[House Hearing, 110 Congress]
[From the U.S. Government Publishing Office]
THE CAUSES AND EFFECTS OF THE AIG BAILOUT
=======================================================================
HEARING
before the
COMMITTEE ON OVERSIGHT
AND GOVERNMENT REFORM
HOUSE OF REPRESENTATIVES
ONE HUNDRED TENTH CONGRESS
SECOND SESSION
__________
OCTOBER 7, 2008
__________
Serial No. 110-208
__________
Printed for the use of the Committee on Oversight and Government Reform
Available via the World Wide Web: http://www.gpoaccess.gov/congress/
index.html
http://www.house.gov/reform
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COMMITTEE ON OVERSIGHT AND GOVERNMENT REFORM
HENRY A. WAXMAN, California, Chairman
EDOLPHUS TOWNS, New York TOM DAVIS, Virginia
PAUL E. KANJORSKI, Pennsylvania DAN BURTON, Indiana
CAROLYN B. MALONEY, New York CHRISTOPHER SHAYS, Connecticut
ELIJAH E. CUMMINGS, Maryland JOHN M. McHUGH, New York
DENNIS J. KUCINICH, Ohio JOHN L. MICA, Florida
DANNY K. DAVIS, Illinois MARK E. SOUDER, Indiana
JOHN F. TIERNEY, Massachusetts TODD RUSSELL PLATTS, Pennsylvania
WM. LACY CLAY, Missouri CHRIS CANNON, Utah
DIANE E. WATSON, California JOHN J. DUNCAN, Jr., Tennessee
STEPHEN F. LYNCH, Massachusetts MICHAEL R. TURNER, Ohio
BRIAN HIGGINS, New York DARRELL E. ISSA, California
JOHN A. YARMUTH, Kentucky KENNY MARCHANT, Texas
BRUCE L. BRALEY, Iowa LYNN A. WESTMORELAND, Georgia
ELEANOR HOLMES NORTON, District of PATRICK T. McHENRY, North Carolina
Columbia VIRGINIA FOXX, North Carolina
BETTY McCOLLUM, Minnesota BRIAN P. BILBRAY, California
JIM COOPER, Tennessee BILL SALI, Idaho
CHRIS VAN HOLLEN, Maryland JIM JORDAN, Ohio
PAUL W. HODES, New Hampshire
CHRISTOPHER S. MURPHY, Connecticut
JOHN P. SARBANES, Maryland
PETER WELCH, Vermont
JACKIE SPEIER, California
Phil Barnett, Staff Director
Earley Green, Chief Clerk
Lawrence Halloran, Minority Staff Director
C O N T E N T S
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Page
Hearing held on October 7, 2008.................................. 1
Statement of:
Dinallo, Eric R., superintendent, New York State Insurance
Department; and Lynn E. Turner, former Chief Accountant,
Securities and Exchange Commission......................... 6
Dinallo, Eric R.......................................... 6
Turner, Lynn E........................................... 17
Sullivan, Martin J., former chief executive officer, AIG; and
Robert B. Willumstad, former chief executive officer, AIG.. 83
Sullivan, Martin J....................................... 83
Willumstad, Robert B..................................... 91
Letters, statements, etc., submitted for the record by:
Braley, Hon. Bruce L., a Representative in Congress from the
State of Iowa, article dated September 9, 2008............. 135
Dinallo, Eric R., superintendent, New York State Insurance
Department, prepared statement of.......................... 9
McCollum, Hon. Betty, a Representative in Congress from the
State of Minnesota, article dated September 28, 2008....... 59
Sullivan, Martin J., former chief executive officer, AIG,
prepared statement of...................................... 86
Turner, Lynn E., former Chief Accountant, Securities and
Exchange Commission, prepared statement of................. 20
Waxman, Hon. Henry A., a Representative in Congress from the
State of California:
Letter dated October 4, 2008............................. 101
Letter dated October 7, 2008............................. 148
Prepared statement of Mr. Greenberg...................... 151
Willumstad, Robert B., former chief executive officer, AIG,
prepared statement of...................................... 93
THE CAUSES AND EFFECTS OF THE AIG BAILOUT
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TUESDAY, OCTOBER 7, 2008
House of Representatives,
Committee on Oversight and Government Reform,
Washington, DC.
The committee met, pursuant to notice, at 10:04 a.m., in
room 2154, Rayburn House Office Building, Hon. Henry A. Waxman
(chairman of the committee) presiding.
Present: Representatives Waxman, Maloney, Cummings,
Kucinich, Tierney, Watson, Higgins, Yarmuth, Braley, Norton,
McCollum, Van Hollen, Sarbanes, Welch, Speier, Davis of
Virginia, Shays, Mica, Souder, Turner and Bilbray.
Staff present: Kristin Amerling, general counsel; Russell
Anello and Stacia Cardille, counsels; Caren Auchman, press
assistant; Alvin Banks, staff assistant; Phil Barnett, staff
director and chief counsel; Jen Berenholz, deputy clerk;
Zhongrui ``JR'' Deng, chief information officer; Ali Golden,
investigator; Michael Gordon, senior investigative counsel;
Earley Green, chief clerk; Karen Lightfoot, communications
director and senior policy advisor; David Rapallo, chief
investigative counsel; Leneal Scott, information systems
manager; Roger Sherman, deputy chief counsel; Mitch Smiley,
special assistant; Lawrence Halloran, minority staff director;
Jennifer Safavian, minority chief counsel for oversight and
investigations; A. Brooke Bennett, minority counsel; Brien
Beattie, Molly Boyl, Alex Cooper, Adam Fromm, and Todd
Greenwood, minority professional staff members; Larry Brady,
John Cuaderes, and Nick Palarino, minority senior investigators
and policy advisors; Patrick Lyden, minority parliamentarian
and Member services coordinator; and Brian McNicoll, minority
communications director.
Chairman Waxman. The committee will please come to order.
Today we're holding our second day of hearings on the financial
crisis in Wall Street. Yesterday we examined the collapse of
Lehman Brothers. Our focus today is AIG.
There are obvious differences between Lehman and AIG.
Lehman is an investment bank. AIG is an insurance company.
Lehman fell because it placed highly leveraged bets in the
subprime and real estate markets. AIG's problems originate in
the complex derivatives called credit default swaps. But their
stories are fundamentally the same.
