the clear message that emerged from a Congressional hearing into
its near-bankruptcy. However, while AIG’s former CEO Hank Greenberg
strongly implied that blame lay with his successors, a corporate
governance expert does not believe Greenberg himself is
blameless.
Born out of insurance agency CV Starr & Company established
in Shanghai, China in 1919 by Cornelius van der Starr, American
International Group (AIG) grew to become the world’s largest
insurer. As recently as 2007 AIG ranked as the US’ 10th-largest
company and until May 2008 boasted an AA rating from Standard &
Poor’s.
Go deeper with GlobalData
That is all history now, with AIG the subject of a of $123
billion federal rescue package which has left it 79.9 percent owned
by the government and preparing to sell major chunks of its vast
business interests.
At the heart of AIG’s woes were credit default swap (CDS)
derivatives, a form of insurance offering protection against
default of credit instruments. When the financial crisis burst, AIG
found itself grossly over-exposed to risk related to CDS’ written
by its AIG Financial Products (AIGFP) unit.
How could things have gone so wrong? The best insight so far
came out of a House of Representatives’ Oversight Committee enquiry
into AIG’s downfall held in October.
One of those testifying was Maurice Greenberg, who joined CV
Starr in 1960 and went on to become AIG’s first CEO, a position he
held until his ousting from AIG in March 2005.
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By GlobalData“Its [AIG’s] market capitalisation increased 40,000 percent
between 1969, when AIG went public, and 2004, my last full year as
CEO,” he proclaimed in his opening remarks. “Today, the company we
built up over almost four decades has been virtually
destroyed.”
Blame does not lie with AIG’s insurance units – which are sound
– but with AIGFP, which was formed in 1987 to diversify AIG’s
earnings without incurring undue risk he stressed.
“From the beginning, AIG’s policy was that AIGFP conduct its
business on a hedged basis – that is, its net profit should stem
from the differences between the profit earned from the client and
the cost of offsetting or hedging the risk in the market,” stressed
Greenberg.“
AIGFP would therefore not be exposed to directional changes in
the fixed income, foreign exchange or equity markets.”
While he was CEO, Greenberg said AIGFP was subject to internal
risk controls, including credit risk monitoring by independent
units of AIG, review of transactions by outside auditors and
consultants, and scrutiny by AIGFP’s and AIG’s boards of
directors.
He added that every new type of transaction or any transaction
of size, including most CDS’ was reviewed by AIG’s chief credit
officer. AIGFP began selling credit default insurance in 1998.
Following his departure from AIG, the volume of credit default
swaps written by AIGFP “exploded,” said Greenberg. He noted that
AIGFP reportedly wrote as many credit default swaps on
collateralised debt obligations (CDO) in the nine months following
his departure as it had written in the previous seven years
combined.
He added that based on information published by AIG, AIG’s net
notional exposure to CDOs at 30 June 2008 was $80.3 billion, of
which $57.8 billion contained subprime mortgage collateral. The
mark-to-market loss on this portfolio at that date totalled $24.8
billion, of which $21 billion related to securities containing
sub-prime mortgage collateral.
Putting forward possible reasons for AIG’s problems, Greenberg
said: “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.”
He added that earlier this year, AIG’s external auditors 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,” he
said.
Another view
A very insightful assessment of AIG was provided by Nell Minow
who heads The Corporate Library (TCL), a research firm specialising
in corporate governance.
“One of our most popular products is our rating of board
effectiveness,” said Minow. ”We rate boards like bonds – A through
F.”
During Greenberg’s tenure TCL had given AIG’s board a D rating
in June 2002 which it downgraded to an F in February 2005.
Following Greenberg’s departure, TCL upgraded AIG’s board to a D
rating in May 2005 and in February 2006 to a C rating.
In its February 2006 assessment of AIG, TCL commented: “We are
increasingly confident in the new board’s willingness and ability
to move the company forward in the best interests of all its
shareholders.”
That was the last upgrade and in November 2007 AIG’s board was
downgraded to a D rating. Minow said that at the time of the
downgrade, AIG’s board continued to reflect Greenberg’s influence
and could not seem to solve or prevent accounting problems. In
addition, the downgrade reflected what TCLs analysts at the time
said were their “very high concerns over executive
compensation.”
Minow continued that TCL’s most recent analysis again raised
concerns related to AIG’s internal controls and then-CEO Martin
Sullivan’s remuneration. In 2007 Sullivan’s compensation was $43.9
million, the bulk of which comprised a $36.5 million annual bonus
and a $5.6 million non-equity incentive bonus. His annual salary
was $1 million.
Problems were inevitable
Summing up, Minow said: “Neither of the CEOs that followed
Greenberg sought to implement significant change, nor did the
reconstituted board apply pressure on them to do so. One
interpretation might be they simply weren’t up to it; a more
cynical, but probably more accurate, interpretation would be the
house of cards constructed by Greenberg in the first place was
already too fragile and too far gone for such efforts to work.”
She concluded: “Certainly it is no accident that AIG was among
the first of the giants to be toppled by the mounting credit crisis
– the seeds of its destruction had been sown by Mr Greenberg, and
endorsed by the AIG board, several years before.”
