Too Big to Fail

by Andrew Ross Sorkin

  A third-generation son of Norwegian immigrants, Willumstad came from a working-class background, growing up in Bay Ridge, Brooklyn, and then on Long Island. By the mid-1980s, he was rising through the executive ranks of Chemical Bank. As a favor to a former boss, Robert Lipp, he flew down to Baltimore to see what Weill and his right-hand man, Dimon, were up to at Commercial Credit, a subprime lender they were running. The drive and entrepreneurial energy of the Weill-Dimon team was strikingly different from the stuffy bureaucracy of Chemical and every other firm he’d seen in the New York banking industry.

  The two offered Willumstad a job, which he accepted, though he couldn’t help but feel a bit of buyer’s remorse when, on his first day on the job, he met seventy-five Commercial Credit branch managers at a conference in Boca Raton and realized he had never seen so many middle-aged men in polyester leisure suits. Willumstad survived that shock—as well as the golf and the drinking—and eventually grew comfortable at the firm. In 1998 he helped lead a blitzkrieg of acquisitions that shocked the financial establishment: Primerica, Shearson, Travelers, and the biggest of all financial mergers, Citicorp. For a brief time the three of them had towered over a financial industry that had an abundance of towering figures; four years after Dimon departed Citi following a bitter falling-out with Weill, Willumstad assumed his old job of president, which proved to be as far as he would rise in the company.

  For a good half hour, Willumstad and Dimon discussed the pros and cons of the AIG position. As chairman of the company, Willumstad knew better than most how deep the company’s problems ran; solving them would be an unimaginably huge challenge. Its parlous state kept bringing him back to the same decision: “I should take the job on an interim basis,” he said firmly.

  Dimon shook his head. “Bullshit,” he said. “Either you want to do the job or you don’t.”

  “I know,” Willumstad conceded. “I know.”

  “You’re confusing the issues here,” Dimon insisted. “First of all, interim CEO is a very complex and difficult thing, and as an interim CEO, it will be exactly the same job as the permanent CEO. If I were the board, I wouldn’t allow it, and if it were me, I wouldn’t do it. It’s like cutting your own balls off.”

  “Zarb thinks it’s all or nothing, too,” Willumstad said, referring to Frank Zarb, AIG’s former chairman. “He doesn’t want to have three CEOs in three years with a fourth one coming in.”

  “You know, if you do things well, it’s still going to take you two years at a minimum,” Dimon said about the prospects of turning things around, leaning forward and punching the air to underscore his points. “The question is, do you want to get back in the saddle or not? If you are going back in the saddle, remember how hard the saddle is.”

  Willumstad nodded in agreement. But he had one other concern. “I don’t like both the public appearance of it and that it looks like I’m going to throw Martin out and put myself in,” he said, but Dimon assured him that that was not a serious issue.

  The board wanted Willumstad to take the job; his wife, Carol, thought he should—she had always believed that he had been robbed of the CEO job at Citi—and now Dimon was adding his vote.

  The next day Willumstad took a black Town Car to AIG’s offices at 70 Pine Street. Upon taking a seat in Martin Sullivan’s office, he delivered his message without any equivocation: “Listen, Martin, the board is going to meet on Sunday, and whether or not you continue in this job is the topic of discussion.”

  Sullivan merely sighed and said, “The board doesn’t fully appreciate how difficult this market is. When I took over, I had to clean up the mess with our regulators, and I can lead us out of these troubles.”

  “Yes, Martin,” Willumstad acknowledged, “but you have to look at what has happened over the last few months. The feeling among directors is that someone has to be accountable…. Look, there are three possible outcomes of the board meeting. I could be coming back to you and saying that the board fully supports you, or the board thinks you should go. The other possibility is that the board says, ‘You have to do the following things in an X period of time or else you’re out.’”

  Sullivan looked down at the floor. “And what do you think the likely outcome will be?”

  “There’s a strong sentiment to make a change, but who knows?” Willumstad replied with a shrug. “You put twelve people in a room, and anything could happen.”

