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

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 had 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 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.”

Cassano did remain on a consulting contract, at the rate of $1 million a month, but Sullivan and others continued to worry about the defection of their staff. With Cassano shunted aside and the FP group already reporting a $5 billion loss, there was constant speculation that FP’s top producers would quickly depart. William Dooley, who replaced Cassano, went to Sullivan with a request: “We need to put together a retention program or we’re going to lose the team.”

Sullivan appreciated the scope of the problem. Because AIG’s employees were paid a percentage of profits—and the firm had just recorded such a huge loss—“the likelihood of these guys getting paid out anything is zero going forward,” as he told the compensation committee. “It’s not like it’s a bad quarter; they can’t make it back next quarter or next year.” For most FP employees it would make more sense to start over elsewhere than to stay in place, he told the board. (In a way, ironically enough, FP’s compensation package better aligned the interests of the employees with shareholders than most traders on Wall Street, who were paid based on the performance of their own book rather than on the profits of the entire firm.)

In early March, AIG’s board, after requiring Sullivan to redraft the proposed retention program more than once, approved a plan that would pay out $165 million in 2009 and $235 million in 2010. At the time, it hardly seemed like a decision that anyone outside AIG would care about—let alone give rise to the political nightmare that would result in censure, death threats, and a mad scramble on Capitol Hill to undo the bonuses.

In May, AIG reported dismal results for the first quarter, a $9.1 billion write-down on credit derivatives and a $7.8 billion loss—its largest ever. Standard & Poor’s responded by cutting its rating on the company by one notch, to AA minus. Four days later, on May 12, the Wall Street Journal reported that management at one of AIG’s most profitable units, the aircraft-leasing business International Lease Finance Corp., was pushing for a split from the parent company through either a sale or a spin-off.

Hank Greenberg, meanwhile, who had just turned eighty-three years old, was urging AIG to postpone its annual meeting, pointing to the poor quarterly performance and the effort to raise $7.5 billion in capital. “I am as concerned as millions of other investors as I watch the deterioration of a great company,” Greenberg wrote in a letter made public. “The company is in crisis.”

In private, other large AIG shareholders had also begun campaigning for changes. Two days before the annual meeting on May 14, 2008, a fax arrived at Willumstad’s office at Brysam—a letter from Eli Broad, a former AIG director who had sold his giant annuities business, SunAmerica, to AIG in 1998 for $18 billion in stock, and a close business associate of Greenberg’s. Joining Broad in the missive were two influential fund managers, Bill Miller of Legg Mason Capital Management and Shelby Davis of Davis Selected Advisers. The group, which controlled roughly 4 percent of AIG’s shares, wanted a meeting to discuss “steps that can be taken to improve senior management and restore credibility.”

On the following evening, Willumstad and another AIG director, Morris Offit, went to Broad’s apartment at the Sherry-Netherland hotel on Fifth Avenue to meet with the three investors. Joining them was Chris Davis, Shelby’s son, a portfolio manager at his firm. Sitting in his expansive living room, with dramatic views of Central Park and the city skyline, Broad quickly launched into a list of complaints about Sullivan and the company’s performance.

After hearing him out briefly, Willumstad interrupted him. “Listen, before you go too far, I just have to be very clear. We are in the middle of raising capital, so I cannot disclose to you anything we haven’t told everyone else. We’re happy to listen and to try to answer any questions.” From then on the evening was awkward and uncomfortable for all parties involved, as Willumstad and Offit could say little more than that the board understood their concerns. “You’re not telling us anything we don’t know,” he acknowledged.