In each case, the companies and their executives grew rich
by taking on excessive risk. In each case, the companies
collapsed when these risks turned bad. And in each case, their
executives are walking away with millions of dollars while
taxpayers are stuck with billions of dollars in costs. The AIG
CEOs are like the Lehman CEO in one other respect: In each
case, they refused to accept any blame for what happened to
their companies.
In preparation for this hearing, the committee has received
tens of thousands of pages of documents from AIG. Our review of
the documents raises three fundamental sets of questions.
Answering these questions will be the focus of today's hearing.
The first set of questions is whether AIG's executive
compensation practices were fair and appropriate. AIG has a
Seniors Partners Plan that provides cash bonuses for its 70
executives. These are the top 70 executives. This plan is
supposed to be performance based. In 2005, AIG's CEO, Martin
Sullivan received $2.7 million under this plan. In 2006, his
first full year as CEO, he received $5.7 million under the
plan. These payments are not in question. Both years were good
years for AIG, and as CEO, Mr. Sullivan naturally was well
rewarded.
2007 is a completely different story. AIG lost over $5
billion in the final quarter of 2007 due to the losses
attributable to its Financial Products Division called AIG-FP.
Under the terms of the Senior Partners Plan, Mr. Sullivan and
the other top executives should have had their bonuses slashed
due to poor performance. But when the compensation committee
met on March 11, 2008, the award bonuses for 2007, Mr. Sullivan
urged the committee to ignore the losses from the Financial
Products Division in calculating his bonus and the bonuses of
the other top executives. We obtained a copy of the minutes
from that meeting, and here's what they say: Mr. Sullivan next
presented management's recommendation with respect to the earn-
out for the Senior Partners Plan, suggesting that the AIG-FP
unrealized market valuation losses be excluded from the
calculation. The board approved this change in the Senior
Partners Plan, ignored the losses from the Financial Products
Division, and gave Mr. Sullivan a cash bonus of over $5
million. Today we'll ask what could possibly justify this
change in the compensation formula.
There are other compensation questions we will also ask. In
March, the board approved a new compensation contract for Mr.
Sullivan that gave him a golden parachute worth $15 million. We
will ask why that was in the interest of the shareholders. And
we will ask about the compensation of Joseph Cassano who was
the executive in charge of the Financial Products Division. Mr.
Cassano was well compensated by AIG. He received more than $280
million over the last 8 years. After his division imploded, AIG
terminated him without cause in February and did not seek to
recover any of Mr. Cassano's compensation. Instead, AIG allowed
him to keep up to $34 million in unvested bonuses and put him
on a $1 million-a-month retainer. Last month the taxpayers
bought out AIG in an $85 billion bailout. This was a direct
result of the mistakes made by Mr. Cassano. Yet even today he
remains on the company payroll, receiving $1 million a month.
The Federal bailout occurred on September 16. Less than 1
week later AIG held a week-long retreat for company executives
at the exclusive St. Regis resort in Monarch Beach, California.
And we have a photograph on display of that resort. Rooms at
this resort can cost over $1,000 per night. Invoices provided
to the committee show that AIG paid the resort over $440,000
including nearly $200,000 for rooms, over $150,000 for meals,
and $23,000 in spa charges.
Well, average Americans are suffering economically. They're
losing their jobs, their homes and their health insurance. Yet
less than 1 week after the taxpayers rescued AIG, company
executives could be found wining and dining at one of the most
exclusive resorts in the Nation. We'll ask whether any of this
makes any sense.
The second set of questions we'll ask is whether Mr.
Sullivan and Robert Willumstad are right when they say they
bear no responsibility for the collapse of AIG. Mr. Sullivan
was CEO from March 2005 to June 2008. Mr. Willumstad was his
successor. He joined the AIG board in January 2006 and has
served as chairman from November 2006 until he was named CEO in
June 2008. According to their testimony, AIG failed because it
was caught in a vicious cycle and hit by a global financial
tsunami. Mr. Willumstad says, ``I don't believe AIG could have
done anything differently.''
The information we received paints a different picture. We
have obtained a confidential letter from the Office of Thrift
Supervision to AIG's general counsel. In this March 10, 2008
letter, the Office of Thrift Supervision writes, ``we are
concerned that the corporate oversight of AIG Financial
Products lacks critical elements of independence, transparency
and granularity.'' Internal documents show that AIG's auditor,
PricewaterhouseCoopers, reported similar problems. Minutes from
a meeting of the board's audit committee in March 2008 revealed
that PricewaterhouseCoopers told the committee that the root
cause of AIG's problems was that risk control groups did not
have appropriate access to the Financial Products Division.
As part of our investigation, the committee requested
information from a former AIG auditor Joseph St. Denis. Mr. St.
Denis was a senior SEC enforcement official who was hired by
AIG to address its ongoing accounting problems. But when he
expressed concerns about how the Financial Products Division
was valuing its liabilities, Mr. Cassano told him, ``I have
deliberately excluded you from the valuation because I was
concerned that you would pollute the process.''
Ultimately, Mr. St. Denis resigned in protest. As he
explains, Mr. Cassano took actions that I believe were intended
to prevent me from performing the job duties for which I was
hired. Unlike Mr. Cassano and Mr. Sullivan, Mr. St. Denis's
actions cost him his bonus.
There are other questionable actions by Mr. Sullivan and
Mr. Willumstad. As losses were mounting and resources were
getting scarce, AIG depleted its capital by over $10 billion
through stock buybacks and rising dividend payments. This
prompted shareholders to write the board, ``the management and
board inexcusably and inexplicably raised the dividend while
simultaneously issuing expensive preferred stock at a
discount.''
And finally, we'll ask whether AIG and in particular Mr.
Sullivan misled investors and the public about the financial
conditions of the company. On December 5, 2007, Mr. Sullivan
told investors, ``we are confident in our marks and the
reasonableness of our valuation methods. We have a high degree
of certainty in what we have booked to date.'' What Mr.
Sullivan didn't tell investors was that, on November 29th, 1
week earlier, PricewaterhouseCoopers had raised their concerns
about Mr. Sullivan, informing him that PWC believed that AIG
could have a material weakness relating to the risk management
of these areas.
There is one witness who should be here today but who will
be missing, Maurice ``Hank'' Greenberg, the long-time CEO of
AIG. Mr. Greenberg blames Mr. Sullivan and Mr. Willumstad for
the downfall of AIG. Many others think it is Mr. Greenberg who
sowed the seeds that led to AIG's failure. Regrettably Mr.
