We are pleased to present our interview Roddy Boyd, the author of a fantastic book on AIG titled, Fatal Risk: A Cautionary Tale of AIG’s Corporate Suicide. Roddy was kind enough to sit down and talk about his experience, his book, and some of the fraudulent companies which he has uncovered. Roddy’s full bio can be found at the bottom of this article.
Can you tell us a little bit about your background?
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1. For about five years I worked on Wall Street at a convertible securities broker-dealer as an analyst and then trader and then spent another year on the buy-side as an analyst for a long/short fund. Though I left Wall Street behind, I have to say it gave me two things: a decent working insight into how the world of finance operates and a comfort level with studying documents and working with numbers. This served me well as I worked my way around the New York financial media over the past dozen years. Thinking on it, let me throw in a third: being able to handle angry people and see past a steady stream of invective to the (possibly) more rational person at the core.
What inspired you to write the book?
2. I had covered American International Group, Inc. (NYSE:AIG) at the New York Post and Fortune Magazine when it was a daily headline maker ca. 2005-2008 and found, at the risk of sounding snide, that much of the coverage was missing the real story. For example, it was never clear to me why former New York Attorney General Spitzer’s claim’s were so uncritically accepted among the media; the man “complained” on 22 or so points and filed his claim on 14, later dropping the number of charges to eight. That said, there was an absurd amount of troubling activity at American International Group, Inc. (NYSE:AIG) and in many ways it was the perfect way into the series of concentric financial stresses we call “The Credit Crisis.” Because so much of AIG was misunderstood in both financial and media circles, I thought there might be some profit to examining it in-depth.
What aspect did regulation (or lack-thereof ) play in regards to AIG’s collapse?
3. With respect to regulation, I think it is best to note “the authorities” are almost always four beats behind what Wall Street is doing. Why Glass-Steagall was so important, or rather, why its elimination in November 1999 was a crucial event, was that it took away the single most important “check and balance” ever placed on Wall Street. When commercial banks–funding overnight via the Fed, thus, with little short-term capital constraint–were allowed to aggressively build up risk-based assets, the “pressure valves” were removed from the equation. Traditionally, investment banks had capital constraints and were unable to operate with high leverage for sustained periods, the ultimate form of structural risk management. To compete with JPMorgan Chase & Co. (NYSE:JPM), Citigroup Inc. (NYSE:C) and Bank of America Corp (NYSE:BAC) –who had gobbled up I-banks and had adopted their risk-oriented cultures–Lehman, Bear Stearns and Merrill Lynch ran at 30 times their equity capital (and often more.) Much hilarity did not ensue. Assessing the wreckage of it all, we should be gimlet-eyed and acknowledge that B of A and Citigroup Inc. (NYSE:C) would have collapsed without government rescue (as would Merrill Lynch and AIG of course; a credible argument could be made that Goldman Sachs would have gone as well.)
In a practical sense, this was best illustrated when UBS AG (NYSE:UBS) began liquidating its nearly $100 billion mortgage/ real estate securities book in 2006-2007. It did so into a marketplace where the aforementioned geniuses (Morgan Stanley (NYSE:MS) deserves some mention here too) were sitting there highly levered and ill-hedged. Ultimately, we had hundreds of billions of dollars worth of paper hitting the Street at a time when equity balances were at an all-time low.
This devolved a rout into a broad-based collapse. AIG, especially its global securities lending program and its Financial Products unit, was “the whale” in a market defined by massive and unhedged positions, an absence of liquidity, with counter-parties who were both capital-constrained and mis-marked. The real estate debacle of 2008 would have assuredly happened in some form or another, but the capital deployment to risk-based assets made the collapse take on a depth and velocity unlike any others.
Glass-Steagall, or some like-minded separator of commercial and investment banks, should be promptly reinstated, as our regulators and policy leaders have demonstrated an unwillingness to let these institutions die. Frankly, I am of the mind that the government should A) force divestiture of the investment banks from Bank of America Corp, Citi and J.P. Morgan and B) ultimately, that all investment banks should (like law and accounting firms) be prevented from being publicly traded, even if this means that federal money be used for some book-value based privitization scheme.
What do you think went wrong?
