All The Devils Are Here: Unmasking the Men Who Bankrupted the World (15 page)

In the spring of 1994, James Bothwell of the General Accounting Office—the same man who had been threatened with the loss of his job after he wrote a tough report about Fannie and Freddie—released a report on the dangers derivatives posed. Though Bothwell was not a derivatives expert, he had a PhD in economics from Berkeley and had been working on his investigation for two years. Corrigan’s 1992 speech had prompted five congressional committees to ask the GAO to look into derivatives. Bothwell and his team had surveyed fourteen major U.S. derivatives dealers—a fifteenth had refused to respond—and written a two-hundred-page report.

The GAO’s report was far from a screed. “We were not against derivatives!” Bothwell says today. The report acknowledged how useful derivatives could be in managing risk. Still, Bothwell was stunned by what he had discovered. Brickell had consistently argued that since most derivatives dealers were banks, they were already regulated by the nation’s bank supervisors. But Bothwell quickly realized that securities firms and insurance companies were also diving into the derivatives business, and that the securities firms had set up separate derivatives affiliates to avoid SEC oversight. The insurance companies also set up separate subsidiaries, and state officials, who were in charge of regulating insurers, told the GAO that these new subsidiaries were outside their authority.

The GAO team was also concerned by the see-no-evil attitude of the derivatives dealers. For instance, Bothwell’s team asked the firms whether they were conducting stress tests on their portfolios, to gauge how they would do under “abnormal market conditions.” Roughly one-third of the respondents said the question didn’t even apply to them.

Most of all, the GAO was concerned about the elephant in the room: the possibility that derivatives posed systemic risk. Because the business was concentrated in a few hands, the failure of one dealer might “cause liquidity
problems in the markets and could also pose risks to the others, including federally insured banks and the financial system as a whole,” the report said.

Yet despite these concerns, the recommendations made by the GAO were hardly radical. “What we are pitching,” Cecile Trop, the assistant director of the GAO, told Congress, “is an early warning system that will help in anticipating and responding to a financial system crisis, should there ever be one. That doesn’t sound too onerous to us; it’s a prudent and reasonable kind of approach.”

No sooner had the report been issued than the industry fired back. Immediately following its release, not one but six leading financial trade associations put out a joint statement that was nothing short of apocalyptic: “We are convinced that any legislation having these effects will harm the American economy.” ISDA issued a report about the GAO’s work, arguing that adopting the GAO’s suggestions would raise costs and reduce the availability of derivative products. It also said that the GAO had not proven that derivatives could create systemic risk. “The industry went after us and went after Congress to convince them that this was not a problem,” says Charles Bowsher, who was then the head of the GAO, and had been Bothwell’s only regulatory ally.

A month after issuing his report, Bothwell appeared as a witness before the House agriculture committee to defend it. (The agriculture committees in the House and Senate have jurisdiction over the CFTC.) As he walked into the hearing room, he was stunned at the line of people, most of them lobbyists, waiting to get in. There were cameras everywhere.

“What you see is that derivatives are growing up between the cracks in the regulatory system,” he testified. “No one really has the authority over that type of activity.”

Two years earlier, when Bothwell had testified about Fannie Mae and Freddie Mac, the response from Congress had been brutal. This was worse. The GAO produces “consistently overblown conclusions which are embarrassingly undersupported by the evidence and replete with undue editorializing,” said Congressman Earl Pomeroy, a Democrat from North Dakota. “We have to be careful about excessive regulatory regulation,” said Wayne Allard, a Republican from Colorado.

Then it was the regulators’ turn to testify. Not a single one—not the FDIC, the SEC, the Treasury, the Fed, the CFTC, nor even the Comptroller—would support Bothwell. Their general view was summed up by Darcy Bradbury, a deputy assistant secretary at Treasury: “As a general principle, there should
be a demonstration that there has been, or will be, a failure of market discipline before the need for such broad Federal regulation is advanced.” When it was the industry’s turn to testify, Gay Evans, who had succeeded Brickell as chairman of ISDA, said, “The GAO proposals for legislation have been rejected by all the key U.S. financial regulators, including the Federal Reserve. Therefore, Mr. Chairman, swaps and privately negotiated derivatives play a key role in reducing, not increasing, risks.”
Therefore?

In a follow-up report issued in 1996, the GAO explained, in one clear sentence, why it thought differently about this issue than everyone else: “Past experience has shown that firms can develop serious problems before the marketplace knows about them.”

There is one final piece to this story. That fifteenth company, the one that refused to participate in the GAO’s survey, was the insurance company American International Group, known on the Street simply by its acronym: AIG. “We got this call saying they couldn’t help us, but at some point they’d explain that,” Bowsher remembers. At that time, AIG was a relatively small player, with a derivatives desk one-third the size of Goldman Sachs’s, which was the biggest derivatives dealer among the investment banks. But the GAO team knew that AIG’s business was growing rapidly.

After the report was complete, Bowsher and Bothwell made it a point to go talk to all the CEOs in person, AIG included. They set up an appointment with AIG’s chief executive, Hank Greenberg, and were summoned to his office on Wall Street, where they waited and waited in an anteroom. Bowsher wasn’t bothered by the wait—he was used to imperial CEOs—and during their meeting he found Greenberg both candid and smart. At least, unlike the others, Greenberg never said the GAO report was stupid. What he did say was that he hadn’t wanted to talk to them because he’d been having trouble with the person who ran his derivatives business. There had been big losses and a battle over control, but Greenberg had fixed all that. He’d “gotten rid of that person, and taken the losses,” Bowsher recalls him saying. And now, Greenberg said, derivatives weren’t something he had to worry about anymore.