Greenberg has told the committee that he is too ill to appear
today to answer questions.
There is a lot of ground for this committee to cover today.
We will probe AIG's executive compensation arrangements, the
leadership of its top officials and the veracity of their
public statements. Our goal is to examine the details of AIG's
fall so that we can learn lessons about the reforms needed to
restore stability to our financial markets.
Like all of our witnesses, Mr. Sullivan and Mr. Willumstad
know we will ask hard questions. I also want them and our other
witnesses to know that we appreciate their cooperation and
appearance before the committee today.
Before yielding to Mr. Shays, who will deliver the
statement on behalf of the Republicans, I do want to announce
that the request that we have received to look at Fannie Mae
and Freddie Mac, which is an investigation already underway,
will be pursued in conjunction with the minority on the
committee. And we will look at holding a hearing on those two
as well as the other hearings that we have scheduled.
Mr. Shays, I want to recognize you at this time.
Mr. Shays. Thank you, Mr. Chairman.
Today we consider the case of the American International
Group, AIG, a global insurance conglomerate saved from
insolvency by an $85 billion loan from American taxpayers. As
part of the deal, we, the American taxpayers, own a controlling
stake in the company. In these bailouts, the U.S. Treasury is
now in the business of picking winners and losers as the global
economy struggles to purge the toxins of speculative greed
polluting capitalism's bloodstream. We need to understand what
makes a private company like AIG too big to fail and what drew
such a large and venerable enterprise to the brink of failure.
In the search for causes, all roads lead to the housing
market, dominated by the Federal National Mortgage Association,
Fannie Mae, and the Federal Home Loan Mortgage Corporation,
Freddie Mac. Without question, mortgage-backed assets sliced
and diced and scattered throughout the financial system lie at
the epicenter of the economic earthquake shaking world markets.
Ripples from defaults on subprime loans underwritten by Fannie
and Freddie grew to a tsunami that helped swamp Lehman Brothers
and others, including AIG. And Fannie and Freddie were able to
launch more than $1 trillion, $1 trillion of bad paper into the
private market because regulators and Congress let them do it.
This committee cannot conduct a credible examination of the
current crisis without focussing on the market distorting power
of the Federal mortgage giants and the firewall against reform,
manned by their enablers here in Congress.
No one is disputing the committee's focus on executive pay.
We agree; company compensation is a telling indicator of a
corporate culture detached from larger market realities and the
fundamental fiduciary duty to be frugal stewards of other
people's money. And that ``me first'' self-indulgence was just
as rampant at Fannie Mae as in its private sector partners and
competitors.
From 1998 to 2003, Fannie Mae CEO Franklin Raines alone
took over $90 million in salary and bonuses. The Raines team
was even caught manipulating accounting practices to overstate
profitability so they could grab what their overseer called,
``ill-gotten bonuses'' in the hundreds of millions of dollars.
The Fannie Mae board gave recently ousted CEO Daniel Mudd a
$2.6 million bonus in 2005 on top of his $3.5 million salary
based on a set of nonfinancial goals, such as promoting
respect, appropriate and productive relationship with
regulators.
In the context of a $6 trillion mortgage securities
portfolio, those paydays may seem like small change, but it's
indicative of a prevalent and noxious rot that threatens the
moral underpinnings of the entire capitalist business model. So
we need to keep the toxic twins, Fannie and Freddie, at the
center of this investigation, not on the edge, not out in the
future but right now.
Yesterday we sent a formal request to the chairman asking
for a specific commitment to make the Federal mortgage
companies a priority in this hearing, not after afterthought.
We can't wait until Halloween to unmask these two failed
monsters of mortgage finance.
As for AIG, I'm interested in learning more about the
corporate decisionmaking that took a solid insurance business
into the far less stable world of credit default swaps and
other exotic derivatives. They thought they were selling
insurance, when in fact they were betting the company's soul in
a high stakes game of Russian roulette. We need to ask what AIG
knew about the risk behind these novel products, when they knew
the bet soured, and how they informed investors, policyholders,
regulators and the public that the company was in peril. AIG,
like Fannie Mae and Freddie Mac, was considered too big to
fail.
Going forward we need to grapple with the implications of
the concept, government will be there to break the fall of some
large businesses but not others. It's been said, capitalism
without failure is like religion without sin. Any doctrine
loses its moral authority when bad conduct is rewarded and the
consequences of poor choices are foisted on someone else.
Investigating the causes and effects of this financial debacle
should involve assigning capability, culpability, and restoring
integrity and balance to the system of risks, rewards, and
penalties our society uses to assign value to labor, capital,
and commerce.
Thank you, Mr. Chairman.
Chairman Waxman. Thank you very much, Mr. Shays.
Chairman Waxman. For our first panel, we'll hear from Lynn
Turner, who served as Chief Accountant of the Securities and
Exchange Commission from 1998 to 2001. He has served on the
boards of public companies as a professor of accounting, as a
partner in an auditing firm and as the managing director of a
research firm. He is currently a senior advisor at Kroll, Inc.
Eric Dinallo currently serves as the superintendent of the
New York State Insurance Department. From 1999 to 2003, he
served as the chief of the Securities Bureau at the New York
State Attorney General's Office. Mr. Dinallo has also served as
general counsel at a large insurance broker and as managing
director for regulatory affairs at Morgan Stanley.
We're pleased to welcome both of you to our hearing this
morning. It's the practice of this committee that all witnesses
that testify before us do so under oath. So I would like to ask
if you would stand and raise your right hands.
[Witnesses sworn.]
Chairman Waxman. The record will indicate that both of the
witnesses answered in the affirmative.
You have given us prepared statements, some quite lengthy.
And I want you to know that all of those statements, both of
those prepared statements will be in the record in its
entirety. What we would like to ask you to do is try to be
mindful of 5 minutes that we allocate to the oral presentation.
We won't cut you off if you exceed 5 minutes, but we will have
a clock in front of you that will be green for 4 minutes. For
the last minute, it will turn yellow. After 5 minutes, it will
turn red. And then we would like you to then wind down your
presentation.
Mr. Dinallo, why don't we start with you.