4. AIG simply grew too big and had a management that ill understood the risks of financial leverage. More specifically, there were too many risk-taking or capital markets facing entities, a consequence of a make-your-numbers culture. Though Hank Greenberg, AIG’s guiding light since the 60s was a legitimate groundbreaker and deserves the credit given him, he had an absolutely second-tier “bench” below himself, vice-chair for Finance Ed Matthews and CFO Howie Smith. This was absurd. Lloyd Blankfein, Gary Cohn and David Viniar could all fall off the face of the earth tomorrow and Goldman Sachs would have competent executive level leadership in place within minutes. AIG, clearly, could say no such thing.
Was it possible at a certain point for investors or regulators to ascertain what Joe Cassano was doing in AIGFP?
5. It was damned near impossible for anyone who was not an experienced financial detective like Jim Chanos and his staff at Kynikos–the only short-seller I could identify short AIGs shares for a protracted time–to get an inkling of what the company was up to at AIG Financial Products. I would emphasize “inkling” since Chanos and team could only deduce that the $1.2 billion dollar collateral posting resulting from the Spring 2005 downgrade to AA+ (from AAA) was based on some guarantee. That’s it. Everything else was vague, mortgage-trading desk chatter. Then again: $73 billion in guarantees were struck at Cassano’s FP and no one at General Counsel Anastasia Kelly’s office paid any real attention to the swaps as they approved them.
Does Goldman Sachs deserve the blame it has gotten for AIG’s fall?
6. Goldman Sachs Group, Inc. (NYSE:GS) deserves a fair portion of blame for “2008,” just not much on the AIG front. They acted within their rights enforcing the collateral posting provisions. That’s heresy in certain quarters, I’ll concede, but they did nothing wrong with AIGFP. They appear to have been the only major dealer seeking rational price discovery; it was astonishing to see how FP had to scramble to develop a cogent argument to support its claim that the swaps were worth par.
The rating agencies actions, Moody’s Corporation (NYSE:MCO), The McGraw-Hill Companies, Inc. (NYSE:MHP) were spectacularly debauched throughout the run-up to the crisis and it is bitter bile indeed to swallow their “Free Speech” defense. I can’t rationally assign blame to them for downgrading AIG when they did, however, which of course was the company’s death knell. Their job is to assign ratings honestly and without favor, it’s just ironic that the one time they sincerely did this was at the absolutely worst time possible. S&P 500 was entirely correct to have done what they did as AIG was facing waves of collateral calls from the swaps trades at FP.
Many people think we should have let AIG failed or at least wiped out (certain classes) of bond holders. What are your views on the topic?
7. Well, if our country won’t rationally regulate financial institutions then simply letting them die comes in a commendable second. Since we all know that’s not on offer, they should at least wipe out equity and subordinated debt-holders and over a period of time, say 90 days, mandate the removal of the CEO, Chairman, CFO, GC et al. Why they can’t at least do this much is beyond my understanding.
You blame Eliot Spitzer for part of the collapse, can you elaborate? Former CEO Hank Greenberg is suing AIG for $25 billion, thoughts?
8. My reporting on Spitzer–and I count myself on some levels a fan, even now, of his willingness to do what the SEC and the DoJ wouldn’t do in 2002-2003–was informed by a careful analysis of his claims, the law underlying them and several years of covering the guy’s office. While he usually had some semblance of plausible legal argument, he conducted his prosecutions from 2003 onward with an aim of self-aggrandizement. With AIG, there were periods where he seems to have lost his mind. Threatening the indictment of a $150 billion market cap company because they weren’t removing the CEO fast enough? That’s Gauleiter stuff right there. Many of his claims against AIG were, to varying degrees, opportunistic and ill-reasoned, designed to garner a quick settlement and publicity. I am NOT saying Greenberg or AIG were blameless, but the AG wasn’t factually accurate in his assertions or professional in the fashion he conducted himself.
Greenberg’s forced departure was, from the perspective of the rational conduct of what all agree was an exceptionally complicated company to run, a stupid move. Martin Sullivan and Steven Bensinger were not suited to the tasks of running the company. AIG collapsed from the cash-drain resulting from a tandem of mark-to-market cash hits from FP swaps book and the cash incineration from the securities lending portfolio. Having a weak management team assuredly didn’t help though.
Most of the blame for AIG’s collapse was placed on the FP division in London? Did senior management know what was going on there?
9. AIGFP did not hedge (or even consider hedging) its swaps book. It’s models for analyzing mortgage pool default prospects universally concluded that a mortgage crisis wouldn’t effect the underlying pools in any material fashion. Neither the legal department nor the risk management units had any knowledge of the basic, industry-standard provisions of credit support annexes–the documents governing swaps both parties agree to adhere to. The Securities Lending program employed a long discredited strategy that was almost certainly in violation of the program’s charter. [This hasn’t been asked, but I would say that the AIG Sec Lending program was the single worst idea I have ever seen from a financial institution.]
