Dear Mr. Buffett_ What an Investor Learns 1,269 Miles From Wall Street - Janet M. Tavakoli [90]
By June 2008, AIG recorded two back-to-back quarters of its largest losses ever. AIG took more than $20 billion in write-downs on its derivative positions through the first quarter of 2008; net losses for the fourth quarter of 2007 were $5.3 billion, and in the first quarter of 2008, AIG reported losses of $7.8 billion. In February 2008, its auditor said it found “material weakness”6 in AIG’s accounting. Eli Broad, a billionaire real estate baron, Shelby Davis of Davis Selected Advisers LP, and Bill Miller of Legg Mason Inc., were AIG shareholders controlling 4 percent of the company (more than 100 million shares). These already accomplished men may have a hidden talent. Apparently, they can read my mind. These shareholders wanted changes in senior management and a new CEO, and they wrote AIG’s board: “The facts presented . . . preclude any individual who was in a position of significant responsibility and oversight during the last three years from having the credibility to lead this company on a permanent basis.”7 That is shareholder speak for: We are not calling those responsible for oversight big fat liars, we are just saying they have no credibility.
By the summer of 2008, more than nine months after the August 2007 Wall Street Journal story, the Slumbering Esquire’s Club (also known as the SEC) and the Department of Justice were investigating whether AIG had overstated the value of its credit derivatives exposure to subprime mortgages.8 In the summer of 2007, the SEC might have questioned everyone’s accounting. Well, not everyone’s—just several large investment banks and various other entities that the SEC regulates.
Likewise, OFHEO, then regulator of Freddie Mac could have questioned Freddie’s accounting. In 2004, David A. Andrukonis, then chief risk officer for Freddie Mac, was concerned about Freddie’s purchases of bad mortgage loans. He told then CEO Richard Syron that the loans would probably “pose an enormous financial and reputational risk to the company and the country.”9 While taking on more risk was bad enough, the Department of Treasury reviewed Freddie’s books in preparation for a bailout and concluded in September 2008 that its capital cushion had been overstated by Freddie Mac’s accounting methods.10
On July 15, 2008, ex-Goldman Sachs banker and then Treasury Secretary Henry (“Hank”) Paulson asked Congress for the authority to buy stakes in Fannie Mae and Freddie Mac. Paulson asserted: “If you have a bazooka in your pocket, and people know you have a bazooka, you may never have to take it out.”11 In my experience, boasting about a big bazooka just tempts the curious to see how you measure up in exciting circumstances, and the person to do that might be named Mr. Gross. Bill Gross manages the Pimco Total Return Fund, the world’s largest bond fund with large exposures to Fannie Mae and Freddie Mac (and AIG along with a number of investment banks as of September 2008). Gross is a fan of Fed intervention, and his investments reflected it. His fund reportedly gained $1.7 billion after the U.S. government took over Fannie Mae and Freddie Mac on Sept 7, 2008.12 Fannie Mae and Freddie Mac were placed in conservatorship to be run by their new regulator, the Federal Housing Finance Agency (FHFA) headed by James Lockhart, the same gentleman that headed up their former regulator, OFHEO. What was the thinking on choosing Mr. Lockhart—let’s give him another chance, because he cannot possibly do a worse job than he did before? The Treasury