F A L L E N G I A N T Case Study of American International Group, Inc. J E N N I F E R D E M A R S
TABLE OF CONTENTS (hyperlinks) I BACKGROUND II CAUSES OF FAILURE III RISKS TAKEN IV LESSONS LEARNED CONCLUSION REFERENCES
AIG Building, 70 Pine St., Lower Manhattan (1931 Photo) B A C K G R O U N D OVERVIEW HISTORY FINANCIAL CONDITION & ANALYSIS
O V E R V I E W American International Group, Inc. (AIG) is a world leader in insurance and financial services. It is headquartered in New York City, and operates in more than 130 countries and jurisdictions. Its primary activities include General Insurance and Life Insurance & Retirement Services. NYC
In 2006, AIG had sales of $113 billion and 116,000 employees (Saporito, 2009). According to the 2008 Forbes Global 2000 list, AIG was once the 18th-largest public company in the world. It was listed on the Dow Jones Industrial Average from April 8, 2004 to September 22, 2008. AIG's common stock is listed on the New York Stock Exchange, as well as the stock exchanges in Ireland and Tokyo. O V E R V I E W London, England
AIG Building, 70 Pine St., Low er Man hattan AIG faltered in America’s sub-prime mortgage crisis. It had traded heavily in credit default swaps and could not meet its obligations. The United States government came to its rescue with an $85 billion bailout on September 16, 2008. O V E R V I E W
AIG has taken a major step toward cleaning up its image by reorganizing its insurance units under AIU Holdings, as of March 2009. AIU and its subsidiary brands are now distinct from AIG (National News, 2009). The holding company, itself, is currently undergoing rebranding that includes a new name, which is expected to be revealed in the near future. O V E R V I E W
H I S T O R Y Cornelius V. Starr started AIG as “American Asiatic Underwriters” in 1919 in Shanghai (Madsen 2008).
H I S T O R Y Starr moved AIG from Shanghai to New York after the Communists came to power in 1949.
In 1962, Starr gave management of the company's lagging U.S. holdings to Maurice R. Greenberg , who shifted its focus onto selling insurance through independent brokers rather than agents. In 1968, Starr named Greenberg his successor. AIG went public in 1969. Maurice R. Greenberg H I S T O R Y
H I S T O R Y Greenberg was fired due to accounting scandal in February 2005, and was succeeded as CEO by Martin J. Sullivan . On June 15, 2008, Sullivan resigned and was replaced by Robert B. Willumstad , Chairman of the AIG Board of Directors. Willumstad was forced by the U.S. government to step down and was replaced by Edward M. Liddy on September 17, 2008.
H I S T O R Y SEPTEMBER 2008 AIG’s credit ratings were downgraded below "AA" levels, causing the company to suffer a liquidity crisis. The United States Federal Reserve Bank created an $85 billion credit facility to help AIG meet increased collateral obligations, in exchange for stock warrants worth 79.9% of the company’s equity. H I S T O R Y
H I S T O R Y LATE SEPTEMBER 2008 Two weeks after AIG was bailed out, the company held a $443,344.71 party for its salespeople at the St. Regis Resort in Dana Point, California.
H I S T O R Y Since September 2008, AIG has been marketing its assets to pay off its government loans. A decline in the valuation of insurance businesses, and the weakening financial state of potential bidders, has hindered its efforts (Barr 2009). AIG subsidiary, International Lease Finance Corp. (ILFC), Los Angeles, CA
H I S T O R Y MARCH 2, 2009 AIG reported a fourth quarter 2008 loss of $61.7 billion. The announcement of the loss had an impact on morning trading in Europe and Asia, with the FTSE100, DAX and Nikkei all suffering steep losses. In the U.S., the Dow Jones Industrial Average fell to below 7000 points, a twelve-year low. H I S T O R Y
H I S T O R Y On top of these losses, in March 2009, AIG was attacked by the public and media for its retention payments of $165 million. March 18, 2009, Liddy waits to testify on Capitol Hill.
March 23, 2009, Now-blank marquee on AIG building in New York City. As a result of public anger over these employee bonuses, AIG has rebranded a majority of its business under AIU Holdings, Inc. (Kaiser & Daly 2009). H I S T O R Y
H I S T O R Y Liddy announced on May 21, 2009 that he is resigning , but will stay until a new CEO is hired. He receives an annual salary of $1 and equity grants, though he may be "eligible for a special bonus for extraordinary performance payable in 2010" (Barnes 2009).
