AIG: Another View

Hank Greenberg, the former Chairman of AIG and the man who largely made that company what it was, testified today before the House Committee on Oversight and Government Reform. The subjects were Greenberg’s views on what happened to AIG–he left the company around four years ago–and the government bailout.

Greenberg is a controversial guy. Not to put too fine a point on it, some people think he is a crook. But putting together AIG was a towering achievement, and no one thinks he is stupid. In my view, his perspective, while no doubt self-serving, is very much worth hearing.

Greenberg, in a nutshell, thinks the bailout was a terrible idea and AIG should have been allowed to go into bankruptcy. He is at a loss as to why American taxpayers should have poured tens of millions of dollars into the company, much of which went to make European banks whole when they otherwise would have taken a loss. He explained AIG’s downfall:

GREENBERG: AIG did not have a solvency problem. It had a liquidity problem. …

ISSA: So an A rating — less than a AAA is not necessarily bad. You’re down to a B rating before you get to be sort of in the junk category. So just for all of us, that downgrade was significant, of course, compared to being sort of blue-chip AAA, but the company was still, at that point, relatively considered to be a well-rated company, not different than GE has been from time to time.

GREENBERG: Yes, but the problem is, in the credit default swap agreements, you’d be required, once you lost your AAA rating, to be required to put up collateral. And so that became not a question of option. It became a question of …

ISSA: Right, the call comes in and, in 48 hours … GREENBERG: … You have to put up … ISSA: … You’re supposed to deliver.
***
CUMMINGS: By the time the firm stopped writing swaps for CDOs that included subprime mortgages, it had nearly $80 billion of these products in its portfolio. How many of those swaps were issued under your leadership?

GREENBERG: First of all, Mr. — Mr. Cummings, as far as I know, there are no losses whatever on the — on the credit default swap. That was — that was reported to the Senate Banking Committee last month by the head of the thrift administration.
It wasn’t losses that brought AIG down, AIG financial products. It was a lack of collateral that they had to put up. And the reason they needed more collateral was because they lost their AAA rating.

Greenberg testified that if the federal government was going to support AIG, it should have done so in the form of loan guarantees rather than cash investment, as I have argued with respect to the TARP program:

If there were guarantees issued rather than cash, it seems to me that would have made a huge difference not only to AIG but to the taxpayer. That was done, as you know, for Citigroup, and there’s — I see no reason that I can think of that guarantees were not used.

If the — if the — if the Fed said, “We’re going to stand behind AIG financial products,” it would have essentially put a — a AAA stamp on F.P. during that period of time, and the counterparties would have had no — I don’t think any — any recourse but to take a guarantee.

That would have made a major difference, not only to AIG but to the taxpayer. They would not have had to put out as much money as they have done so.

Greenberg also argued, as we have in several contexts, that a bankruptcy would have been far preferable to the bailout as it was carried out:

MALONEY: I’d like to ask you, do you believe if we had had that process in place, a receivership would have been better for AIG and the American taxpayer and the economy.

GREENBERG: Thank you for that question. Given the terms, the original terms that the government gave AIG for $85 billion of a loan, which funneled money almost immediately out the back door to counterparties, charged 14 percent interest and took 79.9 percent of the company, clearly, everybody would have been better off, in my judgment, if they had declared Chapter 11.

MALONEY: And can you explain to us how would AIG be better now if they had been in a receivership or Chapter 11?

GREENBERG: Well, there probably would have been dip financing. There would have been a restructuring of the company. I presume that AIG F.P. would have been walled off. You would have — all the counterparties would have been general creditors. They would not have gotten anything like the collateral that they did get.

Remember that the CDOs that were underlying the credit default swaps were not in default. It was the collateral that was required and the fact that they may have had lower marks on the CDOs. But they would have been general creditors.
***
WELCH: Well, the — the question’s really pretty simple. AIG — the fear of AIG failing was that a lot of innocent people would be collateral damage to the collapse. And the federal government did not want innocent people who knew nothing about CDOs or CDSs to go down with the ship.

GREENBERG: Yeah, but — but it depends on how you — how you bail out. I mean, we went through this, and — and I think if they had used guarantees and didn’t use cash, it would have been different. You could have renegotiated with the counterparties.
***
MALONEY: Your testimony that AIG would have been better off if going into Chapter 11 — at this point, the taxpayers have put $180 billion into AIG, and you’re telling me AIG would have been better off. My question is: Would the taxpayers have been better off if AIG had gone to Chapter 11. The taxpayers would have their $180 billion, it would be part of our Treasury, but what would have happened to our economy, in your judgment, if AIG had gone to Chapter 11?

GREENBERG: Well, if AIG went to Chapter 11 at the very beginning and didn’t — and didn’t have access to the $85 billion at those generous terms of 14 percent interest and 79.9 percent of the company, what would have happened? There would have been — there would have been a bankruptcy, but a bankruptcy court would have taken hold of it, and the counterparties would have been general creditors.

It would not have affected the insurance subsidiaries. They’re insulated from that bankruptcy. State laws protect them, and they were adequately capitalized. So it wouldn’t have affected the insurance subsidiaries. It would have affected AIG Financial Products….

