Too Big to Fail

by Andrew Ross Sorkin

  Speaking to investors at the Metropolitan Club in Manhattan in December 2007, Sullivan boasted that AIG was one of the five largest businesses in the world. His company, he stressed, “does not rely on asset-backed commercial paper or the securitization markets responding, and importantly, we have the ability to hold devalued investments to recovery. That’s very important.”

  He did acknowledge that AIG had a large exposure to underwriting a certain financial product whose future even then seemed dubious: tranches of credit derivatives known as super-seniors. “But because this business is carefully underwritten and structured with very high attachment points to the multiples of expected losses, we believe the probability that it will sustain an economic loss is close to zero.”

  By that point in time, however, how AIG saw itself and how everyone had come to view it were rapidly diverging. The clients who bought super-seniors insured by AIG might still be making their payments, but on paper they saw their values falling. Market confidence in CDOs had collapsed; the credit-ratings agencies were lowering their rankings on tens of billions of dollars worth of CDOs, even those that had triple-A ratings.

  In 2007 one of its biggest clients, Goldman Sachs, demanded that AIG put up billions of dollars more in collateral as required under its swaps contracts. AIG disclosed the existence of the collateral dispute in November. At the December conference, Charles Gates, a longtime insurance analyst for Credit Suisse, asked pointedly what it meant that “your assessment of certain super-senior credit default swaps and the related collateral…differs significantly from your counterparties.”

  “It means the market’s a little screwed up,” Cassano said, playing on his Brooklyn roots. “How are you, Charlie? Seriously, that is what it means. The market is—and I don’t mean to make light of this—actually just so everybody is aware—the section that Charlie was reading from was a section that dealt with collateral call disputes that we have had with other counterparts in this transaction. It goes to some of the things that James [Bridgwater, who did the modeling at AIG Financial Partners] and I talked about, about the opacity in this market and the inability to see what valuations are.”

  The dispute with Goldman had become an irritant to Cassano. Another counterparty, Merrill Lynch, had also been seeking more collateral but wasn’t being as aggressive about it as Goldman. Cassano seemed almost proud of his ability to get these firms to back off. “We have, from time to time, gotten collateral calls from people,” he said on December 5, 2007. “Then we say to them: ‘Well, we don’t agree with your numbers.’ And they go, ‘Oh.’ And they go away.”

  At a board meeting that fall, Cassano bristled when questioned about the Goldman collateral issue. “Everyone thinks Goldman is so fucking smart,” he railed. “Just because Goldman says this is the right valuation, you shouldn’t assume it’s correct just because Goldman said it. My brother works at Goldman, and he’s an idiot!”

  Even before Willumstad had been given the position of CEO, he had been consumed by FP. Problems at the unit had been simmering at AIG since Greenberg had been forced to resign in 2005 as the result of another major accounting scandal. New York attorney general Eliot Spitzer had even threatened to bring criminal charges against him after launching an investigation into a transaction between AIG and a subsidiary of General Re, an insurer owned by Warren Buffett, that inflated AIG’s cash reserves by $500 million.

  In late January of 2008, Willumstad had been sitting in his corner office at Brysam Global Partners when he noticed something startling in a monthly report issued to AIG board members: The FP group had insured more than $500 billion in subprime mortgages, mostly for European banks. That piece of business was actually a very clever bit of financial engineering on FP’s part. To meet regulatory requirements, banks could not exceed a certain level of debt, relative to their capital. The beauty of AIG’s insurance—for a short time, at least—was that it enabled banks to step up their leverage without raising new money because they had insurance.

  Willumstad did the math and was appalled: With mortgage defaults rapidly mounting, AIG could soon be forced to pay out astronomical sums of money.

  He immediately contacted PricewaterhouseCoopers, AIG’s outside auditor, and ordered them to come to his office for a secret meeting the following day to review exactly what was happening at the troubled unit. No one bothered to tell Sullivan, who was still CEO, about the gathering.

  By early February, the auditor instructed AIG to revalue every last one of its credit default swaps in light of recent market setbacks. Days later the company embarrassingly disclosed that it had found a “material weakness”—a rather innocuous euphemism for a host of problems—in its accounting methods. At the same time, a humiliated AIG had to revise its estimate of losses in November and December, an adjustment that raised the figure from $1 billion to more than $5 billion.

  Willumstad was vacationing at his ski house in Vail, Colorado, when he finally called Martin Sullivan to deliver the order to fire Joe Cassano.

  “You have to take some action on him,” Willumstad said.

  A startled Sullivan responded that, even if the firm had to restate its earnings, it wasn’t anything to worry about: They were only paper losses. “Well, you know, we’re not going to lose any money,” he said calmly.

  It was now Willumstad’s turn to be taken aback “That’s not the issue,” he said “We’re about to report a multibillion-dollar loss, a material weakness! You have the auditors saying that Cassano has not been as open and forthcoming as he could be.”

  Sullivan acknowledged the controversy surrounding Cassano, but was it really necessary that he be fired?