  On Sunday, June 15, the board of AIG met in the office of Richard Beattie, the chairman of the board’s outside law firm, Simpson Thacher & Bartlett. Sullivan was on the agenda, but he had chosen not to attend. After a brief discussion, the board decided to remove Sullivan and install Willumstad in his place.

  The company over which Willumstad had now been assigned stewardship was one of the most peculiar success stories in American business. American International Group began as American Asiatic Underwriters in a small office in Shanghai in 1919. Nearly half a century later, it had operations throughout Asia, Europe, the Middle East, and the Americas, but with its modest market value of $300 million and about $1 billion worth of insurance policies, the privately owned firm was hardly a juggernaut.

  By 2008, however, the word “modest” was seldom used in connection with AIG. In only a few decades it had grown into one of the world’s largest financial companies, with a market value of just under $80 billion (even after a steep slide in its share price earlier that year) and more than $1 trillion worth of assets on its books. That phenomenal expansion was primarily the result of the cunning and drive of one man: Maurice Raymond Greenberg, known to friends as “Hank,” after the Detroit Tigers slugger Hank Greenberg, and referred to within the company simply as “MRG.”

  Greenberg had had a hardscrabble upbringing worthy of a Dickens hero. His father, Jacob Greenberg, who drove a cab and owned a candy store on the Lowest East Side of Manhattan, died during the Great Depression when Hank was only seven years old. After his mother married her second husband, a dairy farmer, the family moved to upstate New York, where Hank would wake before dawn most mornings to help milk the cows. When he was seventeen, he faked his birth date to join the army. Two years later, Greenberg was among the troops who landed on Omaha Beach on D-day. He was in the unit that liberated the Dachau concentration camp and, after returning to the United States for law school, he returned to the military to fight in the Korean War, in which he was awarded the Bronze Star.

  Returning to New York after Korea, Greenberg talked his way into a job as $75-a-week insurance underwriting trainee with Continental Casualty, where he quickly rose to become the firm’s assistant vice president in charge of accident and health insurance. In 1960, Cornelius Vander Starr, the founder of what would become AIG, recruited Greenberg to join his company.

  A onetime soda-fountain operator in Fort Bragg, California, C. V. Starr was one of the prototypical restless Americans of the early twentieth century, the kind who made their names as wildcatters, inventors, and entrepreneurs. After trying his hand at real estate, he entered the insurance business and at the age of twenty-seven sailed to Shanghai to sell policies. There he discovered a market that was dominated by British insurance companies, but they sold only to Western firms and expatriates; Starr built his business selling policies to the Chinese themselves. Forced out of China after the communist takeover in 1948, Starr expanded elsewhere in Asia. With the help of a friend in the military by the name of General Douglas MacArthur, commander of the occupying force in Japan after the war, Starr secured a deal to provide insurance to the American military for several years. Before the country opened up its insurance market to foreign underwriters, AIG Japan would become the company’s largest overseas property-casualty business.

  By 1968, Starr was seventy-six and ailing, and with an oxygen tank and vials of pills never far from his side, he turned to Greenberg to crack the American market, naming him president and Gordon B. Tweedy chairman. Greenberg wasted no time in making it clear who was going to be taking the lead. At a meeting soon after his
appointment, he and Tweedy were on opposite sides of an argument when Tweedy stood up and began loudly pressing his point. “Sit down, Gordon, and shut up,” Greenberg told him. “I’m in charge now.” Starr, whose bronze bust still greets visitors to AIG’s art deco headquarters, died that December. The following year, AIG went public, and Greenberg became CEO. (Tweedy left soon afterward.)

  Under Greenberg, AIG grew rapidly and became increasingly profitable through expansion and acquisitions, doing business in 130 countries and diversifying into aircraft leasing and life insurance. Greenberg himself became the very model of an imperial CEO—adored by shareholders, feared by employees, and a cipher to everyone outside the company. Despite his slight build, he had an intimidating presence. He drove himself relentlessly, eating nothing but fish and steamed vegetables every day for lunch, and regularly working out on a StairMaster or playing tennis. He showed little affection for anyone, with the exception of his wife, Corinne, and his Maltese, Snowball. Within AIG he was famous for his short fuse and his ceaseless drive to know everything that was happening inside the company—his company. He was rumored to have hired former CIA agents, and security men seemed to be posted everywhere at headquarters.