H I S T O R Y To date, the U.S. government’s total loan package to AIG has topped $182.5 billion (Hamilton, 2009).
F I N A N C I A L C O N D I T I O N AIG CURRENT FINANCIAL HIGHLIGHTS from MSN Money, July 20, 2009. -557.83% Net Profit Margin 0.00 Dividend Rate -720.86 Earnings/Share 340.12 Book Value/Share N/A Payout Ratio 130.87 Revenue/Share 4.09 Debt Equity Ratio -155.05% Return on Equity -97.25 Bil Income 17.53 Bil Sales
F I N A N C I A L C O N D I T I O N AIG REVENUE – QUARTERLY RESULTS (in Millions) from MSN Money, July 20, 2009. 20,458.0 N/A N/A N/A 20,458.0 FY (12/09) 11,104.0 -23,758.0 898.0 19,933.0 14,031.0 FY (12/08) 31,150.0 2 nd Quarter 110,064.0 Total 18,433.0 4 th Quarter 29,836.0 3 rd Quarter 30,645.0 1 st Quarter FY (12/07)
F I N A N C I A L C O N D I T I O N AIG EARNINGS PER SHARE – QUARTERLY RESULTS (in Millions) from MSN Money, July 20, 2009. -$39.67 N/A N/A N/A -$39.67 FY (12/09) -$742.94 -$459.02 -$181.04 -$41.13 -$61.75 FY (12/08) $32.87 2 nd Quarter $46.93 Total -$41.51 4 th Quarter $23.95 3 rd Quarter $31.62 1 st Quarter FY (12/07)
F I N A N C I A L C O N D I T I O N AIG QUARTER OVER QUARTER ESP GROWTH RATE from MSN Money, July 20, 2009. N/A N/A N/A 91% FY (12/09) -154% -340% 33% -49% FY (12/08) 4% 2 nd Quarter N/A 4 th Quarter -27% 3 rd Quarter --- 1 st Quarter FY (12/07)
F I N A N C I A L C O N D I T I O N AIG YEAR OVER YEAR ESP GROWTH RATE from MSN Money, July 20, 2009. N/A N/A N/A 36% FY (12/09) N/A N/A N/A N/A FY (12/08) N/A 2 nd Quarter -1,006% 4 th Quarter N/A 3 rd Quarter N/A 1 st Quarter FY (12/07)
The financials for 2008 were not good, as AIG posted a $99 billion loss for the year. The first quarter of 2009 looks promising, however, with revenue in the first quarter of 2009 outperforming all of 2008. Earnings-per-share is poor, but the first quarter 2009 loss was considerably lower than fourth quarter 2008. It is the hope of the markets that AIG has started to rebound from the low points of their 2008 crisis. F I N A N C I A L A N A L Y S I S
Many factors led to the ultimate takeover of American International Group (AIG) by the U.S. Federal Reserve in September 2008. NYC CAUSES OF FAILURE
CREDIT DERIVATIVES AIG’s trouble began when its Financial Products (FP) unit started selling credit default swaps. AIG FP developed a portfolio of $2.7 trillion in credit derivatives (Leonard, 2008). AIG became liable for much more money than it could pay out if the portfolios were to default. In 2008, AIG FP piled up $40 billion in losses related to its dealings in complex mortgage bond derivatives (Saporito, 2009). NY Times, 5/14/09 CAUSES OF FAILURE
FRIENDS IN WASHINGTON AIG was able to engage in risky business for so long because Washington looked the other way. The company befriended politicians with campaign contributions, escaping regulation that might have prevented the current crisis (Saporito, 2009). CAUSES OF FAILURE
POOR REGULATORY OVERSIGHT Regulators never imagined the extent of the looming defaults. AIG's uncollateralized insurance business was regulated by Washington's Office of Thrift Supervision, whose task is to watch over savings-and-loan companies, not global insurers (Saporito, 2009). Evidently it wasn't watching AIG. CAUSES OF FAILURE
POOR REGULATORY OVERSIGHT Joseph Cassano built up AIG FP on what's been described as regulatory arbitrage. As Federal Reserve Chairman Ben Bernanke explained, "AIG exploited a huge gap in the regulatory system. There was no oversight of the Financial Products division. This was a hedge fund, basically, that was attached to a large and stable insurance company" (Torres & Son, 2009). CAUSES OF FAILURE
CASSANO’S “FRANKENFINANCE” Cassano built his business unit upon "Frankenfinance” (Browning, 2008). He had no background in quantitative finance, and didn’t fully understand the business he was running (Progressive, 2009). Also, his judgment was clouded by his insecurity. Cassano resigned as Chief Executive of AIG FP in March 2008 after the company surprised investors by disclosing losses at the unit. CAUSES OF FAILURE
CAUSES OF FAILURE NO COLLATERAL REQUIREMENTS With its high credit rating, AIG FP wasn't required to stockpile reserves to cover potential losses (Saporito, 2009). Cassano said in August 2007 that he couldn't imagine a situation in which AIG would "lose one dollar in any of these transactions” (Saporito, 2009). Once the company lost its top credit rating, AIG FP should have stopped writing swaps and hedged, or reinsured, its existing ones (Saporito, 2009). But it didn’t.
