Too big to jail? The trouble with our 'rescue' of A.I.G.

Can we believe the official spin on the rescue of American International Group (AIG)? Photo: AIG

NEW YORK, June 3, 2013 — The extraordinary rescue of American International Group (“AIG” or the “Company”) is a heroic success. That is, if you buy the official Treasury Department spin.

Yes, the Federal Reserve Bank of New York and U.S. Treasury Department have finally sold “our” equity investments at a “profit.” However, AIG remains a behemoth that may already have proven it is way too complex to monitor effectively given resources of existing regulators.

Moreover, the public still does not know exactly how a company that was aggressively regulated starting November 30, 2004 could “fail” by September 16, 2008 when the Federal Reserve Bank of New York began a rescue attempt, later joined by the U.S. Treasury Department.

We have yet to learn how the key executive who built and managed AIG’s “rogue” Financial Products Division until it blew up, could escape prosecution in the United States and the United Kingdom.

We do not know how an outside auditing firm that missed so much from 2000 through 2008 could still be responsible for auditing AIG’s financial statements.

Furthermore, unless the Supreme Court reverses an Appellate Court decision, we may never learn what James M. Cole, Therese D. Pritchard, and the firm of Bryan Cave actually did as “Independent Consultant” to the Department of Justice concerning AIG before, during, and after September 16, 2008.

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At each step of the convoluted AIG rescue when capital entered and left the Company, did AIG make “full and fair” disclosure to counterparties and to the investing public?

If not, did AIG somehow gain a waiver of periodic reporting requirements?

A Crucial Missing Dimension in the Official Rescue Narrative

One excellent and succinct summary ascribes blame for the 2008 AIG debacle as follows:

“AIG failed and was rescued by the Government primarily because its enormous sales of credit default swaps were made without putting up initial collateral, setting aside capital reserves, or hedging its exposure—a profound failure in corporate governance, particularly its risk management practices”.

In non-technical language, a division within AIG was earning annual revenues by selling a form of “protection” to investors who worried about whether debt securities they owned would plummet in value.

In the event that these debt securities fell into default, “protected” investors relied on the AIG division to pay them back capital sums that were many times greater than the annual cost of protection. The trouble is, this AIG division never had the capital required to honor its obligations.

Isn’t the repeated sale of “fake” protection from financial harm across state lines and international boundaries a very serious matter, especially when it occurred over a period of many years?

Moreover, the amounts involved were far from trivial:

“As of June 2008, AIG provided more than $ 400 billion of credit protection, primarily to banks, through AIG [Financial Products Credit Default Swaps]. AIG was exposed to the underlying securities, which were composed largely of subprime mortgages in CDOs that were initially rated AAA.”

From what we see in the public domain, the diseased heart inside the stricken corpus of AIG was the Financial Products Division. The trouble is, this division had long been under scrutiny some might imagine should have been very close indeed.

When You Do Not Succeed, You Must Learn Why You Failed

Ordinary investors form views concerning the merits and demerits of a security solely from publicly available information. Companies such as AIG are so complicated that even sophisticated investors have a hard time studying and then reaching conclusions concerning voluminous amounts of information contained in their various public filings.

Mr. Cole and his team of experts were in a very different position than the public to evaluate what may have been plaguing AIG from January 2005 through September 16, 2008.

Mr. Cole described his work as follows:

“In 2005, I was selected by the Justice Department and the SEC to serve as an independent monitor at the insurance company AIG. I was first tasked by court order to look at 5 years of transactions to determine if AIG assisted any of its clients to, as they say, “cook their books” through the use of complex transactions. That work led to another appointment in

2006, in which I developed financial reporting and regulatory compliance programs for the company. While the company resisted some of my efforts, I insisted on tough measures.”

The Bryan Cave team was no ordinary group of outsiders—they were brought inside A.I.G. pursuant to the terms of a deferred prosecution agreement and thus had considerable advantage over Company employees to force them to produce all relevant information. One imagines they therefore had every opportunity to get appropriately educated starting more than three years before A.I.G. ultimately hit the wall.

In the minds of even those who might care about specifics, the rescue is almost ancient history so why even bother plowing over old ground from 2004 through 2008? The answer is simple—it really does matter how close experts came to fixing deficiencies at AIG, especially if you believe, as I do, that threats to the global system are compounding again.

Geo-political conditions are certainly volatile, benchmark interest rates are certainly rising, debt levels remain at towering levels in key nations, populations are ageing, and incomes remain under persistent threat.

Is AIG truly prepared to weather another crisis without government support? If it needs support in a renewed crisis, are U.S. government finances strong enough to save AIG yet again?

The Strange Death of Economic Common Sense

Considering economic progress in “real” (adjusted for devaluation) terms, the system we think we loved actually failed and entered purgatory by September 16, 2008.

Trillions already have been borrowed and spent crafting false delusions of progress that are generally denominated in “nominal” (unadjusted for devaluation) terms. Experienced realists believe that we are again close to a dread abyss only this time we have drained our credibility account and our bank accounts.

There is a fate worse than death—assuring that children and future generations will curse your memory as they suffer for your sins.

America is running out of time and bleeding daily from dysfunctional government that wastes trillions of dollars we simply do not have.

Many large multi-national companies like AIG appear vulnerable.

Let us hope responsible, informed people and the powers-that-be heed this important advice from Thomas Jefferson:

“Nothing is so mistaken as the supposition, that a person is to extricate himself from a difficulty, by intrigue, by chicanery, by dissimulation, by trimming, by an untruth, by an injustice. This increases the difficulties ten fold; and those who pursue these methods, get themselves so involved at length, that they can turn no way but their infamy becomes more exposed.”

Let us fervently hope we can expose and correct our mistakes before we run out of time.

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Charles Ortel

Charles Ortel became a lapsed member of the silent majority in August 2007 when he began alerting the public to dangers posed by structural changes in the global economy. Since then, Charles has appeared in the print, radio and television media with increasing frequency. Brass Tacks will attempt to offer non-partisan perspective on factors contributing to the unresolved, burgeoning crisis and discuss potential solutions. Graduated from Horace Mann School, Yale College and Harvard Business School, Charles tries to learn each day.  

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