  To the outside world the biggest AIG drama was Greenberg’s attempt to secure a dynasty; what he created, instead, was a blood feud among insurance royalty.

  Jeffrey Greenberg, his son, a graduate of Brown and Georgetown Law, had been groomed to succeed Hank. But in 1995, after a series of clashes with his father, Jeffrey left AIG, where he had worked for seventeen years. Two weeks earlier, his younger brother, Evan, had been promoted to executive vice president, his third promotion in less than sixteen months, establishing him as a rival to Jeffrey. With the departure of his brother, Evan, a former hippie who for many years had shown no interest in following his father into the business, was clearly the heir apparent. Yet Evan soon ran afoul of a patriarch who could not surrender any power, and like Jeffrey before him, bolted the company. Jeffrey would go on to become chief executive of Marsh & McLennan, the biggest insurance broker in the world, while Evan became CEO of Ace Ltd., one of the world’s largest reinsurers.

  Ultimately it was clashes with regulators, not family members, that led to the downfall of Hank Greenberg. Headstrong and combative as ever, Greenberg simply picked the wrong time to take a stand against the feds. After the collapse of Enron and a procession of corporate scandals that dominated the front pages at the start of the new century, regulators and prosecutors became emboldened to come down hard on companies that were proving to be uncooperative. In 2003, AIG agreed to pay $10 million to settle a lawsuit brought by the Securities and Exchange Commission that accused the company of helping an Indiana cell phone distributor hide $11.9 million in losses. The settlement figure was relatively high, as the SEC acknowledged at the time, because AIG had attempted to withhold key documents and initially gave investigators an explanation that was later contradicted by those documents.

  The following year, after yet another long tussle with federal investigators, AIG agreed to pay $126 million to settle criminal and civil charges that it had allowed PNC Financial Services to shift $762 million in bad loans off its books. As part of that settlement, a unit of AIG was placed under a deferred prosecution agreement, meaning that the Justice Department would drop the criminal charges after thirteen months if the company abided by the terms of the settlement. (After the indictment of the giant accounting firm Arthur Andersen had led to its collapse, the government preferred the softer cudgel of deferred prosecution agreements as a kind of probation—an approach that had previously been more common in narcotics cases.)

  It was the AIG unit that had been placed on probation for thirteen months—AIG Financial Products Corp., or FP for short—that became Ground Zero for the financial shenanigans that would nearly destroy the company.

  FP had been created in 1987, the product of a remarkable deal between Greenberg and Howard Sosin, a finance scholar from Bell Labs who became known as the “Dr. Strangelove of Derivatives.” A great deal of money can be made from derivatives, which are, in simplest terms, financial instruments that are based on some underlying asset, such as residential mortgages, to weather conditions. Like the bomb that ended the film Dr. Strangelove, derivatives could, and did, blow up; Warren Buffett called them weapons of mass destruction.

  Sosin had been at Drexel Burnham Lambert, Michael Milken’s ill-fated junk bond operation, but left before that Beverly Hills–based powerhouse folded amid an epoch-defining scandal that drove it into bankruptcy in 1990. Seeking a partner with deeper pockets and a higher credit rating, Sosin fled to AIG in 1987 with a team of thirteen Drexel employees, including a thirty-two-year-old named Joseph Cassano.

  Working from a windowless room on Third Avenue in Manhattan, Sosin’s small, highly leveraged unit operated almost like a hedge fund. The early days at the firm were awkward: The wrong rental furniture arrived at the office, and employees had to make do for a while sitting on children’s chairs and working on tiny tables—generating almost immediately, nevertheless, the same immensely profitable returns as they had at Drexel. As was the practice with some hedge funds, the traders got to keep some 38 percent of the profits, with the parent company getting the rest.

