Posted on 11 Jan 2010
The following article was written by Wall Street Journal writer, Holman Jenkins, Jr., after his weekend interview with American International Group's (AIG) former CEO Hank Greenberg.
Goldman Sachs has a new enemy—as if it needed another one.
Hank Greenberg, as we sit in his Park Avenue office, is telling me how to do my job, saying reporters need to get to the bottom of the events that preceded and followed the government bailout of AIG, the insurance company he built into a global giant.
In particular, they need to get to the bottom of the part played by the investment bank of Goldman Sachs. He waves a sheaf of press reports from the New York Times, Washington Post and McClatchy papers about the firm's doings before and during the subprime meltdown. "We're dealing with a jigsaw puzzle where all the pieces are not in the box. Bit by bit, we're getting the pieces. The pieces are failing into place and the picture on the face of the puzzle is not a pretty picture."
Let me get this straight. Is Mr. Greenberg saying the machinations of Goldman Sachs were responsible for the disastrous failure of AIG amid the recent financial crisis? "Well, it certainly wouldn't be difficult to come to that conclusion."
Until a few years ago, Mr. Greenberg was enjoying a stellar career as an insurance CEO, but not a melodramatic one. That all changed in 2005 when he became one of several business titans turned into unwilling stepping stones for the advancement of an ambitious New York attorney general named Eliot Spitzer.
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.
AIG was on the rack, its business about to be destroyed if Mr. Spitzer criminally indicted the firm. So the board jettisoned its long-serving chief to appease the crusading attorney general. Mr. Greenberg, at age 80, settled in for what he must have known would be a long siege of lawsuits and regulatory investigations to occupy his declining years. He couldn't have anticipated, though, that the drama of his non-retirement was only just beginning and would lead to a fight in which something even bigger than his reputation would be at stake—the very survival of the firm he'd built and been ousted from.
That's exactly what came to pass. 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.
Suddenly, AIG was bleeding vast amounts of cash at a time when a spooked market was increasingly unwilling to lend to the firm. Finally, Washington stepped in to prevent AIG's bankruptcy, fearing the alternative was an economic meltdown.
How did it all come apart so quickly? 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."
The next piece fell into place, he says, with recent reports in the press about how, at the top of the housing bubble, "a couple of people there [at Goldman Sachs], bright guys, decide the housing market is going to collapse." Goldman went to work creating new subprime housing-backed derivatives , Mr. Greenberg says, and "began marketing the hell out of them and at the same time shorting them" (or betting they would fall in value).
Bingo. 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."
In short, it added up to a perfect trap for AIG. As panic spread through the financial sector, impossible amounts of cash were required of the firm under insurance contracts that had years to run and (as Mr. Greenberg argues and events seem to be showing) would likely end up performing adequately in the long run.
But this is just half the puzzle, he says. 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?
Most of all, he cannot fathom why Treasury and the Federal Reserve let billions of dollars in taxpayer cash fly out the backdoor to Goldman and other firms. 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.
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."
From his present perch, he sees only three ways the AIG mystery will ever be plumbed. "Either investigative journalists continue to add the missing pieces of the puzzle," he says. "Or, two, members of Congress call for an investigation and put people under oath. Or, three, if these two things fail, aren't there likely to be class-action suits that put people under oath in depositions and discovery?"
Mr. Greenberg recognizes he's playing a dangerous game here, since his goal ultimately is to coax Washington into softening the terms of the AIG bailout.
For one thing, the obvious party to lead a class-action shareholder lawsuit is none other than Mr. Greenberg himself, in his status as chief of Starr International, a company that for decades has been the largest single holder of AIG shares (and a whole other story in itself). Indeed, he acknowledges that he and other large shareholders have batted around the idea of a lawsuit. Fellow investors wanted him to take the lead, but he demurred, saying his other AIG-related litigation at the time and his Spitzer victimization had made him too much of a lightning rod. His fellow investors, however, were no keener on serving as lead plaintiff, fearing to antagonize the government and not wishing a distraction from their main business of portfolio management.
For the time being, then, a lawsuit challenging the AIG takeover is not in the cards, but Mr. Greenberg hasn't given up on political suasion. His goal is a major revision of the terms of the bailout to put private capital back in charge—a goal he quite evidently believes can be advanced by airing the secret history behind the AIG debacle.
"There's too much smoke, too many smart people asking questions that deserve an answer. I would hope that investigative reporters do the job they love to do and bring out the truth. I would hope that Congress would then say we must do something about this in all fairness. The American people should know about this and then bring about the changes necessary to avoid the total destruction of a great company that was the pride of America in the insurance industry."
To that end, he has drawn up (with the help of investment banker Joseph Perella) a plan that's now in the hands of Treasury and the Fed. He wants the government's $112 billion loan stretched out to, say, 20 years and the interest rate slashed to something closer to the government's own cost of borrowing.
He also wants Washington unilaterally to dial back its 79.9% stake in the firm. Taxpayers would be better off, he says, effectively returning a big chunk of the government's stake to AIG's existing shareholders. Majority government ownership only serves to scare off the private capital that could revive the firm as a taxpaying and job-creating corporate citizen. "In fact, if the government owned 15% or 20%," he says, "that would probably be worth more in the marketplace than the 79.9%."
Finally, he wants reform of Maiden Lane II and III, the Federal Reserve vehicles that relieved AIG of some of its subprime exposure and have been reaping the lion's share of the gains (75%, compared to 25% for AIG) as the securities rebound in value now that the economy is mending and the crisis has passed.
Of course, any softening or forgiveness of the AIG "rescue" terms would be politically fraught at this point. But if Mr. Greenberg is right, attitudes may evolve in the months ahead given public receptivity to a new storyline that AIG was a victim of Goldman sharpies. Hence another of his proposals—to have Goldman and other counterparties who seemingly profited from AIG's troubles return some of their taxpayer-subsidized winnings in the form of low-interest loans to help the insurer back on its feet.
Mr. Greenberg has been to the White House three times since Barack Obama became president, and not on social calls. But the discussions revolved around North Korea and foreign relations, issues of interest in his role as a leader of the organization Business Executives for National Security. On AIG, however, he keeps plugging away. "I don't give up easily. What was done, in my view, was done, as Paulson said, to liquidate the company. I think that was wrong. And I think it's important to fight against things that are wrong. A lot of people at AIG lost their life savings. They spent year after year building the greatest insurance company in history and we owe it to them to fight to help make the company great again and get back some of the value that was lost."
Mr. Greenberg has already got his reputation back. Mr. Spitzer was forced to leave office under shameful circumstances, and his supposedly open-and-shut case against Mr. Greenberg vanished. An SEC complaint was settled without Mr. Greenberg admitting guilt (and in fact denying it vehemently). A jury handed him a victory in a recent trial in which AIG claimed he and Starr International had improperly come by Starr's large holding in AIG stock.
But he's got at least one more battle to fight. As he points out with unimpeachable accuracy, politicians in Washington may hope the AIG situation will somehow take care of itself, but it won't. Sooner or later, the government will either have to give the firm its life back or pull the plug.