  “Two very high-profile CEOs have just been fired for less,” Willumstad reminded him. Charles Prince of Citigroup and Stan O’Neal of Merrill Lynch had both been ousted in the fall of 2007 after overseeing comparably large write-downs. “You can’t not take some action both publicly as well as to send a message to the rest of the organization.”

  Finally, Sullivan relented but made one last pitch for Cassano. “We should keep him on as a consultant,” Sullivan recommended.

  “Why?” Willumstad asked, as perturbed as he was baffled by the suggestion.

  Sullivan maintained that FP was a complicated business and that he didn’t have the resources to manage it without some help, at least initially.

  In exasperation Willumstad said, “Take a step back. Just think about it for a minute, both from an internal as well as an external point of view. The guy’s not good enough to run the company, but you’re saying you’re going to need to keep him around?”

  Sullivan then appealed to Willumstad’s sense of competitiveness. If the firm kept Cassano on the payroll, he’d wouldn’t be able to jump to a rival firm—which, leaving aside his questionable business schemes, might still be valuable to the company. “If I keep him on a consulting contract, he’ll have a noncompete and he won’t go someplace else and steal all our people.”

  On that issue Willumstad finally relented. He was a pragmatist, and consultants were easily gotten rid of.

  “Okay,” he agreed, “but you have to figure out how to manage that if you want to keep consulting with him. And you can’t let him stay actively engaged in the business. That’s just insanity.”

  Cassano did remain on a consulting contract, at the rate of $1 million a month, but Sullivan and others continued to worry about the defection of their staff. With Cassano shunted aside and the FP group already reporting a $5 billion loss, there was constant speculation that FP’s top producers would quickly depart. William Dooley, who replaced Cassano, went to Sullivan with a request: “We need to put together a retention program or we’re going to lose the team.”

  Sullivan appreciated the scope of the problem. Because AIG’s employees were paid a percent of profits—and the firm had just recorded such a huge loss—“the likelihood of these guys getting paid out anything is zero going forward,” as he told the compensation committee. “It’s not like it’s a
bad quarter; they can’t make it back next quarter or next year.” For most FP employees it would make more sense to start over elsewhere than to stay in place, he told the board. (In a way, ironically enough, FP’s compensation package better aligned the interests of the employees with shareholders than most traders on Wall Street, who were paid based on the performance of their own book rather than on the profits of the entire firm.)

  In early March, AIG’s board, after requiring Sullivan to redraft the proposed retention program more than once, approved a plan that would pay out $165 million in 2009 and $235 million in 2010. At the time, it hardly seemed like a decision that anyone outside AIG would care about—let alone give rise to the political nightmare that would result in censure, death threats, and a mad scramble on Capitol Hill to undo the bonuses.

  In May, AIG reported dismal results for the first quarter, a $9.1 billion write-down on credit derivatives and a $7.8 billion loss—its largest ever. Standard & Poor’s responded by cutting its rating on the company by one notch, to AA minus. Four days later, on May 12, the Wall Street Journal reported that management at one of AIG’s most profitable units, the aircraft-leasing business International Lease Finance Corp., was pushing for a split from the parent company through either a sale or a spin-off.

  Hank Greenberg, meanwhile, who had just turned eighty-three years old, was urging AIG to postpone its annual meeting, pointing to the poor quarterly performance and the effort to raise $7.5 billion in capital. “I am as concerned as millions of other investors as I watch the deterioration of a great company,” Greenberg wrote in a letter made public. “The company is in crisis.”

  In private, other large AIG shareholders had also begun campaigning for changes. Two days before the annual meeting on May 14, 2008, a fax arrived at Willumstad’s office at Brysam—a letter from Eli Broad, a former AIG director who had sold his giant annuities business, SunAmerica, to AIG in 1998 for $18 billion in stock, and a close business associate of Greenberg’s. Joining Broad in the missive were two influential fund managers, Bill Miller of Legg Mason Capital Management and Shelby Davis of Davis Selected Advisers. The group, which controlled roughly 4 percent of AIG’s shares, wanted a meeting to discuss “steps that can be taken to improve senior management and restore credibility.”

  On the following evening, Willumstad and another AIG director, Morris Off it, went to Broad’s apartment at the Sherry-Netherland hotel on Fifth Avenue to meet with the three investors. Joining them was Chris Davis, Shelby’s son, a portfolio manager at his firm. Sitting in his expansive living room, with dramatic views of Central Park and the city skyline, Broad quickly launched into a list of complaints about Sullivan and the company’s performance.

  After hearing him out briefly, Willumstad interrupted him. “Listen, before you go too far, I just have to be very clear. We are in the middle of raising capital, so I cannot disclose to you anything we haven’t told everyone else. We’re happy to listen and to try to answer any questions.” From then on the evening was awkward and uncomfortable for all parties involved, as Willumstad and Off it could say little more than that the board understood their concerns. “You’re not telling us anything we don’t know,” he acknowledged.

