also preserving the ability of the private sector to help AIG to address its problems over the longer term.

Instead, AIG’s Board of Directors entered into an agreement with the Federal Reserve Bank of New York for a two-year, $85 billion credit facility. The deal includes the issuance of preferred stock that is intended to deliver ownership of 79.9 percent of AIG to the United States Treasury, and it is now clear that AIG and the Federal Reserve intend to do so without shareholder approval.

This is a bad deal for AIG’s tens of thousands of employees and millions of shareholders. First, the credit facility requires AIG to pay interest on undrawn capital. By requiring AIG to pay interest on money it does not borrow, the agreement encourages the company to draw down the full amount of the loan even if it does not need the capital. In order to service the principal and interest on this loan, AIG will have no choice but to engage in a fire-sale of profitable assets. Second, the equity component of the deal is not necessary. AIG has more than $1 trillion in assets, including key AIG assets that already act as security for the $85 billion loan facility. That security provides sufficient protection to American taxpayers. It was not necessary to wipe out virtually all of the shareholder value held by AIG’s millions of shareholders, including tens of thousands of employees and many more pensioners and other Americans on fixed incomes. Those millions of Americans could have fared better if AIG had filed for bankruptcy protection, since they would at least have had the chance of recouping value on their investments in AIG over the longer term. Bankruptcy would not have had to affect AIG’s sound operating companies because the bankruptcy could have been limited to the parent company and impaired subsidiaries.

Although AIG stockholders could have fared better if the company had filed for bankruptcy protection, other stakeholders – like AIG’s Wall Street counterparties in swaps and other transactions – would have fared worse. Those transactions would have been frozen in a bankruptcy rather than gradually unwound. Although that result could have posed systemic risk absent a broader federal bailout, it’s not clear that dismantling AIG was a better solution. Nor is it clear why, in designing a federal response to AIG’s short-term liquidity problem, some AIG stakeholders were prioritized over others. Questions have been posed, but answers have not yet been provided. I hope that we will hear some soon.

There is no doubt that AIG’s liquidity crisis required action, but the question is what kind of action. The role and functioning of the ratings agencies needs to be carefully re-examined, and earlier changes to mark-to-market accounting rules and short selling regulations now being amended would have mitigated AIG’s liquidity problems and, I believe, would have resulted in different outcomes. AIG would not have been nationalized and would not be in the process of substantial liquidation. Thousands of jobs would have been saved, and America’s premier global insurer would be intact.

It was not necessary to design a program that both wipes out millions of stockholders and effectively precludes private sector solutions to AIG’s manageable problems. As a general matter, public policy solutions should protect ordinary Americans and encourage private sector solutions to private sector problems. I will continue to work toward that goal, and I hope that Congress will too.