Too Big to Fail [88]
Ultimately it was clashes with regulators, not family members, that led to the downfall of Hank Greenberg. Headstrong and combative as ever, Greenberg simply picked the wrong time to take a stand against the feds. After the collapse of Enron and a procession of corporate scandals that dominated the front pages at the start of the new century, regulators and prosecutors became emboldened to come down hard on companies that were proving to be uncooperative. In 2003, AIG agreed to pay $10 million to settle a lawsuit brought by the Securities and Exchange Commission that accused the company of helping an Indiana cell phone distributor hide $11.9 million in losses. The settlement figure was relatively high, as the SEC acknowledged at the time, because AIG had attempted to withhold key documents and initially gave investigators an explanation that was later contradicted by those documents.
The following year, after yet another long tussle with federal investigators, AIG agreed to pay $126 million to settle criminal and civil charges that it had allowed PNC Financial Services to shift $762 million in bad loans off its books. As part of that settlement, a unit of AIG was placed under a deferred prosecution agreement, meaning that the Justice Department would drop the criminal charges after thirteen months if the company abided by the terms of the settlement. (After the indictment of the giant accounting firm Arthur Andersen had led to its collapse, the government preferred the softer cudgel of deferred prosecution agreements as a kind of probation—an approach that had previously been more common in narcotics cases.)
It was the AIG unit that had been placed on probation for thirteen months—AIG Financial Products Corp., or FP for short—that became Ground Zero for the financial shenanigans that would nearly destroy the company.
FP had been created in 1987, the product of a remarkable deal between Greenberg and Howard Sosin, a finance scholar from Bell Labs who became known as the “Dr. Strangelove of Derivatives.” A great deal of money can be made from derivatives, which are, in simplest terms, financial instruments that are based on some underlying asset, such as residential mortgages, to weather conditions. Like the bomb that ended the film Dr. Strangelove, derivatives could, and did, blow up; Warren Buffett called them weapons of mass destruction.
Sosin had been at Drexel Burnham Lambert, Michael Milken’s ill-fated junk bond operation, but left before that Beverly Hills–based powerhouse folded amid an epoch-defining scandal that drove it into bankruptcy in 1990. Seeking a partner with deeper pockets and a higher credit rating, Sosin fled to AIG in 1987 with a team of thirteen Drexel employees, including a thirty-two-year-old named Joseph Cassano.
Working from a windowless room on Third Avenue in Manhattan, Sosin’s small, highly leveraged unit operated almost like a hedge fund. The early days at the firm were awkward: The wrong rental furniture arrived at the office, and employees had to make do for a while sitting on children’s chairs and working on tiny tables—generating almost immediately, nevertheless, the same immensely profitable returns as they had at Drexel. As was the practice with some hedge funds, the traders got to keep some 38 percent of the profits, with the parent company getting the rest.
The key to the success of the business was AIG’s triple-A credit rating from Standard & Poor’s. With it the fund’s cost of capital was significantly lower than that of just about any other firm, enabling it to take more risk at a lower cost. Greenberg had always recognized how valuable the triple-A rating had been to him and guarded it carefully. “You guys up at FP ever do