CAUSES OF FAILURE CARELESS RISK MANAGEMENT When it was initially writing all that CDS protection, AIG thought it wasn't possible to take any losses because its contracts were supporting such highly rated, highly protected slices, according to a former AIG FP employee (Eisinger, 2008). AIG FP lost more than $10 billion in 2007 and $14.7 billion in the first six months of 2008 (Fox, 2008).
GREED By 2007, the CDS market had grown into a $70 trillion annual business. In selling CDS, AIG was receiving huge payments . AIG's FP unit was an endless money machine, adding $6 billion of riches to AIG's reserves from 1988 until 2005 (Lenzner, 2008). CAUSES OF FAILURE
CAUSES OF FAILURE DON’T ASK, DON’T TELL As long as AIG FP was producing a profit, senior management didn’t ask or care how it was being achieved. Martin Sullivan (fired from being Chief Executive of AIG in June 2008) had even eliminated a twice-a-month meeting to assess the work of the unit. He just wasn’t interested (Browning, 2008).
CAUSES OF FAILURE DANGEROUS EMPLOYEE INCENTIVES Howard Sosin founded AIG FP in 1987, and remained there until 1993. When he was first hired, he was offered a 20 percent stake in the FP unit and 20 percent of its profits (Browning, 2008). While many hedge fund managers receive this type of incentive program, this a conflict of interest . This causes a manager to throw caution to the wind in order to make a profit. Understanding that the higher the risk, the higher the expected return, Sosin was given almost free reign.
CAUSES OF FAILURE SYSTEMIC RISK Insurance companies can handle catastrophic risk but not systemic risk. AIG underwrote systemic risk. "One thing about the insurance model: it relies on diversification as its means to exist," said a top executive at an AIG competitor. "If an insurance company plays in a field where it underwrites systemic risk, that's a totally different experience" (Saporito, 2009).
CAUSES OF FAILURE THREAT OF GLOBAL DISASTER The CDS market is far from transparent. Nobody knew for sure what the consequences of AIG's failure for financial markets would be. The fear was that it could lead to total chaos. On March 10, Bernanke remarked, “In a crisis, the authorities have strong incentives to prevent the failure of a large, highly interconnected financial firm, because of the risks such a failure would pose to the financial system and the broader economy” (FRB Speech, 2009).
CAUSES OF FAILURE HUGE BONUS PAYOUTS After its bailout, AIG’s payout of retention bonuses, not to mention luxury trips and other perks, has caused AIG further failure in the form of a public relations fiasco .
R I S K S T A K E N April 30, 2009, Demonstrators outside AIG Headquarters in NYC.
CREDIT RISK The level of credit risk that AIG insured by selling credit default swaps (CDS) was far beyond what it could tolerate. The company mismanaged CDS selling because it failed to plan for what would happen if the assets protected by the swaps would default on a large scale.
<ul><ul><ul><ul><ul><li>O P E R A T I O N A L R I S K S </li></ul></ul></ul></ul></ul>Computer Models AIG placed too much faith in math that told them the worst would never happen. Credit risks were justified because computer simulations showed only a tiny chance that the firm would ever have to pay out anything.
OPERATIONAL RISKS Employee Quality Control One of the AIG’s familiar arguments about retention bonuses is that it must keep in place the people who helped cause the catastrophe because new talent is nearly impossible to find. AIG is still keeping Senior Vice President and Chief Risk Officer Robert Lewis in place, though he may be one of the prime culprits of AIG's collapse (Carney, 2009 & WSJ, 2009).
