It's a serious matter to say a company is lying on its financial statements. But AIG told big lies in August 2007. (More on that later.) So big that I met with Jamie Dimon, Chairman and CEO of JPMorgan Chase, and called Warren Buffet, famed investor and Chairman and CEO of Berkshire Hathaway.
If you hold meetings and make calls like that, you better be very sure there is big trouble. I was sure. AIG didn't admit its problems when there was still time to avoid disaster. Instead, it pushed back on the truth. In September 2008, it needed a government bailout.
Capitalism Doesn't Reward Failure, But Crony Capitalism Does
AIG was in serious financial trouble, and its employees didn't deserve bonuses for 2007, much less 2008. That's how capitalism works when a company is in trouble. Capitalism doesn't reward failure.
U.S. taxpayers bailed out AIG and its counterparties (who didn't deserve bonuses, either). Employees earned huge partial bonuses anyway, and no one went to jail. Now, five years later, AIG's new CEO, Robert Benmosche, is acting like a big smug guy who got away with something, because AIG did.
Benmosche didn't like that the government criticized AIG for paying lavish "partial" bonuses to hundreds of employees. He said only 10 employees were behind the bad trades. But that's how capitalism works. If your problems are so severe that it damages the entire company, employees don't get paid. Ill-managed companies in deep financial trouble aren't supposed to pay lavish compensation.
"Everybody was in an uproar with "their hangman nooses... sort of like what we did in the Deep South... and I think it was just as bad and just as wrong."
I believe it was wrong for AIG to fudge its accounting, require a taxpayer bailout of $140 billion [$182.3 billion counting all credit lines], pay huge compensation anyway, avoid prosecution, and then have the new CEO whine about it like a cowardly bully.
Representative Elijah Cummings Provides Perspective
Rep. Elijah Cummings (D-Maryland) sits on the House Oversight and Government Reform Committee. He had an appropriate reaction to Benmosche's words:
As the leading critic of AIG's lavish spending before and after its taxpayer-funded bailout -- and as the son of sharecroppers who actually experienced lynchings in their communities -- I find it unbelievably appalling that Mr. Benmosche equates the violent repression of the African-American people with congressional efforts to prevent the waste of taxpayer dollars.
Benmosche now says: "It was a poor choice of words. I never meant to offend anyone by it."
That was after Cummings said Robert Benmosche should resign, opining he has a "fundamental inability to lead" AIG.
Well, Benmosche certainly has a strange attitude after what happened with AIG. His complaints strike me as unmanly.
Cummings isn't just up against AIG's attitude; he works in Washington where his colleagues have been happy to protect AIG and its powerful banking cronies. Senator Dick Durbin (D-Il) observed:
"The banks -- hard to believe in a time when we're facing a banking crisis that many of the banks created -- are still the most powerful lobby on Capitol Hill. And they frankly own the place."
I applaud Congressman Cummings for speaking his mind. It is not risk free. After a senior banking executive read my remarks in the Wall Street Journal in August 2007, he said:
"AIG can crush you like a bug. You'd do well to remember that."
I Was Offended by AIG's Numbers (Not Its Compensation, But Now that You Mention It...)
On August 13, 2007, more than a year before the AIG meltdown, I publicly challenged AIG's phony accounting for credit default swaps linked to over $19 billion in "super senior" exposure to subprime and other dodgy loans.
These were meant to be super safe, but any competent CDO specialist should have been able to perform the same analysis I did. Instead of super safe, AIG had several billion dollars' worth of principal risk due to exposure to mezzanine tranches backed by a significant percentage of poorly underwritten loans, and losses were eating through all of the so-called protection. Yet, despite market prices already eroding on the underlying collateral, AIG took no accounting losses at all.
That was far from AIG's only problem. From "AIG Seeks Small Subprime Risk; Others See More," by David Reilly, Wall Street Journal Page C1, August 13, 2007):
Yet the company's valuation models seem to ignore the fact that those derivatives would likely take a haircut if sold in today's depressed market. 'There's no way these aren't showing a loss,' says Janet Tavakoli, president of Tavakoli Structured Finance Inc., a Chicago research firm. 'That's simply a market reality, she adds, that should be showing up in AIG's results.'
AIG called me with a standard charm offensive after my comments appeared in the WSJ.
By February 2008, AIG was cited for "material weakness" in its accounting. [Note: This date was corrected from February 2011 to February 2008. Six months after I challenged AIG"s accounting, and prior to the September 2008 crisis, it was cited for material weakness. Per AIG, its last material weakness was re mediated in the fourth quarter of 2008.] Yet none of AIG's officers were held accountable for Sarbanes-Oxley violations after making materially misleading public statements and signing off on false SEC filings.
On August 13, 2007, also more than a year before the AIG bailout, I appeared with Eugene Ludwig of Promontory Capital, Steve Forbes, CEO of Forbes, and CNBC's Carl Quantanilla to discuss AIG's failure to record accounting losses, hedge funds, and liquidity and insolvency issues. You may be able to view the video if you have access to CNBC Pro. Mary Shapiro, former head of the SEC, entered the revolving door and now works for Promontory. Eugene Ludwig stated the following in response to the ECB's assertion that credit markets were stabilizing after cash injections.
"I think the Central Banks around the world have the tools to be able to contain this credit correction, and it's clear they're prepared to use them. And what we've seen right now is they've used those tools and it's calming the marketplace." Incredibly, Ludwig claimed banks were "less directly involved in the subprime correction" and were "well-regulated" and "disciplined."
How did that work out for the banks, including Citigroup, Bank of America, and JPMorgan Chase in September 2008? Not only was the above statement not true, banks were subject to their unwise interconnections with hedge funds and insurers as well as their own contributions to systemic risk.
I said the following about AIG:
"AIG must believe in miracles, because if they think that we're going to believe their credit default swap mark-to-markets on their super seniors, when they have CDO-squared risk, and their portfolios are populated with BBB [rated] tranches backed by subprime paper to the tune of 29%..."
Carl Quantanilla interrupted: "whistling past the graveyard."
Who did the bailout most benefit?
As the TARP report later revealed, Goldman Sachs would have been in trouble in September 2008, and it was the chief beneficiary of the AIG bailout. The bailout was an unjustified windfall for counterparties that were the chief architects of AIG's distress. Instead of buying AIG's CDOs at 100 cents on the dollar, each deal should have had a thorough fraud audit and not only should further billions not have been paid, billions already paid out should have been clawed back. Instead of potential indictments, the Fed rewarded this behavior with unconditional bailouts.
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