STATEMENTS OF ERIC R. DINALLO, SUPERINTENDENT, NEW YORK STATE
INSURANCE DEPARTMENT; AND LYNN E. TURNER, FORMER CHIEF
ACCOUNTANT, SECURITIES AND EXCHANGE COMMISSION
STATEMENT OF ERIC R. DINALLO
Mr. Dinallo. Thank you, Chairman. Thank you, Chairman.
It's an honor to be here. I'm here to try to explain, from
our perspective, a little bit about what happened at AIG and
what the New York State Insurance Department's role in that
was.
The Insurance Department regulates certain insurance
companies. I think that's a very important distinction to make
at the beginning. AIG was not strictly an insurance company, as
was said earlier. It was probably the largest financial
services company in the world. And in fact, I think its
economic activity on the financial services side exceeded its
economic activity on the insurance side.
I agree that a large number of the problems there were due
to credit default swaps and collateralized debt obligations
stemming from subprime and the mortgage industry. But that
activity was largely, if not exclusively, done out of Financial
Products Division, which was sort of a subsidiary of the
holding company.
The most immediate problem that got our attention was the
pending downgrade of the company. So one of the rating agencies
had threatened on I think it was September, I don't know, 9th
or so to downgrade the company. That's when I received a call
from the general counsel and the former CFO asking if we would
be able to help provide certain liquidity through the insurance
subsidiaries, which were very solvent and well capitalized. For
the time before that, we had been monitoring the situation but
it was a monitoring of the situation based on the declining
stock price of the company and our wanting to confirm that the
insurance subsidiaries were solvent and policyholders were
protected.
So it was in those conditions that we showed up at the
company on Friday, Saturday and Sunday, the long weekend, which
went into Monday and Tuesday at the Federal Reserve where
different private solutions were looked at. The history is well
written now in the press. But I can answer questions about
that.
But the solvency problem was fine. The liquidity problem
kept on growing over the weekend. And the hole looked larger
and larger. And whatever we could have done through New York
State, which the Governor of New York, David Paterson, had
authorized us to try to help do, became not enough, and we
ended up with a larger and larger liquidity holder problem.
We were there to validate the concerns of the company,
which were true. We were also there I think to validate for the
Federal Reserve that there was real solvency and capital in the
insurance companies which was what the bedrock of the
transaction was. In other words, the $85 billion could not have
been loaned if there was not any hope of getting the money
back, and to a large extent whatever returns there are going to
be is because of the robustness of the insurance company.
To a large extent, I agree. I think that AIG got well away
from its core competency of insurance. It went into very
complex instruments called credit default swaps, which I can
explain some of the basics as I've been asked. But overall, the
State regulation of it, I think, worked quite well. It is a
lesson for us to talk about, I hope, about what is the right
way to regulate holding company undertakings.
There were 71 U.S. insurance companies. As I said, without
them, there would not have been a bailout. But to an almost
exclusive extent, the problem was caused by activities
conducted out of Financial Products. Those activities were
largely through the writing of credit default swaps. They are a
legitimate need for hedging of risk, which was the beginning of
credit default swaps probably in the 1980's. It's where you own
a bond, let's just say, you own Ford bonds. And you want to
hedge your risk that Ford is going to default on those bonds,
so you go to a third party and you ask them to essentially
insure you against that default. That's the swap. That's the
part of the swap. You're swapping the risk of the default with
a third a party. That is called hedging also. And it is often
also called insurance in the sense you are buying insurance
against the default of the bond.
But I think that the committee should know that is now only
about 10 percent or so of credit default swaps that are
outstanding in the world. There are probably over $60 trillion
of credit default swaps. An overwhelmingly high percentage are
what I termed a couple months ago naked credit default swaps.
What that means is you enter into a contract with a party.
Neither of you own any exposure to Ford. You're just taking a
bet. You're taking a gamble on whether Ford is going to default
or enter into bankruptcy or not. It's a form of shorting. It's
the way we short the credit-worthiness of our industries. It is
far larger than the equity shorting--and you've heard about
naked shorting in the equities market and how Chairman Cox
asked to have that prohibited and did.
It's interesting that on the bond side, on the credit-
worthiness side, we've permitted this to run completely
unchecked to the point that it is larger than the entire
economic output of the world annually. That's where we are on
credit default swaps.
And the Governor has said that he's willing to regulate the
piece that we can, which is the insurance piece, that original
10 percent we can easily call an insurance product. We can
regulate that because it is an insurance transaction as I
described. You own the bonds. You have exposure. You're not
going to the track and placing a bet, and that's when you get
your exposure. And we can do that. And the Governor has
announced that as of January 1st, if there is not a more
holistic solution through a central counter-party clearing or
an exchange or some kind of clearing house that the Governor
and the insurance department is willing to do that to help sort
of clarify what Chairman Cox called the regulatory black hole
of credit default swaps.
I will note, just because I'm in front of Congress and
maybe this is helpful, that it required the Commodity Futures
Modernization Act of 2000 which I believe was a statute passed
by Congress to exempt credit default swaps, the naked kind that
I described, from being subject to the gaming laws of the
various States and to what are called the bucket shop laws.
That is a very--it's kind of funny, but it is kind of funny. I
could read to you that there's a law that's directly on point
that prohibits that kind of activity, entering into this
agreement without any exposure to the reference. And it
required the CFMA to say that's not gambling. And likewise, as
Chairman Cox pointed out, it also was required that it be not a
security, otherwise it would have been regulated by the SEC.
So the CFMA both in one fell swoop said CDSs are not a
security, and they're also not subject to the gaming laws of
the land. And I think when you talk about moral hazard and the
way they got it right in the 1920's, which is the law I'm
referencing, 1907, they probably understood some things then
that we sort of forgot along the way. And now we're $63
trillion to the worse. Later on, I can read you if you'd like,
but it's pretty well established, and I think it's something
that we should at least examine along with whether Glass-
Steagall was such a mistake or not and other ways that we sort
of protect our depository institutions, like insurance
companies and commercial banks, from attendant activities at
the holding company level.
Thank you very much.
[The prepared statement of Mr. Dinallo follows:]
[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]
Chairman Waxman. Thank you, Mr. Dinallo.
Mr. Turner.
STATEMENT OF LYNN E. TURNER
Mr. Turner. Thank you, Chairman Waxman, committee members.
I think this is a very important hearing in light of the
fact that we're watching millions of Americans lose their jobs.