OPERATIONAL RISKS Compensation Practices Focus on retention bonuses means that executives are getting paid not for their results, but rather for their reputation (Gellner, 2009). This tends to weaken the solvency of the company, as more money goes to compensation expenses rather than to reinvestment in more tangible assets. Estate of AIG Executive James Hass, Fairfield, CT
LIQUIDITY RISK On Sept. 15, 2008, AIG lost its AA credit rating. Moody's and S&P downgraded it immediately after Lehman failed. It had already been downgraded from AAA in 2005. The ratings downgrade triggers in its CDS contracts forced AIG to post $15 billion in collateral. AIG couldn't come up with that much cash on short notice.
MARKET RISKS AIG plunged into lucrative new markets without thoroughly understanding of market risk. AIG was unprotected and unprepared when the assets underlying its credit default swaps failed in great numbers. OPERATIONAL RISKS April 3, 2009, March on Wall Street & AIG as part of the Bail Out People, Not Banks Protest. M A R K E T R I S K S
<ul><li>AIG plunged into lucrative new markets without thoroughly understanding MARKET RISK. </li></ul><ul><li>AIG had believed, before its collapse, it would have to take a very unlikely systemic failure for its CDS business to go sour (Fox, 2008). </li></ul><ul><li>AIG was never stopped from growing “too big to fail.” </li></ul><ul><li>AIG did not realize that all of its CDS contracts were highly correlated. </li></ul>
LEGAL RISKS AIG’s use government money has invited legal trouble. One recent example is that insurance regulators are looking into allegations that AIG is under-pricing coverage (Hoffman, 2009).
REPUTATIONAL RISKS AIG’s reputation was in the gutter when it got bailed out. Since then, the company has not done much to salvage its character. Does it even matter? More large bonuses are now scheduled to be handed out to executives at AIG. It will be a miracle if the company can recover and ever sell off it’s assets to repay American taxpayers.
LESSONS LEARNED Retain the Talent and Reward Properly In the era of downsizing and mergers, those employees who push a company forward are the most valuable.
LESSONS LEARNED Transparency is Essential Without transparency, as in AIG's case, there is miscommunication, scandal and inefficiency, which ultimately impacts the entire chain.
LESSONS LEARNED Gain Shareholder Trust Open up more to the public, offer added value and education, and build trust (Moore, 2009).
W H A T I S W O R K I N G <ul><li>The AIG bailout has helped stabilize the financial markets. Federal money has helped AIG redeem some of its derivatives contracts, getting them off its books and out of the system. </li></ul><ul><li>It’s also helping AIG unwind itself. Had AIG been forced to liquidate those assets, AIG would have gotten pennies on the dollar for valuable assets and many other businesses would suddenly have been devalued, too. </li></ul><ul><li>It’s keeping AIG’s insurance businesses stable. If AIG had been forced to liquidate, it would have affected its insurance units and millions of policyholders. With a more orderly process underway, the policyholders are now completely protected (Newman, 2009). </li></ul>
W H A T I S N O T W O R K I N G <ul><li>Revolting bonuses. Giving bonuses to the people who brought down AIG is a perversion of justice. Officials at the Federal Reserve and the Treasury Dept. should have put terms into the original bailout agreement that prevented this. </li></ul><ul><li>Counterparty payouts. AIG has used much of its government aid money to refund money to big banks and other “counterparties,” to cash out some of those credit-default swaps and reduce AIG’s liabilities. However, regulators still haven’t explained why the counterparties got all their money back. </li></ul><ul><li>Secrecy. We (taxpayers) keep learning the terms of the AIG bailout well after the fact . In general, we should learn the details of the bailout as they occur (Newman, 2009). </li></ul>
CONCLUSION Between the CDS and securities lending, AIG still has lots of work to do. The government’s burden of AIG will not go away anytime soon. AIG has "made meaningful progress," but the company is still at the mercy of the economy (Saporito, 2009). In the businesses it wants to keep, like commercial insurance, competitors see an opportunity to grab market share. For the assets it wants to sell, there are few buyers. What remains is still a giant, vulnerable company.
