Too Big to Fail [91]
In late January of 2008, Willumstad had been sitting in his corner office at Brysam Global Partners when he noticed something startling in a monthly report issued to AIG board members: The FP group had insured more than $500 billion in subprime mortgages, mostly for European banks. That piece of business was actually a very clever bit of financial engineering on FP’s part. To meet regulatory requirements, banks could not exceed a certain level of debt, relative to their capital. The beauty of AIG’s insurance—for a short time, at least—was that it enabled banks to step up their leverage without raising new money because they had insurance.
Willumstad did the math and was appalled: With mortgage defaults rapidly mounting, AIG could soon be forced to pay out astronomical sums of money.
He immediately contacted PricewaterhouseCoopers, AIG’s outside auditor, and ordered them to come to his office for a secret meeting the following day to review exactly what was happening at the troubled unit. No one bothered to tell Sullivan, who was still CEO, about the gathering.
By early February, the auditor instructed AIG to revalue every last one of its credit default swaps in light of recent market setbacks. Days later the company embarrassingly disclosed that it had found a “material weakness”—a rather innocuous euphemism for a host of problems—in its accounting methods. At the same time, a humiliated AIG had to revise its estimate of losses in November and December, an adjustment that raised the figure from $1 billion to more than $5 billion.
Willumstad was vacationing at his ski house in Vail, Colorado, when he finally called Martin Sullivan to deliver the order to fire Joe Cassano.
“You have to take some action on him,” Willumstad said.
A startled Sullivan responded that, even if the firm had to restate its earnings, it wasn’t anything to worry about: They were only paper losses. “Well, you know, we’re not going to lose any money,” he said calmly.
It was now Willumstad’s turn to be taken aback “That’s not the issue,” he said “We’re about to report a multibillion-dollar loss, a material weakness! You have the auditors saying that Cassano has not been as open and forthcoming as he could be.”
Sullivan acknowledged the controversy surrounding Cassano, but was it really necessary that he be fired?
“Two very high-profile CEOs have just been fired for less,” Willumstad reminded him. Charles Prince of Citigroup and Stan O’Neal of Merrill Lynch had both been ousted in the fall of 2007 after overseeing comparably large write-downs. “You can’t not take some action both publicly as well as to send a message to the rest of the organization.”
Finally, Sullivan relented but made one last pitch for Cassano. “We should keep him on as a consultant,” Sullivan recommended.
“Why?” Willumstad asked, as perturbed as he was baffled by the suggestion.
Sullivan maintained that FP was a complicated business and that he didn’t have the resources to manage it without some help, at least initially.
In exasperation Willumstad said, “Take a step back. Just think about it for a minute, both from an internal as well as an external point of view. The guy’s not good enough to run the company, but you’re saying you’re going to need to keep him around?”
Sullivan then appealed to Willumstad’s sense of competitiveness. If the firm kept Cassano on the payroll, he’d wouldn’t be able to jump to a rival firm—which, leaving aside his questionable business schemes, might still be valuable to the company. “If I keep him on a consulting contract, he’ll have a noncompete and he won’t go someplace else and steal all our people.”
On that issue Willumstad finally relented. He was a pragmatist, and consultants were easily gotten rid of.
“Okay,” he agreed, “but you have to figure out how to manage that if you want to keep consulting with him. And you can’t let him stay actively engaged in the business. That’s just insanity.