They've lost their homes. Now, as we watch the stock market
come down, they're also losing their savings. Much of this is
destruction and devastation I think that could have, and quite
frankly should have, been avoided.
Chairman Waxman. Could you pull the mic a little closer to
you? There is a button on the base.
Mr. Turner. It is on. Is that better?
Put it in the words of philosopher George Santana, those
who cannot remember the past are condemned to repeat it. And
certainly we fall in that category today.
AIG serves as a reminder, an unfortunate but excellent
example of what is wrong with our financial system today. While
there are many capital participants that have operated within
sound business, ethical, and legal boundaries, there have been
far too many that have not. We began the decade with the mess
around names such as Enron and WorldCom, followed by the Wall
Street analyst scandal, then on to mutual fund late trading and
market timing, then the stock option backdating at such
companies as United Health, and now we find ourselves in the
midst of the biggest and by far and away the most destructive
of all, the subprime fiasco.
This is a crisis that could have and, in my opinion, should
have been averted before it cost the American taxpayers what
appears to be in excess of a trillion dollars before we're all
said and done with it. And certainly there's plenty of blame to
go around. All of us I think probably share in that to some
degree. But I hope the focus of Congress and this committee
would be, on a bipartisan basis, holding hearings that, much
like an investigation occurs when a plane crash goes down,
determines what went wrong and then promptly turns around and
fixes it so we don't repeat history.
From my perspective, some of the causes of this economic
crisis include executives and mortgage brokers engaging in
unsound if not illegal business practices, compensation and
incentives resulting in some business executives being paid
both coming and going as they walk away from the equivalent of
quite frankly a train wreck with huge severance packages that
their corporate boards actually agreed to; accounting standard
setters who failed to provide the markets with the necessary
transparency; woefully inadequate due diligence by investment
banks underwriting the securities; cheap debt set up by our
monetary policy people that created low interest rates and led
to tremendous leverage in debt in this country; as Eric
mentioned, a $62 trillion unregulated credit derivative market
which had absolutely no transparency whatsoever; the SEC being
handcuffed by a lack of resources, lack of regulatory authority
and changes in policy that no doubt have hampered enforcement;
the lack of a regulator that could regulate at the holding
company level for national and global insurance companies; and
the failure of the Federal Reserve and banking regulators whose
exams failed to identify and rectify unsound lending practices
at institutions such as IndyMac, WaMu, Countrywide, and
Citigroup, and often these practices led to what is our
fundamental problem, loans got made that people could not
repay.
In addition, policymakers and regulators have allowed
financial institutions to merge and grow into colossal entities
that have shown they can have a devastating impact on our
economy when they get into trouble. Some are arguing that, as
we've heard, they're now too large to fail. And with their
failure now, though, resulting in taxpayers paying hundreds of
billions to rescue them, it's time to examine good public
policy to ensure that regulation of these entities provide much
greater transparency, freedom from some of the conflicts we've
seen, accountability for their actions and oversight.
Investor confidence is paramount to the success of any
capital market. And transparency is what creates that
confidence. Indeed, it is the lifeblood of any capital market
system. When people believe they can no longer trust those for
whom they invest their money, they withdraw it quickly and find
safer havens for it, as we're seeing today. And when they
demand their money back from a financial institution for fear
of losing it, it can cause a serious liquidity crisis and
failure, as we've seen at Bear Stearns, Lehman, and others. And
as the money dries up and demand for the investment of the
stock in these institutions falls, so does their stock price,
making capital difficult if not impossible to raise. It's a
vicious cycle. But it is one that has occurred many times in
the past.
More specifically, with respect to AIG, there has been, in
my opinion, poor management and governance that has led to a
poor tone at the top and lack of risk management controls. I
heard the chairman talk about Mr. St. Denis and his concerns.
Mr. St. Denis worked for me at the SEC. He worked for me when I
was a partner in the accounting firm. And his credibility is
beyond reproach, and I'd seriously consider the comments that
he has provided you.
The company has engaged in questionable business practices,
including assisting others engage in illegal activities. This
along with a constant slew of errors being reported in its
financial statements have led to various investigations by
legal authorities and sanctions. It's not a company that has a
good track record. And in addition, opaque disclosure has been
less than forthcoming. In the summer of 2007 an AIG executive
said that the company would not incur a dollar of loss, would
not incur a dollar of loss on its derivatives. Yet by December
of last year, counterparties to the credit insurance required
posting a collateral of over $5 billion, a number that had
grown to $14 billion as of June 2008. And in a stunning
revelation, the company disclosed on October 3rd that it
borrowed $61 billion of the $85 billion made available to it by
the Federal Reserve. The rapid changing disclosures on this,
from zero to $61 billion in less than 12 months, is phenomenal,
and investors certainly have to raise the question of, did we
get the straight scoop back a year ago?
At the same time, AIG, in a move that appears to deflect
criticism, blamed its problems on accounting rules which
required it to disclose losses to its investors. This is like
blaming the thermometer folks for a fever. As we saw with the
savings and loan crisis and as the GAO, Congress's own watchdog
has reported at the time, the ability of financial institutions
to reporting--to avoid reporting to clients in the value of
assets contributes to unsound business practices and large
losses for the government who has to step in with a bailout.
Again, we should not forget the past and repeat these costly
mistakes. Thank you, Mr. Chairman.
[The prepared statement of Mr. Turner follows:]
[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]
Chairman Waxman. Thank you very much, Mr. Turner. We'll now
recognize Members for 5 minutes each to ask the two of you
questions.
And I want to recognize Mrs. Maloney first.
Mrs. Maloney. Thank you, Mr. Chairman.
And I'd like to welcome our panelists and thank them for
their public service, particularly Mr. Dinallo from New York
State. Thank you and the Governor for your creative response to
the AIG crisis.
Last night and this morning I have been criticized for some
pundits of my line of questioning on deregulation. Some of them
called it partisan. I just want to begin by saying that our
financial crisis is not a partisan issue. I truly do believe
that every Republican, Democrat, Independent, conservative,
liberal are dedicated to working toward a solution, and I
believe the Members of Congress want to find a solution.
I am going to ask questions on deregulation and the
relationship to the problems we confront. But I want to preface
it by saying I am not being partisan. I am not criticizing
anyone or any act or any particular thing. I am just trying to
understand more about it.
