Andrew Sorkin - Too Big to Fail - The Inside Story of How Wall Street and Washington Fought to Save the FinancialSystem--and Themselves

By 1968, Starr was seventy-six and ailing, and with an oxygen tank and vials of pills never far from his side, he turned to Greenberg to crack the American market, naming him president and Gordon B. Tweedy chairman. Greenberg wasted no time in making it clear who was going to be taking the lead. At a meeting soon after his appointment, he and Tweedy were on opposite sides of an argument when Tweedy stood up and began loudly pressing his point. “Sit down, Gordon, and shut up,” Greenberg told him. “I’m in charge now.” Starr, whose bronze bust still greets visitors to AIG’s art deco headquarters, died that December. The following year, AIG went public, and Greenberg became CEO. (Tweedy left soon afterward.)

Under Greenberg, AIG grew rapidly and became increasingly profitable through expansion and acquisitions, doing business in 130 countries and diversifying into aircraft leasing and life insurance. Greenberg himself became the very model of an imperial CEO—adored by shareholders, feared by employees, and a cipher to everyone outside the company. Despite his slight build, he had an intimidating presence. He drove himself relentlessly, eating nothing but fish and steamed vegetables every day for lunch, and regularly working out on a StairMaster or playing tennis. He showed little affection for anyone, with the exception of his wife, Corinne, and his Maltese, Snowball. Within AIG he was famous for his short fuse and his ceaseless drive to know everything that was happening inside the company— his company. He was rumored to have hired former CIA agents, and security men seemed to be posted everywhere at headquarters.

To the outside world the biggest AIG drama was Greenberg’s attempt to secure a dynasty; what he created, instead, was a blood feud among insurance royalty.

Jeffrey Greenberg, his son, a graduate of Brown and Georgetown Law, had been groomed to succeed Hank. But in 1995, after a series of clashes with his father, Jeffrey left AIG, where he had worked for seventeen years. Two weeks earlier, his younger brother, Evan, had been promoted to executive vice president, his third promotion in less than sixteen months, establishing him as a rival to Jeffrey. With the departure of his brother, Evan, a former hippie who for many years had shown no interest in following his father into the business, was clearly the heir apparent. Yet Evan soon ran afoul of a patriarch who could not surrender any power and, like Jeffrey before him, bolted the company. Jeffrey would go on to become chief executive of Marsh & McLennan, the biggest insurance broker in the world, while Evan became CEO of Ace Ltd., one of the world’s largest reinsurers.

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 anything to my Triple-A rating, and I’m coming after you with a pitchfork,” he warned them.

But Sosin chafed under the short management leash that had been placed on the unit and in 1994 left along with the other founders after a falling-out with Greenberg.

(Long before Sosin’s departure, however, Greenberg, infatuated with the profit machine that FP had become, had formed a “shadow group” to study Sosin’s business model in case he ever decided to leave. Greenberg had PricewaterhouseCoopers build a covert computer system to track Sosin’s trades, so they could later be reverse engineered.) After much persuasion from Greenberg, Cassano agreed to stay on and was promoted to chief operating officer.

A Brooklyn native and the son of a police officer, Cassano was known for his organizational skills, not his acumen in finance, unlike most of the talent Sosin had brought with him—“quants,” quantitative analysts, with PhDs who created the complex trading programs that defined the unit.

In late 1997, the so-called Asian flu became a pandemic, and after Thailand’s currency crashed, setting off a financial chain reaction, Cassano began looking for some safe-haven investments. It was during that search that he met with some bankers from JP Morgan who were pitching a new kind of credit derivative product called the broad index secured trust offering—an unwieldy name—that was known by its more felicitous acronym, BISTRO. With banks and the rest of the world economy taking hits in the Asian financial crisis, JP Morgan was looking for a way to reduce its risk from bad loans.