AIG Liquidity Crisis

American International Group, Inc is an American insurance corporation that was founded in 1919 (Sjostrom, 2009). The company operates in over 130 countries. Founder, Cornelius Vander Starr, ran the company until 1968 when he turned AIG over to Hank Greenberg. At that time, AIG was a privately held corporation (How Hank Did It). Greenberg had been running AIG for 37 years, longer than any other U.S. major corporation CEO. HeGreenberg transformed the company into the largest insurer in the world, made AIG the number 9 company on the Fortune 500 list, and at the end of 2005 the company’s $850 billion of assets made it the fourth largest company in the U.S. (How Hank Did It). The company consists of general insurance, life insurance & retirement services, and financial services and asset management. The general insurance unit engages in commercial property, casualty, workers’ compensation, and mortgage guarantee insurance. The financial services unit leases capital for equipment and aircraft, capital market transactions, consumer finance, and insurance premium finance. The asset management division engages in several investment related services and investment products to individuals, institutions, and pension funds (Sjostrom, 2009). In February 2005, American International Group, Inc. was subpoenaed by Eliot Spitzer, New York state’s attorney general, for documents relating to accounting fraud having to do with transactions known as finite insurance (How Hank Did It). AIG booked $500 million as income for the loss portfolio transfer and then added $500 million in reserves for the year 2000. The parties also at fault were the executives from General Re, a subsidiary of Berkshire Hathaway. This involved a loss portfolio transfer from General Re (the primary insurer) to AIG (the reinsurer). The transaction should not have been counted as an insurance deal. The $500 million should have been accounted for as deposits on AIG’s books, instead the company boosted its loss in reserves (Hulburt, 2005). There was also no underwriting risk associated with the deal. The $500 million was basically a loan from Gen Re to AIG that AIG would repay the money in claims payments to Gen Re (Hulburt, 2005). Investigators also wanted to find out if the company kept some Caribbean subsidiaries off its books to understate the true leverage of its operations and hide the risks it had insured (How Hank Did It). AIG was also under investigation by the New York Insurance Department, the Securities and Exchange Commission, and the United States Justice Department. On March 14, 2005 Hank Greenberg, AIG’s CEO was forced to step down and a few weeks later, he was also forced to step down as the chairman of the Board of Directors (How Hank Did It). Once Greenberg stepped down, Spitzer stated that if AIG cooperated in the investigation, that he would not bring about criminal charges. The directors cooperated and at the end of April the board released the results of its own investigation of accounting indiscretion (How Hank Did It). On May 31, 2005, AIG filed its 10-K report, in which it restated its financials for the years 2000, 2001, 2002, 2003, and 2004. AIG adjusted its net income for the five-year period downward by $3.924 billion, or 10.4 percent. AIG also adjusted its stockholders’ equity for the year 2004 downward by $2.264 billion, or 2.7 percent. Between February 11, 2005 and May 31, 2005, AIG’s stock price fell by nearly 25 percent (Hulburt, 2005). On February 9, 2006 AIG and the New York State’s Attorney General’s Office agreed to a settlement in which AIG would pay a fine of $1.6 billion. On February 26, 2008, five executives from AIG and General Re were found guilty by a federal jury for their roles in the scandal; they were convicted of 16 counts of a conspiracy to boost AIG’s reserves (All Five convicted for aig-gen re deal, 2008). The five executives on trial were Ronal Ferguson, Christopher Garand, Elizabeth Monrad, and Christian Milton. Milton was the AIG VP for reinsurance while the others were employed by General Re. They were convicted of conspiracy, securities fraud, making false statements to the SEC, and mail fraud. Mr. Garand faces a maximum of 160 years in prison and up to $29.5 million in fines. The remaining four could receive a maximum of 230 years in prison and $46 million in fines. Prosecutors also introduced into evidence dozens of tapes that captured some of the defendants in conversation about the deal. The recordings came from a Gen Re system that automatically recorded calls in case there was an insurance derivative trade dispute (All Five convicted for aig-gen re deal, 2008). So basically the big scandal at AIG all stemmed from cooking the books to make revenues and assets seem much higher than they actually were. A huge part leading to