MALONEY: But the impact on the overall economy — we’re told that if AIG had failed, the whole economy would have come down. There was a report that AIG prepared for Treasury that made it sound like the world was going to come to the end if AIG had gone into Chapter 11.

I have asked several times for the Treasury’s analysis of why it was critical for the financial stability of our country to save AIG. I am waiting for that to come forward.
But my main point is what would have happened to the overall economy, and you are basically saying nothing would have happened to the American economy.

The critical insurance arm which is so critical for finance in our country would have been independent and saved, and the risky products over in London — who got the majority of the bonuses, by the way, and caused all the problem — it would have — they would have lost their jobs. It would not have tumbled the markets. It would not brought down the housing market. It would not have brought down insurance. It would — basically, are you saying it would not have impacted in any major way the American economy? Am I correct in what you’re saying?

GREENBERG: Well, I think there would have been a ripple, but it wouldn’t have been — it wouldn’t have been — it wouldn’t have been catastrophic. The insurance companies would have continued doing business. They’re protected. They were adequately capitalized, and that capital couldn’t be moved around.
Would there be — some business leave AIG and go to another company? Possibly. Competitors would have — would have fed on the fact that AIG parent became bankrupt and the — so competitors would have tried to move some business. But I don’t think it would have been disastrous, any more than it is right now. The government has nationalized essentially AIG.
***
ISSA: And lastly, I just want to follow up on what Ms. Maloney said, because I think it’s critical. Had AIG filed bankruptcy, a substantial — and correct me if I’m wrong — a substantial portion of the money that was delivered to AIG, which then went to foreign banks would have not gone if they’d simply said, “File bankruptcy, and there’s a default, and to the extent that somebody wants to make you whole, great, but otherwise, you lose,” we would have preserved 40 billion or so dollars of U.S. Treasury money.

GREENBERG: They would have become a general creditor, and…

ISSA: So… GREENBERG: … at the end of the day, if — if AIG — if it was wound up, would — would have made whatever — 20 cents on the dollar, an agreement of 30 cents on the dollar. There’d be some negotiation and some settlement.

ISSA: Mr. Chairman, if I could just sort of close this question, because I think it’s — it’s — it’s critical to what you’ve given us here today, had the federal government allowed AIG to go bankrupt, tens or hundreds of billions of dollars would have been preserved of federal Treasury money by simply allowing foreign banks to accept the risk which they made when they allowed a private entity to insure on their behalf with a public statement that they were able to evaluate.

GREENBERG: That’s correct.

I have not seen any coherent explanation of why our government put the interests of European banks ahead of those of American taxpayers. Maybe this is part of the Obama administration’s effort to be popular in Europe, I don’t know.

There was, of course, plenty of discussion about regulation of financial companies like AIG and the regulatory failures that led to our present financial crisis. Greenberg pointed out that AIG was subject to no shortage of regulation:

When you say credit default swaps should be regulated, who do you think should be doing that regulation?

GREENBERG: Well, first of all, let me say that AIG itself had a federal regulator at — the Office of Thrift Supervision was a federal regulator of AIG, in addition to the state regulatory bodies for each of the insurance subsidiaries.

So there was — there was regulation. Now, was the regulation adequate? Should it have been broadened? I think that must be reviewed to determine whether or not it’s adequate.

Greenberg, however, seems to have an erroneous idea of the powers of the OTS:

GREENBERG: I think — I think if the Office of Thrift Administration (sic) had said, “Hey, you’re — you’re over — you’re overreaching by writing as much credit default swaps as you are and have been doing,” it should have been — it should have been brought to the attention of management.

And — and if management didn’t do anything about it, then there should — they should have had the authority to say, “Stop.”

In fact, though, OTS had precisely that authority, as we pointed out here:

HENSARLING: I believe I heard in an earlier answer to one of the questions, I believe I heard you say that OTS in 2004 should have stopped the book of business that I think you were alluding to to CDS and the AIG securities lending commitments. Did I understand you correctly?

POLAKOFF: Yes, sir.

HENSARLING: So if you said you should have stopped it in 2004, that implies you could have stopped it in 2004. Is that correct?

POLAKOFF: Yes, sir.

HENSARLING: So there were not limits on your power. Perhaps, there were limits on your knowledge or insight, but there was not limits on your power to stop what you cite, as I believe AIG’s liquidity — I’m reading from your testimony — was the result of AIG’s business lines. So you did have the power to stop those business lines. Is that correct?

POLAKOFF: Yes, sir. ***

HENSARLING: Again, it appears, if this is correct, it was not a lack of supervisory authority that caused you not to take action with respect to these two lines. Is that correct?

POLAKOFF: Yes, sir. …

HENSARLING: So, again, in retrospect, it wasn’t the lack of authority. It wasn’t the lack of resources. It wasn’t the lack of expertise. You just flat made a mistake. Is that a correct assessment?

POLAKOFF: In 2004, we failed to assess how bad the mortgage economy, the real estate economy would become in 2008. Yes, sir.

As so often happens, the problem was not a lack of regulation, the problem was that the regulators made exactly the same mistake that the businessmen made.

Despite that error, I think Greenberg’s testimony made a lot of sense. The bailouts being conducted by the Obama administration are, in my view, a fiscal disaster and a sellout of the American taxpayer.

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