I
n 1994, the year of that meeting with Bowsher and Bothwell, Maurice R. “Hank” Greenberg was sixty-nine years old and had been the chief executive of AIG for a remarkable twenty-six years. Perhaps even more remarkable, despite his age and the length of his tenure, he showed no signs of slowing down. He had no succession plan, and zero interest in creating one. Two of his sons had become high-ranking executives at AIG and were often mentioned as potential successors. Both eventually left to run other insurance companies once they realized that Greenberg was never going to give them the keys to the kingdom. He was dominant, brilliant, irascible, short tempered, controlling, obsessive—and by far the most successful insurance executive of his era, and perhaps any era. Since 1968, when AIG’s founder, C. V. Starr, catapulted him over two higher-ranking executives to be the CEO, he had transformed Starr’s company—which had been founded in Shanghai nearly fifty years earlier—from a quirky, privately held firm into the largest insurance company in the world. It had a stock price that outpaced its competitors, a reputation for treading where others wouldn’t, and earnings growth so steady—topping $2 billion a year by the mid-1990s—that it was the envy of the industry. AIG wasn’t just Greenberg’s company; it was his creation, his baby, his sun and his moon and his stars. People sometimes joked that he planned to run it from the grave.

The son of a taxi driver from the Bronx, Greenberg was as up-by-his-bootstraps as a twentieth-century New Yorker could be. He ran away from home at seventeen to fight in World War II, took part in the Normandy invasion, attended the University of Miami and New York Law School, got drafted to fight again in Korea, and finally wound up in the insurance industry when he complained about the man interviewing him for a job—to the man’s boss. In 1960, C. V. Starr lured Greenberg to AIG; two years later he
put him in charge of AIG’s struggling U.S. operations, which he turned into a roaring success. Six years later, with Starr just months from death, he anointed Greenberg as his successor.

Greenberg’s passion for AIG went well beyond the norm—and woe to any company executive who didn’t share that passion. He thought nothing of calling executives at three a.m. to discuss business—behavior for which he made no apologies. One Thanksgiving he called AIG executive Ed Matthews, his longtime consigliere. “We’re just about to sit down for dinner,” Matthews told him. “I just finished my dinner,” replied Greenberg, who then proceeded to talk business for so long that Matthews’s family had finished their own Thanksgiving dinner by the time the conversation ended. He would have weekly meetings with his key lieutenants, the main point of which sometimes seemed to be to give Greenberg the opportunity to berate them in front of their peers. “He could be unmerciful,” recalls a longtime AIG hand.
Fortune
magazine, in one of the many AIG profiles it has published over the years, told of a time an executive being assailed by Greenberg couldn’t take it anymore. “You know?” he finally conceded. “You’re right.” Greenberg shot back, “I don’t need you to tell me I’m right.”

Indeed, Greenberg felt sure he had a better understanding of the different divisions than the men running those divisions did. After all, it was Greenberg who had come up with the brainstorms, pushed into the new businesses, and engineered the mergers that had turned AIG into an insurance behemoth. AIG operated 300 insurance subsidiaries in 130 countries, and Greenberg had his finger on the pulse of every last one of them. Or so, at least, it seemed. “A lot of the strategy was run out of Hank’s head,” says a former AIG executive. “He had most of the ideas about how to run the businesses.” And he fully expected his executives to carry out those ideas, no questions asked.

One famous story involved Iranian-American executive K. C. Shabani, who Greenberg sent to Iran in the early 1970s. Because Shabani knew some family members of the shah of Iran, Greenberg assigned him the task of convincing the shah to allow AIG to operate inside the country, something no foreign insurance company was then allowed to do. Once in Tehran, Shabani discovered that the only way AIG could get into Iran was if the parliament passed a law inviting it in. He returned to the United States and told Greenberg that the chances of this happening were remote. “If I were you, I’d give up,” he said, according to
Fortune
.

“I didn’t ask you what was necessary to do this,” replied Greenberg. “I just asked you to get it done.” He did. Among other things, Shabani married the
shah’s social secretary, having at some point gotten divorced from his American wife. Sure enough, the law was passed in 1975, and AIG ran a profitable business in Iran until the Iranian revolution four years later.
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To put it another way, Greenberg didn’t so much manage his executive team as control them, running AIG as a not-so-benevolent dictatorship. One way he did this was by establishing for the top AIG brass one of the most generous—yet most onerous—bonus plans ever devised. Each year, the three hundred top executives were granted “units of participation” in a company called Starr International Company, or SICO. SICO, which was based in Panama, was AIG’s largest shareholder, and its value rose as AIG’s shares rose. Greenberg, in turn, was SICO’s biggest shareholder, with 25 percent of the company, and SICO’s board was made up almost entirely of AIG executives. Here, however, was the catch: you couldn’t get your hands on your accumulated SICO bonuses until you turned sixty-five. If you were still with AIG when you turned sixty-five, you could walk away with tens of millions of dollars. But if you left the day before your sixty-fifth birthday, you got nothing. Greenberg, of course, was the one who decided how many units of participation you got.

There was, however, one piece of AIG that Greenberg didn’t control. It was known as AIG Financial Products—FP, everyone called it. It was the part of the company in the derivatives business. Headquartered in Wilton, Connecticut, and London, it was run by Howard Sosin, who was every bit the control freak that Greenberg was, and who made it plain that he expected Greenberg to stay out of his playpen. Even though the division was making plenty of profits, this was hardly a situation that could continue indefinitely. And it didn’t: eventually Sosin faltered, at which point Greenberg pounced. That is what Greenberg was referring to when he spoke to Bowsher and Bothwell. He had finally managed to put FP under his thumb.