And so with that being said, I'd like to ask Mr. Dinallo a
few questions about the lack of regulation around credit
default swaps of which seem to be at the center of AIG's
downfall. Credit default swaps are basically insurance
contracts to protect against defaults on bonds and loans. It's
an enormous market.
Since 2000, it has exploded from $900 billion to $58
trillion. That's roughly twice the size of the entire U.S.
stock market. It is also bigger, I understand, than the annual
output of the entire world economy for 1 year. And yet,
incredibly, the market for credit default swaps is entirely
unregulated. Although they operate like insurance contracts,
parties selling these guarantees are not required to have
capital reserves to protect the other party. And I would first
like to ask, because they are so huge, $58 trillion, if there
is no value behind them, as some economists allege, could they
bring down our entire economy?
Mr. Dinallo. Well, I guess we're going to find out. I hope
not. But I will say that the distinction between credit default
swaps and insurance policies is when you write an insurance
policy, you're required to have a certain amount of solvency
and capital behind that commitment. For a large, large, large
percentage of credit default swaps, you're required to have
absolutely no collateral or capital behind them. I--I do agree
that it is interesting to note that, as Lynn said, it is not,
you know, insider trading or late trading or the analyst cases
or lax regulation or firm regulation or hard enforcement or
soft enforcement that brought down the global economy.
I think it's politically neutral to observe; it's what we
chose not to regulate. And I don't think that's actually very
partisan at all. I think we as a country in 2000 made certain
choices, along Gramm-Leach-Bliley and the CFMA, to permit this
kind of activity as being a way to, ironically, to hedge risk.
This is the ironic part. CDSs were to meant to hedge risk. But
they multiplied risk incredibly in part because now only about
10 percent of what you describe is actually an insurance policy
kind of transaction. The rest is really just a bet about the
future of a company's credit-worthiness.
Mrs. Maloney. So are those products just gambling, as you
mentioned?
Mr. Dinallo. Well, the Governor called them gambling.
Mrs. Maloney. We had the bucket shop laws, and we banned it
in New York State. And then the commodities law usurped our
position, and you think that should change?
Mr. Dinallo. We did ban it. In 1909, after the crash of
1907, we banned this kind of activity that used to be done in
bucket shops where they would just take bets on the market,
bucket the trades. And yes, that is what we did. And it
required this--and no lawyer, no good lawyer could convince a
client that a naked credit default swap was not also possibly
prosecutable as gaming, so the CFMA, appropriately, because we
do need some kind of futures market--there is a role here--but
it completely exempted them. And the results are, in part, what
you see today, which is not necessarily all about credit
default swaps, as Lynn said, but also just the opacity.
One of the important points, I think, is when we were
working through the bond insurers and back at MBIA and all the
work we did on those, as you know, and at AIG, no one,
including ISDA, could tell you how much credit default swaps
were written on those entities as reference points. So if AIG
had failed, no one knew how much CDS was written on AIG.
Mrs. Maloney. My time has expired.
Chairman Waxman. Yes. Thank you.
Thank you, Mrs. Maloney.
Mr. Mica.
Mr. Mica. Thank you.
First of all, let me say that I'm pleased that we may be
looking at Fannie Mae and some of its responsibility in
fomenting the financial crisis and the mess that we see right
now.
I'm disappointed, though, that we didn't start with some of
the culprits, and we should actually have reviewed some of what
took place with the Federal backed agency that helped, again,
get us started down this wrong path. Yesterday and today we're
sort of splashing around in the wading pool, and we really need
to be looking at the cesspool. We're talking today about AIG, a
private firm, now with government backing, but it was a private
firm; and yesterday about Lehman Brothers, a private investment
firm and their compensation, their running away with millions
of dollars of investor dollars. And we're ignoring the core
perpetrator of all this, Fannie Mae, whose executives ran away
with tens of millions of dollars in public-backed bonuses,
public-backed activities.
Is it correct that AIG and Lehman are private investor
firms as opposed to Fannie Mae?
Mr. Dinallo. Yes.
Mr. Mica. Just for the record, they both nodded their heads
affirmatively.
Mr. Turner, I read your written testimony. I agreed with
most of it. You didn't mention Fannie Mae or Freddie Mac. Were
their practices in any way contributory to the financial mess
we're in?
Mr. Turner. I have actually done work on behalf of OFHEO at
both Fannie and Freddie.
Mr. Mica. Ok, then I don't want to hear your opinion----
Mr. Turner. But let me just say that I see great
similarities between both of those institutions and AIG. And I
applaud you, very highly, for taking a look at those two
because I don't see a whole lot of distinction.
Mr. Mica. Well, I want to do more than applaud because if
this committee isn't going to investigate, I intend to ask the
now--the special counsel statute has expired, but it's my
understanding that the Attorney General can help us drain the
swamp and go after those who created the cesspool. And I'm
going to ask my fellow Republicans and Democrats to consider
asking the Attorney General to go after those folks who robbed
the American taxpayer and start with Fannie Mae, which is a
federally backed institution, which you both nodded to, which
started, in my opinion, this whole mess. There were
contributing factors. Glass-Steagall, didn't that contribute?
Just answer yes if you agree.
Mr. Turner, did you think Glass-Steagall, the repeal----
Mr. Turner. I think the repeal of Glass-Steagall was a
contributing factor here.
Mr. Mica. OK, Mr. Commissioner?
Mr. Dinallo. I agree.
Mr. Mica. One of the interesting things, too, New York
did--in most cases, the States were pretty good regulators of
insurance, is that correct?
Mr. Dinallo. Thank you. Yes. I think the record would
support that.
Mr. Mica. And default swap is really out of your purview.
But even regulation of what Fannie Mae and what they were doing
and some of the activities that took place at government-
sponsored financial enterprises: 2002, Mr. Shays and I
introduced a law that would have brought this activity under
the SEC. That would have helped regulate it. 2004, it was
introduced and passed, actually, I think in 2005 by the House
and blocked in the Senate, is that right?
Mr. Turner. It was actually--Congressman Frank, much to his
credit, did introduce legislation that got passed in the House
over here, and I applaud----
Mr. Mica. But it was blocked in the Senate.
Mr. Turner. But it was not passed in the Senate, and that
was greatly unfortunate.
Mr. Mica. Yes, I voted against it--Glass-Steagall, Mr.
Waxman and I voted against--not to repeal that. We voted
opposite for the regulation in 2005.