You talk about AIG losing focus of risk? Everyone has a different definition of risk, what do you think went wrong?
10. AIG did not so much as lose focus of the concept of risk as refuse to be substantively engaged with it. Let’s take an expansive view of risk and call it the array of variables that can, singly or in combination with other factors, create an adverse development. [In this case, the adverse development was financial.] There is no proof I encountered that AIG did more than generate classic “sell-side” models for its foray into mortgage securities. As noted above, since AIG Financial Products chief model builder Gary Gorton generated models carrying using at least an implicit assumption that even stressed mortgage pools remain credit good–and truth be told, FPs have–then there was no real risk to be had. It logically follows that you could price your insurance at eight or nine basis points per $1 million and since few CDOs ever traded below par, or so it seemed, why make a big deal of (far off seeming) issues like mark-to-market accounting? After all, if all CDOs are marked at par every night, then the ISDA agreement concerns about posting collateral for price moves are just so much legal boilerplate.
When you think like that, and it has to be noted this was many times the thought Win Neuger’s team at Sec. Lending put into the matter, risk is not an issue to be concerned with. I would also note that there was the issue of tradition being discarded: At FP, the regimes before Cassano (Howard Sosin and Tom Savage) were outspoken about their broad distrust of mortgage securities and refused to engage in that market, at nearly any level. Hank Greenberg had forbidden Securities Lending from being anything other than a high-liquidity, no credit-risk venture. These policies were thrown out in a most public fashion and dissenters silenced or marginalized, post Greenberg’s dismissal.
You discuss Jim Chanos, quite a bit in the book; What role did he have with AIG?
11. Jim Chanos, the founder of hedge fund Kynikos Associates, and the highest-profile short-seller there is, was the only long term short-seller of AIG I could uncover and as such, a useful literary foil or counterweight to what, in the book, had been a description of decades worth of AIG’s growth and success. From time to time, shorts had played AIG to miss a quarterly number or something similar, but Chanos had been a long time skeptic of AIGs numbers and business model and built a big short in early 2005 as the Spitzer investigation gained traction. He and his staff were quite accurate, almost prescient, especially regarding the swap book, but moral victories don’t pay when it comes to short-selling. Their anticipated major drop in AIGs share price did not happen in 2005, 2006 and 2007, so Kynikos covered their position with a loss in 2007 and moved on to shorting Federal National Mortgage Association (OTC:FNMA), the mortgage insurers, Ambac Financial Group, Inc. (PINK:ABKFQ) and MBIA Inc. (NYSE:MBI)
Can you discuss some of the frauds you uncovered?
12. For the record, I do not short stocks or own puts et al. on anything, let alone what I write about (and I don’t work for anyone who does.) I use The Financial Investigator as a way of fleshing out what I love to do: analyzing the documents of (generally) publicly traded companies for problems. I do it for all it is free and, as one critic of mine remarked, I earn every dollar. There used to be more of this work, but much of financial journalism is now of a pack variety, violently focused on a topic du jour–look at the frenzy around Facebook Inc (NASDAQ:FB)’s offering or Jamie Dimon testimony–and there is virtually no concern for the massive incongruities found in the financial filings of a tech company (to use an example of one potential investigative subject.)
To bring more of this work to the investing public, I am setting up a 501c3 called the Southern Investigative Reporting Foundation that will do more investigative reporting, and release it more often, than FI.com.
Thoughts on Chinese Frauds?
13. Chinese stocks, particularly Chinese reverse mergers, were siren calls of fraud. They were transcendentally fraudulent–risibly fake numbers, absurd documents, the earnest support of crappy investment banks–what was not to love? The whole episode 2009-2011 sort of framed out some thinking I had been developing. Sadly, John Hempton of Bronte Capital beat me to it:
China is in many ways the greatest, most elaborate joke in the history of the capital markets. There may come a day when these issues are addressed by a government acting in good faith, concerned about its role in the world. That day is not directly on the horizon however.
Roddy Boyd, is the author of Fatal Risk: A Cautionary Tale of AIG’s Corporate Suicide. On his website, Thefinancialinvestigator.com, Roddy does “document-driven investigative journalism”, uncovering potential fraudulent stocks. He was recently named one of the most dangerous people in financial media, in article by Josh Brown in the Huffington Post.