AIG: A Case Study of Government Intervention Out of Control
April 15, 2009
The following is a paper I wrote for a class I took at an on-line university:
In 1962, Maurice “Hank” Greenburg became the head of a struggling insurance company, American International Group. By the time Greenburg was forced to resign he had transformed the company into the largest Insurance Company in the world. Only three years after his resignation, in 2008, that company was at the eye of a financial storm that would shake the world economy, requiring billions of “Bail-Out Money” from the government. Although it was its financial services division that caused the mess, the ramifications have occurred throughout the company. I will explore the changes that happened, the persons involved and the ramifications of those changes. I will also show how sometimes change in an organization is not predictable and thus Richard Axelrod’s engagement paradigm not appropriate in dealing with unplanned, unpredictable change.
There is an old fable about the Emperor’s New Clothes. In this fable, the Emperor of a kingdom commissions some tailors to make him a new set of clothes. The tailors, who are con artists, tell him that the clothes are special because the clothes were invisible to all those but the intelligent so no one wanted to admit that they saw nothing. One day this kid yells out, “Why is the Emperor naked?” and the whole scam fell apart. I met that kid in 2006 when I was a life insurance agent attending a conference being held by a American General Life Insurance Company, a subsidiary of AIG and during lunch this older agent was rambling on about how real estate prices could not continue to rise and when the bubble burst in the housing market you would start seeing defaults in all the subprime mortgages that were being written. He said that the economy was so leveraged into those mortgages that the effect would be like dominos falling causing the worst financial crises since the great depression. Although we were all being polite, as soon as this guy left the room everybody snickered at him. Two years later, the reason that the government had to bail out AIG was that, in a nut shell, AIG had insured those mortgages. Is this something that a man like Hank Greenburg would consider to be a smart business move?
Elliot Spitzer was the attorney general for the state of New York from 1999 until he was elected Governor of in 2006 when he was elected largely on his reputation for cleaning up Wall Street. The Dot Bomb, a situation where there was a bubble in the NASDAQ in tech stocks due to a proliferation of internet companies had occurred. When the bubble burst, Spitzer, who unbeknownst at the time had a penchant for high priced call girls, had decided to use the dot bomb for his political gain by investigating brokers and companies that he felt should pay for “the innocent people who lost money in the dot bomb.” I worked in the financial services industry at that time for Sun American Securities, a subsidiary of AIG from 2003 to 2005 and then for Allstate Financial Services from 2005 to 2007, the CEO of Allstate at the time was Ed Liddy, the current CEO of AIG. In both those firms executives and compliance officers were terrified of Mr. Spitzer.
One of the targets of Spitzer’s investigations was AIG and its CEO, Hank Greenburg. Spitzer did not like the way AIG was doing its accounting and wanted Greenburg gone, “Spitzer in 2005 set out to get Maurice “Hank” Greenberg, then chairman and CEO of AIG insurance company, and he coerced the AIG board into firing Greenberg by threatening to file criminal charges against the company as a whole, a corporate death sentence. Then, before charges were filed, he went on national television and accused Greenberg of “fraud” that was “illegal,” the only question being whether it was civil or criminal. But Spitzer never did file charges.” (March 13, 2008, McClatchy Business Tribune News) In 2005, the AIG Board of Directors did remove Greenburg, the man who had built them into an insurance powerhouse in order to get Spitzer off of their backs. By February of 2008, the value of AIG stock had fallen vastly in the post-Greenburg Era, “Trading above $72 in February 2005 before it was Spitzerized (sic), AIG shares closed yesterday at $39.57. The company’s directors defend themselves by saying Mr. Spitzer gave them little choice but to dismiss Mr. Greenberg. Whether that was true at the time, they — and Mr. Spitzer — owe an apology to AIG shareholders.” (Freeman, May 16, 2008) Actually, Mr. Spitzer owes an apology not only to the AIG Shareholders, but also to the AIG Employees and to the American People, to whom his witch-hunts ended up costing billions over 100 billion in bail-out money.