the investigation by the SEC, Spitzer, and others was the fore-mentioned $500 million transfer of loss portfolios between AIG and Gen Re, but this was not all that AIG was up to. The SEC wanted to know if Greenberg had found to way to manipulate stock price other than by his books. To no surprise they found that with a little pressure to the experts and his friend, Richard Grasso, chairman of the NYSE, he was in fact able to do that as well. It turned out that throughout his life Greenberg had been very good and making almost any situation advantageous to him or in this case, his company. Being the type of man he was, Greenberg, regularly rubbed shoulders with important people, as this was seen in his political side. Since he operated internationally and nationally he had also developed certain closeness with political figures and regulators both in the US and around the world. All of these special pieces of what made the company operate so well is also what eventually got them in trouble. Eventually it was time for the US government to step in and take the reins. They made it very clear that the governmental aid was not to help AIG get back on its feet, but instead due to the fact that AIG had become so intertwined with so many important businesses that its’ failing could cause a collapse of the United States economic market. Justin Fox says it simply, “Essentially, AIG got into the business of insuring much of the world's financial system against the consequences of a global financial meltdown. It turned out to be incapable of delivering on that insurance—no private company could deliver on it, which is one reason why AIG's business of selling credit default swaps was a scam. And so government has stepped in as the ultimate insurer.” (Fox)
The government had given bailout money in multiple stages which makes it very hard to track and understand, but in total they received roughly $180 billion and were taken over by the government. Eighty-five billion of which was a loan to AIG at the rate of 11%. The government promptly installed new management and ordered the firm to sell off its profitable subsidiaries immediately to start paying off their debt. At this point the government and the American people own AIG and they are still climbing out of their gigantic hole. As we learned with Enron, now AIG, and many other scandals in the past ten years, things are changing in the US. Technology is at an all-time high and continues to improve nearly every day. In fact, we double the amount of storage space per square in computers once every 18 months, which is a significant change from the original computers which took up a whole room. This added technology and gained intelligence by the American people, lawmakers, and regulators nearly ensures that companies that use illegal practices (especially in accounting areas) will get caught in today’s world. Personally, it makes me wonder how much we really grew in the 1990s and how much was fraudulently recorded. Lessons to be learned are quite simple. First and foremost, don’t cheat, don’t lie, don’t steal, don’t falsify, don’t misrepresent, or purposely mislead… today, you will get caught and prosecuted. Furthermore, these practices “drag a business’s name through the mud” and make them look horrible to public opinion. This, in turn, drives stock price and shareholder wealth into the ground as well. Obviously today it is simply better to be good at legal, ethical business. Since the scandal between AIG and Gen Re new reform measures have been imposed in the reinsurance game. “Because accounting for reinsurance contracts as insurance contracts, rather than as investment contracts, is so appealing to companies’ financial statements, companies like AIG have been tempted to (and guilty of) report(ing) reinsurance contracts as insurance contracts, even when there is no underwriting risk transfer present.” (Hulbert) Hopefully, we are ready to prevent a disaster like this from every happening again.

References
All Five convicted for aig-gen re deal . (2008, February 26). Retrieved from http://www.tech-decisions.com/News/2008/2/Pages/All-Five-Convicted-For-AIG-Gen-Re-Deal.aspx

Fox, Justin. "Why the AIG bailout just keeps getting bigger - The Curious Capitalist - TIME.com." The Curious Capitalist - Commentary on the economy, the markets, and business - TIME.com. Web. 09 Feb. 2010. .

How Hank Did It. Fallen Giant. Retrieved February 8, 2010, from Google Scholar.

Hulburt, Heather. (2005). Financial reinsurance and the aig/gen re scandal. Google Scholar, Retrieved from http://www.cpcusociety.org/file_depot/0-10000000/0-10000/3267/conman/CPCUeJournalNov05article1.pdf

Sjostrom, W.. (2009). The AIG Bailout. Washington and Lee Law Review, 66(3), 943-991. Retrieved February 4, 2010, from ABI/INFORM Global. (Document ID: 1916868411).