  Even in the face of mounting shareholder pressure to have him removed, Sullivan appeared to be in good spirits before the annual meeting that morning. He worked the conference room on the eighth floor of the AIG tower, shaking hands and greeting shareholders. He chatted amiably with one investor about a 2–0 win by soccer’s Manchester United over Wigan Athletic the previous Sunday, which enabled the team to nip Chelsea for the league championship on the last day of the season. The victory was a feather in Sullivan’s and AIG’s caps: The company had paid Manchester United $100 million to have its logo on the players’ shirts for four seasons. Apart from that, there was little else to mollify disgruntled shareholders. The headline in the Wall Street Journal the next day observed trenchantly: “AIG Offers Empathy, Little Else.”

  Despite Willumstad and Off it’s assurances about the company’s efforts to increase its liquidity, the decision to try to raise new capital only led to further clashes. JP Morgan and Citigroup were spearheading the push for AIG to take additional write-downs and to disclose them. By this time, AIG had been hit by calls for an additional $10 billion in new collateral on the swaps it had sold to Goldman and others. The JP Morgan bankers knew what was being said on Wall Street and they knew how considerably others’ valuations disagreed with AIG’s own. To the bankers, the finance executives at AIG were amateurs. Not a single one impressed them—not Sullivan, not Steven J. Bensinger, the firm’s CFO.

  The contempt was mutual; AIG executives were dismayed by the arrogance of the JP Morgan team. They and the bankers at Citi had been entrusted with one of the biggest capital-raising efforts ever and were being paid handsomely for their services: more than $80 million for each bank. Their high-handedness in piously informing AIG how its assets should be valued achieved little but to provoke the insurers to dig in their heels.

  JP Morgan persisted in asking AIG for a disclosure. On a Sunday afternoon conference call about the capital effort, Sullivan himself came on the line, sounding less cheerful than usual. “Look, we are going to put our pencils down right now. I think either you need to get on board with us or we will have to move on without you.”

  The JP Morgan bankers hung up and discussed their options. Steve Black, who had dialed in from South Carolina, was deputized to call Sullivan back. “Okay, you want us to put our pencils down. We will. But then we are not going to participate in the capital raise, and when people ask us why we’re dropping out, we will have to tell them that we had a disagreement, that there are different views on the potential losses on some of your assets.”

  In the face of that threat, AIG had no choice but to cave; raising the money was critical, and it could not afford to have a battle with its main banker become public. AIG executives were further irritated when the dispute over valuations was disclosed and JP Morgan did not want to have its name attached to it; the filing refers to “another national financial services firm.”

  At a large conference table at Simpson Thacher, just moments after AIG’s directors voted Willumstad as the new CEO, he addressed the board.

  He stressed that one of the first things that needed to be done was to make peace with Greenberg. He was AIG’s largest shareholder, controlling 12 percent of the company, and his various battles with the firm were a costly distraction. “He’ll be linked to the company forever anyway,” Willumstad added.

  After the board meeting, Willumstad returned to his apartment on the Upper East Side. He dialed Hank Greenberg’s number with some trepidation; Greenberg never made anything easy. It took some time to get him on the phone.

  “Hank? Hi, this is Bob Willumstad. I wanted to let you know that the board has just met and decided to replace Martin—”

  “Good riddance,” Greenberg muttered.

  “—and a release is going to go out tomorrow announcing that I am the new CEO.”

  There was a moment of painful silence. “Well, congratulations, Bob,” Greenberg finally said, almost faintly. “It was good of you to call and let me know.”

  “Look, Hank. I know that there have been a lot of issues between you and the company. But I’m willing to make a fresh start and see if there’s some way we can’t resolve these issues.”

  “I am willing to listen,” Greenberg replied. “I do want to help the company with its problems.”

  The two men agreed to have dinner together that week. As he hung up the phone, Willumstad was further convinced that settling with Greenberg had been a necessary step. It would even help the stock price. But Greenberg was a hard-ass negotiator, and any deal would take time and patience.

  The problem was, Willumstad wasn’t at all sure just how much time he had.

  CHAPTER NINE

  On Friday, June 27, 2008, Lloyd Blankfein, exhausted after a nine-hour flight to Russia, took a stroll around th
e square outside his hotel in St. Petersburg. He had just arrived in the city on a Gulfstream, along with his wife, Laura, and Gary D. Cohn, Goldman’s president and chief operating officer. A history buff, Blankfein had finished David Fromkin’s A Peace to End All Peace: The Fall of the Ottoman Empire and the Creation of the Modern Middle East during the flight.

  The other members of the Goldman board weren’t due to land for several hours, so Blankfein had some time to himself. It was a pleasantly warm afternoon, so he decided to take in the sights. Towering above him across the square, the gold dome of St. Isaac’s Cathedral was radiant against the overcast sky. That night the Goldman board and their spouses would be treated to a private tour of the State Hermitage Museum, which was housed in six buildings of the former imperial palace along the Neva River.

  If all around him the financial world was in a state of chaos, Blankfein had reason to feel contented about Goldman on the eve of its board meeting. The firm was once again proving itself to be the best on Wall Street, weathering—so far, at least—the toughest market anyone could remember.

  And what better place to be gathering than in Russia? What China was to manufacturing, Russia was to commodities, and commodities were king at the moment. Oil, most crucially, was going for $140 a barrel, and Russia was pumping out millions of barrels a day. For a moment, it could make anyone forget about the problems back in the United States.