All the Devils Are Here [202]
He also tried to bring AIG into the modern age, spending millions to upgrade the systems that Greenberg had always ignored. But in truth, these were mainly cosmetic changes. What Sullivan didn’t do—what he lacked the capacity to do—was change AIG at its core. The silos that Greenberg had erected still existed. The sharing of information, especially bad news, was almost nonexistent. Division heads told headquarters only what they wanted headquarters to hear; there were still no systematic processes that cut across all divisions, the way there are at most big companies. Division managers could reach for extra profits however they saw fit—even if it entailed taking undue risk. Because executives didn’t fear Sullivan the way they’d feared Greenberg, they often took liberties they would never have taken under Greenberg. Sullivan lacked the force of personality to curb their excesses.
Risk management, in particular, was a glaring weakness under Sullivan. Whatever Greenberg’s other shortcomings, he did have a keen sense for when to take a risk and when to pull back—and of course he had all the information he needed at his fingertips, because when Hank Greenberg demanded it, he got it. Regular meetings that Greenberg had conducted about risk were canceled by Sullivan, who bumped most risk decisions to underlings. Under Sullivan, the risk managers were almost entirely dependent on the division heads for information. They often didn’t have enough information to push back in areas where excessive risk might be building up. And they treated each division’s risks as individual issues, never looking across the entire corporation to see if there were company-wide risks that needed to be addressed.
AIG’s securities lending program, which was run out of the investment division, was a classic example of the company’s risk management failings. That was the program in which, for a fee, AIG would lend out its securities to short sellers, who put up cash collateral. Then it would invest the proceeds in short-term securities that could be sold quickly when the short seller wanted his cash back. At the end of Greenberg’s last full year, 2004, AIG had already begun the dangerous practice of investing some of the cash in mortgage-backed securities, which generated a higher return for AIG but were hardly the kind of short-term, liquid securities that could easily be sold.
In late 2005, the executive in charge of the securities lending program went to Bob Lewis, requesting that the company raise the limit on the securities he was allowed to purchase in the mortgage market. He also wanted to rev up the program itself, which at the end of 2004 had a balance of $53 billion. He made this request at the very same time that AIG-FP had decided to stop insuring the super-senior tranches because the subprime underwriting standards had deteriorated so badly. A well-run risk department would have immediately realized that one AIG division was asking to take more risk in the exact area where another division, far better versed in these kinds of securities, was cutting back. A good risk manager would have said no.
But Lewis did not say no. Instead, he cut a deal. As he later testified before the Financial Crisis Inquiry Commission, he agreed to raise the limit, but insisted that the securities lending program only invest in the “highest-quality” residential mortgage-backed securities. “No CDOs,” he added. But while the securities the investment division bought weren’t CDOs, they were still securitized subprime mortgages that had the same underwriting problems that FP was worried about. By the end of 2006, the balance on the securities lending program had risen by $20 billion, to $73 billion. And by the end of 2007, it had risen to $83 billion—by which time clients were rushing to return the securities they had borrowed and get their cash back. Because the mortgage-backed securities AIG owned were impossible to sell, the securities lending program began to have cash shortfalls—$6.3 billion by the end of 2007, and a staggering $13.5 billion