But the responsibility lies with Congress, not with a State
of New York Department of Insurance or some other State to
regulate and go after some of these speculative investment
activities at that level. Is that not right?
Mr. Dinallo. The responsibility of the State regulators,
which I think they executed on extremely well here----
Mr. Mica. Yes, but you couldn't control the situation, is
that correct?
Mr. Dinallo. To protect policyholders and protect the
solvency of the insurance company.
Mr. Mica. It's the responsibility of the Congress of the
United States, and also it's the responsibility of the Congress
to start first with its--and clean up its own dirty cesspool,
which is Fannie Mae. And we still don't have a commitment or a
date to do that. And I know exactly why.
Chairman Waxman. The gentleman's time has expired.
Mr. Cummings.
Mr. Cummings. Thank you very much, Mr. Chairman.
And to the witnesses, I want to thank you all for being
here.
And my constituents are concerned about where the $700
billion is going. They want to know, because they get up every
morning. They work hard. They give up their tax dollars, and
they're trying to figure out where did the money go? Where is
it going?
Mr. Turner and Mr. Dinallo, after the bailout of AIG last
month, the U.S. Government effectively bought an 80 percent
share in the company. That should have caused a fundamental
change, you would think, in how the company was spending funds
on compensation, bonuses and benefits. But it doesn't look like
that's what happened. The committee learned that shortly after
the bailout went through, executives from AIG's major U.S. life
insurance subsidiary, AIG American General, held a week-long
conference at an exclusive resort in California.
The resort is called the St. Regis Monarch Beach. Let me
put up some pictures of the hotel up on the screen. It's very
impressive. This is an exclusive resort. The rooms start,
gentlemen, at $425 a night. Some are more than $1,200 a night.
By the way, that's more than some of my constituents pay on a
mortgage payment every month on the homes that they're now
losing, by the way.
We contacted the resort where AIG held this week-long
event. And we requested copies of AIG's bills. We learned that
AIG spent nearly half a million dollars in a single week at
this hotel. Now this is right after the bailout.
Mr. Turner, have you heard of anything more outrageous, a
week after taxpayers commit $85 billion to rescue AIG, the
company's leading insurance executives spend hundreds of
thousands of dollars at one of the most exclusive resorts in
the Nation? Mr. Turner.
Mr. Turner. I've been a business executive myself, and I
tell you what, when our company--you know, when things got
tough, you cut back on expenses. You just go out and eliminate
those type of things. I'm sure they had the issue, they were
probably already committed to it and were going to have to
spend it one way or another. But nonetheless, I remember, we--
as business executive VP and CFO of a company, we would
actually go out and cancel those conferences because we just
didn't want to send a message to the employees that we are
spending on this type of thing and we need to cut back
expenses.
Mr. Cummings. And if a company is drowning, then you're
going to go and spend that kind of money? It's crazy. And I
agree with you.
Let me describe for some of you the charges that the
shareholders who are now U.S. taxpayers had to pay. Check this
out. AIG spent $200,000 for hotel rooms. And almost $150,000
for catered banquets. AIG spent--listen to this one--$23,000 at
the hotel spa and another $1,400 at the salon. They were
getting their manicures, their facials, their pedicures and
their massages while the American people were footing the bill.
And they spent another $10,000 for, I don't know what this is,
leisure dining.
Ms. Speier. That's bars.
Mr. Cummings. Oh, thank you very much.
Mr. Dinallo, let me ask you, not as the insurance
commissioner but as a taxpayer, does this look right to you?
Mr. Dinallo. I think there are some regrettable headlines
in that. But I will say one thing, having been at large global
companies and knowing what condition AIG was in when the
injection occurred, the absolute worst thing that could have
happened to AIG after the Government extended $85 billion would
have been for them to basically go into a run-off situation,
for employees to leave, for traders and major underwriters to
flee the company. So if there was a thinking that they needed
to bring everybody together in order to keep the productivity
of the insurance companies in tact and protect policyholders by
keeping them from going into a run-off status, I do agree there
is some profligate spending there, but the concept of bringing
all the major employees together to mix--let me just--to ensure
that the $85 billion could be as greatly as possible paid back
would have been not a crazy corporate decision.
Mr. Cummings. Well, I would tend to disagree with you. When
it comes to pedicures facials manicures, the American people
are paying for that.
Mr. Dinallo. I agree.
Mr. Cummings. And they're very upset.
Mr. Dinallo. I said there are regrettable and wrong
headlines in that. But the idea of making sure that you can get
the game plan back on track so you can pay off the loan is not
an irrational one.
Mr. Cummings. That is an expensive way to get the game plan
back on track.
Mr. Dinallo. I agree.
Chairman Waxman. The gentleman's time has expired.
Mr. Bilbray.
Mr. Bilbray. Thank you, Mr. Chairman.
And, Mr. Chairman, let me say personally, thank you very
much for agreeing to do a hearing on Freddie and Fannie. I
appreciate you doing that. I hope we can get that date.
Mr. Turner, I appreciate your frankness of saying, even
though I'm not talking about it, we need to go back and look,
concentrate on Freddie and Fannie.
I appreciate, Mr. Chairman, your ability to respond to that
reality.
And in fact, Mr. Chairman I would almost say that we may be
sitting in a situation that now that Freddie and Fannie has
become public agencies, that we may want to talk to the
Attorney General about the possibility of a special prosecutor
to go in and take a look at that as one of the public agencies.
And I think that's important to show the American people we
really are serious at getting to correcting some of these
problems and really doing it based on an in-depth study of the
problem.
Let me sort of backtrack. This issue of the credit swaps,
it seems like there are two--there's a balancing line here,
where it is an insurance hedge and then they move into a
gambling. Now, the preemption that the feds put in to say it is
not gambling totally, wouldn't you agree that maybe we ought to
go back and revisit that and try to develop a bright line
between what is gambling and the States can intervene on as
opposed to what is insurance and States can't intervene?
Mr. Dinallo. Yes. What I would have done is I would have
said that each one of those activities had to get some kind of
an exemption activity by activity. So there is a good argument
that sort of, in crop insurance, you need futures to protect
yourself against crop failure, etc. There are lots of hedging
activities that are kind of on the border. You don't maybe
absolutely own the security or the bond, but you do have
exposure. But we basically through the law--I could read to
you--we completely exempted all of it. And I think it needs to
be seriously revisited.