One of the items that exacerbated what was a crises in subprime mortgages into a global crises was the use of Credit Default Swap (CDS) Per Economicshelp.org, the way a credit default swap works is “The buyer of a credit default swap pays a premium for effectively insuring against a debt default. He receives a lump sum payment if the debt instrument is defaulted. The seller of a credit default swap receives monthly payments from the buyer. If the debt instrument defaults they have to pay the agreed amount to the buyer of the credit default swap.” (Nov 11, 2008, EconomicsHelp.Org) When real-estate prices were on the rise, these were great for the buyer who was receiving a monthly income from these instruments. When the real-estate market crashed and defaults and foreclosures started becoming more prevalent, the buyers came to collect the money from the sellers which the seller, companies we have heard a lot of the past few months, AIG, Lehman Brothers, Merrell Lynch, Goldman Sachs, did not have. Some of those companies, like Lehman Brothers, were allowed to go bankrupt; others like AIG were bailed out with billions of dollars by effectively being taken over by the government; The United States Government now owns over 80% of the company. In February, 2009, Greenberg, still AIG’s largest individual share holder, sued AIG claiming that they had dismantled the controls on these Credit Default Swaps that he had in place, “Greenberg contends in the suit, filed in the Southern District Court of New York on February 27, that his successor Martin Sullivan “presided over the rapid increase of AIG’s volume of CDS. Most of the increase involved CDOs exposed to subprime mortgages [and] as of December 31, 2007, CDS issued by AIG hedged the default risk on at least $527 billion in debt, including debt securities backed by subprime mortgages.”
When AIG was bailed out by the Government, Former Sec of Treasury Hank Paulson turned to the former CEO of Allstate, Edward Liddy. From 2004 to 2006 I was an Exclusive Financial Specialist at Allstate. All of the agents I worked with hated Ed Liddy because one day Ed had called all of the agents into a meeting fired them all and made them independent Contractors. Had they not agreed to be independent contractors, without any benefits, they would have lost their retirement, which was essentially their book of business. Hank Greenberg actually did the same thing at AIG in the early 1960s. Nine years after Allstate did this there are still lawsuits pending against Allstate. (Dale March 23, 2009)
Liddy’s actions at Allstate definitely indicate he is not an “employee’s man.” Currently executives in the Financial Products division of AIG are already claiming that when Liddy came on after the bailout he told the employees of that division that he was committed to paying them their bonuses. Once there was outrage though, Liddy did not appear to stay committed to his word and asked them to give at least half the bonuses. Liddy was the man the government brought in to make sure it would get its investment back from AIG, which is an interesting choice since evidence has emerged that after Hurricane Katrina, Allstate, under Liddy, had overcharged the federal flood program for wind damage (Schearer, March 20th 2009)
The division of AIG that got the company in trouble with the Credit Default Swaps was it Financial Services Division. AIG has several other divisions and subsidiaries. One of which is American General Life Insurance Company. American General is rated in the top brackets by AM Best, Moody’s Fitch and Standard and Poor’s (www.aigag.com) That subsidiary had nothing to do with the credit default swaps and was in good shape as witnessed by its high ratings, even though the parent company was essentially taken over by the government to keep it out of Bankruptcy. The situation with the parent company however, is still having its effects on American General. It is common practice in the life insurance industry for companies to reward their top producing independent agents. These agents are all independent contractors and thus are free to enter into contracts and do business with any company. An insurance agent does have a fiduciary responsibility to their clients to get them a policy that fits their needs. One of the rewards that the company uses is to have conferences for the top agents at vacation places like Los Vegas, Hawaii or even Athens Greece. Every insurance company has several of these a year for their independent agents.
Two weeks after the Government Bailout of AIG, American General had one of these events in Orange County California at the St Regis Monarch, where rooms cost in excess of $565.00 a night. (www.democraticunderground.com) This caused quite an uproar at the time. The appearance was that the government paid for the party with part of the 80 billion in bailout money and the American Taxpayer was outraged. It did not matter that American General had nothing to do with the situation with credit swaps, and in fact none of the bailout money had actually gone to American General, nor did it matter that the party was not for AIG employees but rather independent agents and that throwing those types of parties were standard practice in the life insurance business. One change that American General Agents will be seeing is a big reduction in these types of functions; Of course, the agents are free to do business with any company so American General is going to need to figure out other ways to get agents to do business with them. Maybe they will even consider introducing better products at a lower price than its competitors.
Another subsidiary of AIG is the 21st Century Insurance Company. 21st Century sells property and casualty insurance products such as Auto and Home Insurance. The company has been in business since 1958 and it was acquired by AIG in 2007 and its name was changed to AIG Direct. 21st Century has a business model where it does not utilize agents, people buy it’s policies by phone or on-line meaning that although they can sell their policies for less, customers also do not have an agent to service their policies and if they should need help must rely on an 800 number. Under this business model, they advertise on Cable TV Stations. This has the surreal effect, in October of 2008 of while watching Fox News coverage of the AIG Bailout, seeing commercials for AIG Direct auto insurance. In November, 2008 the name of the company was rebranded back to 21st Century. In March 2009, the company sent out a happy talk letter to its customers about how well they were doing and how they had not used and were not going to use any of the bail-out money. On April 3, 2009 they announced the layoffs of over 500 employees along with the closure of several offices. Sales are down and part of the problem is the public backlash against the AIG Bailout (Colker 2009, April 3)
The AIG subsidiaries will probably be sold or spun off in order to generate the money that they need to get the Government out of an ownership position. Nowhere in the United States Constitution does it mention anything about the Government being allowed to own insurance conglomerates, even if they are too big to fail. The Soviet Union and Peoples Republic of China tried government ownership of businesses and that clearly didn’t work. Great Briton tried socialism in the 1960s and 1970s and their economy was in a tailspin until Margaret Thatcher dismantled it in the 1980s. Socialism is an affront on humanity as it denies the basic dignity of a human being and replaces responsibility with blame. It takes responsibility away from the individual and gives it to a made up group. It did not work in China, Russia or Great Briton in the 20th Century; it is not going to work in the twenty first century for the United States either. What Ronald Reagan said in the 1980s hold true today, “The most feared words in the English Language are I am from the government and I am here to help you.” If you don’t believe me just walk into your local Department of Motor Vehicles.