AIG was a disaster waiting to happen, is the clear message that
emerged from a Congressional hearing into its near-bankruptcy.
However, while AIG’s former CEO Hank Greenberg strongly implied
that blame lay with his successors, a corporate governance expert
does not believe Greenberg himself is blameless
Born out of insurance agency CV Starr & Company established
in Shanghai, China in 1919 by Cornelius van der Starr, American
International Group (AIG) grew to become the world’s largest
insurer. As recently as 2007 AIG ranked as the US’ 10th-largest
company and until May 2008 boasted an AA rating from Standard &
Poor’s.
That is all history now, with AIG the subject of a of $123
billion federal rescue package which has left it 79.9 percent owned
by the government and preparing to sell major chunks of its vast
business interests.
At the heart of AIG’s woes were credit default swap (CDS)
derivatives, a form of insurance offering protection against
default of credit instruments. When the financial crisis burst, AIG
found itself grossly over-exposed to risk related to CDS’ written
by its AIG Financial Products (AIGFP) unit.
How could things have gone so wrong? The best insight so far
came out of a House of Representatives’ Oversight Committee enquiry
into AIG’s downfall held in October.
One of those testifying was Maurice Greenberg, who joined CV
Starr in 1960 and went on to become AIG’s first CEO, a position he
held until his ousting from AIG in March 2005.
“Its [AIG’s] market capitalisation increased 40,000 percent
between 1969, when AIG went public, and 2004, my last full year as
CEO,” he proclaimed in his opening remarks. “Today, the company we
built up over almost four decades has been virtually
destroyed.”
Blame does not lie with AIG’s insurance units – which are sound
– but with AIGFP, which was formed in 1987 to diversify AIG’s
earnings without incurring undue risk he stressed.
“From the beginning, AIG’s policy was that AIGFP conduct its
business on a hedged basis – that is, its net profit should stem
from the differences between the profit earned from the client and
the cost of offsetting or hedging the risk in the market,” stressed
Greenberg.“
AIGFP would therefore not be exposed to directional changes in
the fixed income, foreign exchange or equity markets.”
While he was CEO, Greenberg said AIGFP was subject to internal
risk controls, including credit risk monitoring by independent
units of AIG, review of transactions by outside auditors and
consultants, and scrutiny by AIGFP’s and AIG’s boards of
directors.
He added that every new type of transaction or any transaction
of size, including most CDS’ was reviewed by AIG’s chief credit
officer. AIGFP began selling credit default insurance in 1998.
Following his departure from AIG, the volume of credit default
swaps written by AIGFP “exploded,” said Greenberg. He noted that
AIGFP reportedly wrote as many credit default swaps on
collateralised debt obligations (CDO) in the nine months following
his departure as it had written in the previous seven years
combined.
He added that based on information published by AIG, AIG’s net
notional exposure to CDOs at 30 June 2008 was $80.3 billion, of
which $57.8 billion contained subprime mortgage collateral. The
mark-to-market loss on this portfolio at that date totalled $24.8
billion, of which $21 billion related to securities containing
sub-prime mortgage collateral.
Putting forward possible reasons for AIG’s problems, Greenberg
said: “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.”
He added that earlier this year, AIG’s external auditors 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,” he
said.
Another view
A very insightful assessment of AIG was provided by Nell Minow
who heads The Corporate Library (TCL), a research firm specialising
in corporate governance.
“One of our most popular products is our rating of board
effectiveness,” said Minow. ”We rate boards like bonds – A through
F.”
During Greenberg’s tenure TCL had given AIG’s board a D rating
in June 2002 which it downgraded to an F in February 2005.
Following Greenberg’s departure, TCL upgraded AIG’s board to a D
rating in May 2005 and in February 2006 to a C rating.
In its February 2006 assessment of AIG, TCL commented: “We are
increasingly confident in the new board’s willingness and ability
to move the company forward in the best interests of all its
shareholders.”
That was the last upgrade and in November 2007 AIG’s board was
downgraded to a D rating. Minow said that at the time of the
downgrade, AIG’s board continued to reflect Greenberg’s influence
and could not seem to solve or prevent accounting problems. In
addition, the downgrade reflected what TCLs analysts at the time
said were their “very high concerns over executive
compensation.”
Minow continued that TCL’s most recent analysis again raised
concerns related to AIG’s internal controls and then-CEO Martin
Sullivan’s remuneration. In 2007 Sullivan’s compensation was $43.9
million, the bulk of which comprised a $36.5 million annual bonus
and a $5.6 million non-equity incentive bonus. His annual salary
was $1 million.
Problems were inevitable
Summing up, Minow said: “Neither of the CEOs that followed
Greenberg sought to implement significant change, nor did the
reconstituted board apply pressure on them to do so. One
interpretation might be they simply weren’t up to it; a more
cynical, but probably more accurate, interpretation would be the
house of cards constructed by Greenberg in the first place was
already too fragile and too far gone for such efforts to work.”
She concluded: “Certainly it is no accident that AIG was among
the first of the giants to be toppled by the mounting credit crisis
– the seeds of its destruction had been sown by Mr Greenberg, and
endorsed by the AIG board, several years before.”