R E F E R E N C E S Barnes, P. (2009, March 20). Treasury, Fed Reviewed AIG Bonus Info Months Ago. Retrieved June 30, 2009, from http://www.foxbusiness.com/story/markets/industries/finance/treasury-fed-reviewed-aig-bonus-info-months-ago/ Barr, A. (2008, May 9). AIG's shares fall 9% on record loss, $12.5 billion capital plan - MarketWatch . Retrieved July 1, 2009, from http://www.marketwatch.com/story/aigs-shares-fall-9-on-record-loss-125-billion-capital-plan Browning, L. (2008, September 8). AIG’s House of Cards . Retrieved July 9, 2009, from http://www.portfolio.com/news-markets/top-5/2008/09/28/AIGs-Derivatives-Run-Amok Carney, John (2009, March 27). The Business Insider. AIG's Whole Toxic Risk Management Team Still Happily Employed. Retrieved July 13, 2009 from, http://www.businessinsider.com/aigs-toxic-risk-management-team-still-happily-employed-2009-3 Eisinger, J. (2008, September 18). What Went Wrong at A.I.G.? Retrieved July 9, 2009, from http://www.portfolio.com/news-markets/top-5/2008/09/18/What-Went-Wrong-at-AIG FRB Speech - Bernanke, Financial Reform to Address Systemic Risk--March 10, 2009 . (2009, March 10). Retrieved July 9, 2009, from http://www.federalreserve.gov/newsevents/speech/bernanke20090310a.htm
R E F E R E N C E S (c o n t.) Fox, J. (2008, December 30). Did those people at AIG not understand anything about financial risk? Retrieved July 16, 2009, from http://curiouscapitalist.blogs.time.com/2008/12/30/did-those-people-at-aig-not-understand-anything-about-financial-risk/ Fox, J. (2008, September 16). Why the Government Wouldn't Let AIG Fail . Retrieved July 9, 2009, from http://www.time.com/time/business/article/0,8599,1841699,00.html Gellner, R. (2009, July 10). AIG bonus payments create self-destructive atmosphere . Retrieved July 16, 2009, from http://www.examiner.com/x-11326-Liberal-Examiner~y2009m7d10-AIG-bonus-payments-create-selfdestructive-atmosphere Hamilton, J. (2009, May 9). Edward Liddy: JengaPig CEO? Retrieved July 1, 2009, from http://www.examiner.com/x-8616-Houston-Workplace-Examiner~y2009m5d22-Edward-Liddy-JengaPig-CEO Hoffman, M. A. (2009, July 13). New York, Pennsylvania probe AIG pricing allegations| Business Insurance . Retrieved July 16, 2009, from http://www.businessinsurance.com/article/20090713/NEWS/907139988 Kaiser, E., & Daly, C. B. (2009, March 18). AIG CEO asks employees to repay some bonus money - Reuters . Retrieved July 1, 2009, from http://www.reuters.com/article/ousiv/idUSN1731687320090318 Lenzner, R. (2008, September 28). Why Wasn't AIG Hedged? Retrieved July 9, 2009, from http://www.forbes.com/2008/09/28/croesus-aig-credit-biz- cx_rl_0928croesus.html
R E F E R E N C E S (c o n t.) Leonard, A. (2009, March 18). There's still risk it could all blow up . Retrieved July 9, 2009, from http://www.salon.com/tech/htww/2009/03/18/aigs_ceo_takes_the_stand/ Madsen, W. (2008, September 23). AIG is a special case . Retrieved July 1, 2009, from http://onlinejournal.com/artman/publish/article_3777.shtml Moore, G. (2009, March 27). Transparency, Talent, Trust: What can Pharma learn from AIG. Retrieved July 21, 2009 from, http:// social.eyeforpharma.com/blogs/ged - moore /transparency-talent-trust- what-can- pharma-learn-aig Newman, R. (2009, March 17). What’s Good, What’s Bad About the AIG Bailout. Retrieved July 21, 2009 from, http://www.usnews.com/blogs/flowchart/2009/03/17/whats-good-whats-bad-about-the-aig-bailout.html Progressive. (2009, July 8). The Man Who Crashed the World . Retrieved July 9, 2009, from http://www.propeller.com/story/2009/07/08/the-man-who-crashed-the-world Saporito, B. (2009, March 19). Time. How AIG Became Too Big to Fail . Retrieved July 1, 2009, from http://www.time.com/time/business/article/0,8599,1886275,00.html The Wall Street Journal (2009, March 27). Top Risk Officers Remain at Insurer's Helm. Retrieved July 13, 2009 from, http://online.wsj.com/article/SB123812287215554481.html Torres, C., & Son, H. (2009, March 3). Bernanke Says Insurer AIG Operated Like a Hedge Fund (Update 3) . Retrieved September 9, 2009, from www.bloomberg.com/apps/news?pid =20601087&sid= aCrzJbsxzKdk