The changes that occurred at AIG were to some extent external. Neither Spitzer nor his successor ever brought any charges against Greenberg or any AIG official; Greenberg lost his company without due process. We can speculate but it was unknown if Greenberg would have participated in the investment of Credit Default Swaps to the extent that his successors did. As with several bubble before that there was a feeling that real estate prices would continue to rise so that they were a safe investment. Hindsight, as we know is always 20/20. Ed Liddy has also shown himself to be a top down style of leader. He did not consult with the agents at Allstate before making them all independent contractors. In the situation of AIG and the changes that it faced the Axelrod engagement paradigm was not applicable.
At the time of the bailout, AIG could not pay what it owed for the credit default swaps. No time was available to call a meeting of its thousands of employees, allow everyone a chance for input, have lunch, sing We are the World then do a walk about to catch the people who were not at the meeting. There wasn’t even time to do a webinar to at least allow people to buy into a solution, an on the spot decision needed to be made. That is one of the characteristics of a leader. They have to be willing to make the tough decisions that no one else is willing to make. Under Hank Greenberg, AIG had strong leadership. When that strong leadership was taken away, arbitrarily by an over-zealous state official, the company faltered and since it was “too big to fail, “ it brought down a portion of the economy with it”
When the company is broken up into its subsidiaries, each one will need to have a mission statement and a vision. At that time it would be a good idea to bring in some of Axelrod’s engagement paradigm and allow the stakeholders to participate in the creation of their new companies. Each company should have a meeting to let everyone say what they need to say regarding the fall of AIG so that the company is buried and everyone can just get on with it. Then they should get input and have another meeting to go over results and ensure there is a consensus on the mission and vision of the new companies.
The story of the fall of AIG teaches us several lessons. One is about the dangers of allowing a government official too much power. The board of AIG, acting out of fear, allowed Elliot Spitzer to remove Maurice “Hank” Greenberg as CEO of the company.(even though whether AIG would have still invested as much as it did in Credit Default Swaps is unknown and hindsight is 20/20.) It also shows us that there is no such thing as a sure bet and that sometimes change is not predictable and whether a company can successfully make a change is not always guaranteed.
References
Ashford University (2007) Organizational Change San Francisco, McGraw Hill
Axelrod (2002) Terms of Engagement, San Francisco, Berrett Kohler
Colker (2009, April 3) AIG Subsidiary 21st Century Insurance is Downsizing, Retrieved April 6, 2009 from www.latimes.com
EDITORIAL: Spitzer put the bully in ‘bully pulpit’: He ignored moral code that defined his career. (13 March). McClatchy – Tribune Business News,***[insert pages]***. Retrieved April 5, 2009, from ABI/INFORM Dateline database. (Document ID: 1445055241).
Freeman, J. (2008, May 16). Eliot Spitzer and the Decline of AIG. Wall Street Journal (Eastern Edition), p. A.13. Retrieved April 5, 2009, from ABI/INFORM Global database. (Document ID: 1479480381).
Former AIG chief fingers successor for CDS woes. (2009, March). Credit, 10(3), 6. Retrieved April 5, 2009, from ABI/INFORM Trade & Industry database. (Document ID: 1666308741).
Schearer, H (2009, March 20th) Who is Ed Liddy and What Did He Do Before AIG Retrieved April 3 2009 from www.huffingtonpost.com
Dale, M (2009, March 23) Allstate Agents in Court Over Contractor Status. Retrieved April 3, 2009 from www.forbes.com
http://www.economicshelp.org/blog/finance/credit-default-swaps-explained/
[...] jeffrey1959 added an interesting post on AIG: A Case Study of Government Intervention Out of ControlHere’s a small excerptOnly three years after his resignation, in 2008, that company was at the eye of a financial storm that would shake the world economy, requiring billions of “Bail-Out Money” from the government. Although it was its financial services … [...]