  The key to the success of the business was AIG’s triple-A credit rating from Standard & Poor’s. With it the fund’s cost of capital was significantly lower than that of just about any other firm, enabling it to take more risk at a lower cost. Greenberg had always recognized how valuable the triple-A rating had been to him and guarded it carefully. “You guys up at FP ever do anything to my Triple-A rating, and I’m coming after you with a pitchfork,” he warned them.

  But Sosin chafed under the short management leash that had been placed on the unit and in 1994 left along with the other founders after a falling out with Greenberg.

  (Long before Sosin’s departure, however, Greenberg, infatuated with the profit machine that FP had become, had formed a “shadow group” to study Sosin’s business model in case he ever decided to leave. Greenberg had PricewaterhouseCoopers build a covert computer system to track Sosin’s trades, so they could later be reverse engineered.) After much persuasion from Greenberg, Cassano agreed to stay on and was promoted to chief operating officer.

  A Brooklyn native and the son of a police officer, Cassano was known for his organizational skills, not his acumen in finance, unlike most of the talent Sosin had brought with him—“quants,” quantitative analysts, with PhDs who created the complex trading programs that defined the unit.

  In late 1997, the so-called Asian flu became a pandemic, and after Thailand’s currency crashed, setting off a financial chain reaction, Cassano began looking for some safe-haven investments. It was during that search that he met with some bankers from JP Morgan who were pitching a new kind of credit derivative product called the broad index secured trust offering—an unwieldy name—that was known by its more felicitous acronym, BISTRO. With banks and the rest of the world economy taking hits in the Asian financial crisis, JP Morgan was looking for a way to reduce its risk from bad loans.

  With BISTROs, a bank took a basket of hundreds of corporate loans on its books, calculated the risk of the loans defaulting, and then tried to minimize its exposure by creating a special-purpose vehicle and selling slices of it to investors. It was a seamless, if ominous, strategy. These bond-like investments were called insurance: JP Morgan was protected from the risk of the loans going bad, and investors were paid premiums for taking on the risk.

  Ultimately, Cassano passed on buying BISTROs from JP Morgan, but he was intrigued enough that he ordered his own quants to dissect it. Building computer models based on years of historical data on corporate bonds, they concluded that this new device—a credit default swap—seemed foolproof. The odds of a wave of defaults occurring simultaneously were remote, short of another Great Depression. So, absent a catastrophe of that magnitude, the holders of the swap could expect to receive millions of do
llars in premiums a year. It was like free money.

  Cassano, who became head of the unit in 2001, pushed AIG into the business of writing credit default swaps. By early 2005, it was such a big player in the area that even Cassano had begun to wonder how it had happened so quickly. “How could we possibly be doing so many deals?” he asked his top marketing executive, Alan Frost, during a conference call with the unit’s office in Wilton, Connecticut.

  “Dealers know we can close and close quickly,” Frost answered. “That’s why we’re the go-to.”

  Even as the bubble was inflating, Cassano and others at AIG expressed little concern. When in August of 2007 credit markets began seizing up, Cassano was telling investors, “It is hard for us, without being flippant, to even see a scenario within any kind of realm of reason that would see us losing $1 in any of those transactions.” His boss, Martin Sullivan, concurred. “That’s why I am sleeping a little bit easier at night.”

  The pyramidlike structure of a collateralized debt obligation is a beautiful thing—if you are fascinated by the intricacies of financial engineering. A banker creates a CDO by assembling pieces of debt according to their credit ratings and their yields. The mistake made by AIG and others who were lured by them was believing that the ones with the higher credit ratings were such a sure bet that the companies did not bother to set aside much capital against them in the unlikely event that the CDO would generate losses.

  Buoyed by their earnings, AIG executives stubbornly clung to the belief that their firm was invulnerable. They thought they’d dodged a bullet when, toward the end of 2005, they stopped underwriting insurance on CDOs that had pieces tied to subprime mortgage-backed securities. That decision enabled them to avoid the most toxic CDOs, issued over the following two years. The biggest reason, though, for the confidence within the firm was the unusual nature of AIG itself. It was not an investment bank at the mercy of the short-term financing market. It had very little debt and some $40 billion in cash on hand. With a balance sheet of more than $1 trillion, it was simply too big to fail.