Sullivan Says He Was Unaware in 2005 of AIG Swap Risk

Martin Sullivan, former chief executive officer of American International Group Inc., said he was unaware in 2005 of the tripling of risk through derivatives at the bailed-out insurer’s Financial Products unit.

“My first knowledge of the super senior credit-default swaps portfolio was sometime in 2007,” Sullivan, 55, said today in a hearing of the Financial Crisis Inquiry Commission in Washington. The swaps fueled losses that forced New York-based AIG to take a government bailout in 2008.

Sullivan said he was focused on improving AIG’s relations with regulators in 2005 after replacing CEO Maurice “Hank” Greenberg, who left amid federal and state probes into accounting. The insurer’s outside auditor said Sullivan didn’t hold his staff accountable for financial reporting matters, according to documents released today by the FCIC.

Sullivan said that before 2007 he received reports about the “totality” of the Financial Products unit without being alerted to the specific trades that later contributed to AIG’s near collapse. He was ousted in 2008 as the firm’s writedowns mounted on bets that he previously said would be “manageable.”

“I never recognized that portfolio, and there were no issues raised in that correspondence that would have given me cause for concern,” Sullivan testified today.

Photographer: Andrew Harrer/Bloomberg

Martin Sullivan, former chief executive officer of American International Group Inc., listens during a Financial Crisis Inquiry Commission hearing on the role of derivatives in the financial crisis in Washington. Close

Martin Sullivan, former chief executive officer of American International Group Inc.,... Read More

Close
Open
Photographer: Andrew Harrer/Bloomberg

Martin Sullivan, former chief executive officer of American International Group Inc., listens during a Financial Crisis Inquiry Commission hearing on the role of derivatives in the financial crisis in Washington.

‘Lacking in Execution Skills’

Auditor PricewaterhouseCoopers LLP identified Sullivan’s weaknesses as including a “difficulty in holding people accountable for internal control-related matters” and “making difficult decisions,” according to FCIC documents. The report released today said that the auditor told then-AIG Chairman Robert Willumstad in February 2008 that the insurer’s chief financial officer should attempt to compensate for Sullivan because he was “lacking in execution skills.”

Willumstad replaced Sullivan as CEO less than six months later. Steven Silber, a spokesman for PwC, said the company does not comment on client matters.

AIG, once the world’s largest insurer, received a U.S. bailout designed to protect banks that bought $62.1 billion in swaps from the firm. The FCIC is reviewing decisions that led to the insurer’s rescue as lawmakers seek to prevent another company from accumulating so much risk that its collapse could threaten global economic stability.

While the securities linked to swaps hadn’t defaulted in late 2008, the market value of the assets collapsed, triggering collateral calls that drained cash and pushed AIG into a rescue.

‘An Understatement’

Robert Lewis, AIG’s chief risk officer, said he didn’t know swaps contracts included collateral call provisions until after Goldman Sachs Group Inc. made its first demand in July 2007, according to the FCIC documents. When asked if the provisions caused consternation within AIG, Lewis said, “I would say that’s an understatement.”

“I only became aware of the collateral calls completely in the latter part of 2007,” Lewis said in the hearing. “The responsibility for liquidity risk management was not directly under my jurisdiction.”

AIG was able to handle the collateral calls “and there was no indication whatsoever when I left that in two months’ time, the company was going to need government intervention,” Sullivan said.

He answered questions after commission Chairman Phil Angelides said AIG’s swaps tied to asset-backed securities tripled to $54 billion in the 12 months ended Dec. 31, 2005.

Angelides, who will report the commission’s findings to Congress and President Barack Obama in December, said Sullivan should have known more about risk at AIG.

‘Failure of Leadership’

“We will probably debate on this panel many, many issues, but I do not think that the failure of leadership and effective management at AIG will be a matter of much debate,” Angelides said.

Joseph J. Cassano, who led AIG’s derivatives unit, testified today that he “never compromised” underwriting standards on the swaps sold to banks including Goldman Sachs and Societe Generale SA. Cassano, 55, was head of AIG’s Financial Products unit until March 2008, and stepped down after Sullivan asked him to resign.

Had he remained at AIG through the end of 2008, Cassano would have “negotiated a much better deal for the taxpayer than what the taxpayer got,” he told the commission.

Credit-Default Swaps

As part of a November 2008 revision to AIG’s rescue, banks were fully reimbursed in exchange for delivering collateralized debt obligations linked to the $62.1 billion in swaps. The securities were placed in a taxpayer-funded vehicle called Maiden Lane 3. Cassano said that while at AIG he won concessions from banks that demanded collateral from the insurer.

Cassano also defended his statements to investors minimizing the risk AIG faced. Three years ago, AIG executives couldn’t envision a “scenario within any kind of realm or reason that would see us losing $1 in any of those transactions,” Cassano told analysts then.

“Often repeated are my words during an earnings call in August 2007 that I did not expect any realized, economic losses (as opposed to unrealized accounting losses) on this portfolio,” Cassano said in a written statement submitted before the hearing. “I meant exactly what I said.”

Lewis testified that AIG was “wrong about how bad things could get” in credit markets. “What ended up happening was so extreme that it was beyond anything we had planned for.”

Cassano said an AIG committee that included Lewis approved his transactions. Lewis said accountability for risks assumed by AIG businesses resides “within the business units themselves.”

Goldman Sachs

Goldman Sachs President Gary Cohn and Chief Financial Officer David Viniar were also slated to appear before the FCIC during the two-day hearing. Goldman collected $12.9 billion after the rescue from contracts with AIG.

Viniar has said that collateral agreements would have helped protect the firm, among AIG’s biggest counterparties, against default. AIG’s $182.3 billion bailout ensured that Goldman Sachs was paid in full.

Cassano had shied away from public statements while regulators investigated his role in the swaps trades. The U.S. Justice Department and the U.K.’s Serious Fraud Office dropped probes last month, and the U.S. Securities and Exchange Commission closed its investigation, AIG and Cassano’s lawyers said this month.

Selling the swaps “was an act of incredible corporate irresponsibility,” Steve Kohlhagen, a former finance professor at the University of California, Berkeley, and an ex-AIG Financial Products executive, said in prepared remarks.

To contact the reporters on this story: Hugh Son in New York at hson1@bloomberg.net; Matthew Leising in Washington at mleising@bloomberg.net; Inyoung Hwang in New York at ihwang7@bloomberg.net.

Bloomberg reserves the right to remove comments but is under no obligation to do so, or to explain individual moderation decisions.

Please enable JavaScript to view the comments powered by Disqus.