Mr. Bilbray. Mr. Chairman, this is the type of line that I
wish, instead of just us meeting, and maybe we ought to ask the
Speaker to reconvene the Financial Services Committee, to meet
now, not out a month from now, to talk about the specific
proposals that the House could come back into session and
address.
Gentlemen, if you were in Congress, you were a Member of
Congress and maybe in the Financial Services Committee, what
changes and what proposals would you propose to the Speaker of
the House of Representatives, to the President and the leader
of the Senate at this time and place?
Mr. Dinallo. I would first revisit the CFMA on its credit
default swap decisions that it's a completely unregulated and
open field and that it's neither a security nor subject to the
gaming laws and get back to the hedging instrument, which is I
think core for our society and appropriate. I would take a
serious look at Gramm-Leach-Bliley and decide whether the
supermarket of financial services is worth it when sometimes
things really smell on aisle six and infect the rest of what we
view as kind of sacred stuff, which is depository money;
whether it's insurance policy proceeds or banking, commercial
banking deposits, there needs to be a greater clarity about how
the holding company activities, which here did not bring down
the insurance companies but did ding them from a franchise
value greatly, can harm those two depository type institution
activities, and whether it's always good to just let them
willy-nilly be together under a holding company type umbrella.
Mr. Turner. Congressman Bilbray, you actually raised a very
good question. My first comment would be that certainly, I
think, the American public were concerned about how quick we
ran into the $700 billion bailout, but I do applaud you for
doing the bailout. I think without a doubt it needed to be
done. It could have been done in perhaps a different fashion.
But I think the public is looking for Congress to do what
this committee--and I agree with you, what the Financial
Services and the Senate Banking Committee should be doing, and
that is immediately holding a series of hearings, just like the
Pecora hearings were held in the 30's. We need a set of
hearings that first identify some of the issues where each of
the problems should be. It should be all inclusive. It should
be the whole swamp. As people mentioned, let's drain it all
out, and then turn around and, once we know where each of the
issues are, bring in very knowledgeable people, like a Chairman
Volker and like a Chairman Leavitt and the type, to turn around
and get the best of their thinking.
And then with that, then let's go take a real good shot at
putting in the things that need to be fixed. And there's a gob
of things. There's questions about who should be doing the
examination of these. There's questions about failures at the
Fed and failures at the SEC. Do we need to restructure those
examination functions, which I think we probably do? Do we have
adequate resources? Do we need to repeal the Gramm-Leach-Bliley
in light of what's happened with the growth of these
institutions and they're too big to fail?
Certainly there's things that need to be done in terms of
transparency because both in the credit derivatives market as
well as some of the other subprime stuff, there's been a
tremendous, tremendous lack of transparency, which has directly
contributed to the lack of confidence. And I serve on two--the
boards of two investment funds. And right now, people can't
tell which companies they can trust and which ones they can't
because of that lack of transparency. Until we get that problem
solved, we are going to continue to see days like we saw
yesterday in the stock market.
Mr. Bilbray. Mr. Chairman, thank you.
I just got back from my district. And the outrage is not
that we threw money at the problem but that we threw money at
the problem and look like we've walked away for a month. And if
it such a crisis to throw that much money out there, my
constituents are saying there should be a crisis that you get
in and not walk away from answers or demanding answers to solve
the problem.
Thank you very much for the opportunity to question the
panel.
Chairman Waxman. Thank you very much Mr. Bilbray.
Of course, that's the purpose of this hearing.
Mr. Kucinich.
Mr. Kucinich. Thank you very much, Mr. Chairman.
To Mr. Dinallo, Treasury Secretary Paulson is the former
CEO of Goldman Sachs. Mr. Paulson, of course, was involved in
helping to save AIG. And Goldman Sachs is AIG's largest trading
partner. News reports say that Goldman Sachs had at least $20
billion at stake in AIG.
Now you, sir, were involved in negotiations to rescue AIG.
Was the CEO of Goldman Sachs Lloyd Blankfein and other Goldman
Sachs executives present at meetings to save AIG?
Mr. Dinallo. Yes.
Mr. Kucinich. Could you speak into the mic.
Mr. Dinallo. Yes. Yes.
Mr. Kucinich. Was Secretary Paulson at any of those
meetings?
Mr. Dinallo. None that I was present at.
Mr. Kucinich. Do you have any knowledge that Secretary
Paulson was present at any meetings relating to saving AIG?
Mr. Dinallo. I'm not trying to avoid the answer. I just had
no personal knowledge of that.
Mr. Kucinich. Do you have knowledge that he was the former
CEO of Goldman Sachs?
Mr. Dinallo. Oh, absolutely. Oh, I can talk to you--I am
happy to talk to you about this. You're asking me yes-or-no
questions, and I'm finding it hard to----
Mr. Kucinich. Before the bailout, did Secretary Paulson or
other Federal officials raise concerns about the impact that
the AIG collapse would have on Goldman Sachs?
Mr. Dinallo. Yes, but not only Goldman Sachs. In fact, if I
may, I'll just tell you that I--I admire Tim Geithner, the
president of the Federal Reserve. He has taught me various
techniques in working through some of these problems. One of
them is he believes----
Mr. Kucinich. I'm not really asking you about Mr. Geithner,
so I want to know----
Mr. Dinallo. Well, I just want to finish--please, sir.
Mr. Kucinich. But you are on my time and I want you to
answer my questions. Now my question is, the head of global
commerce----
Mr. Dinallo. Yes.
Mr. Kucinich. For Lehman sent an e-mail on July 13, 2008,
to Lehman's CEO which said, ``it is very clear GS,'' speaking
of Goldman Sachs, ``is driving the bus with the hedge fund
cabal and greatly influencing downside momentum,'' meaning that
Goldman Sachs was working to intentionally drive down the price
of Lehman's stock. This was in mid July; 2 months later, Lehman
went down with tremendous impact on the market and impact all
over the world. But AIG was saved.
Now, what I'm trying to find out, you know, if Lehman's
death was natural causes or murder. Now we're told that
Secretary Paulson, as a former CEO of Goldman Sachs, has
brought in another former Goldman Sachs employee to manage the
$700 billion bailout fund.
Now, Mr. Dinallo, you are the superintendent of New York
insurance.
Mr. Dinallo. Yes.
Mr. Kucinich. You are a regulator. As a regulator, do you
have any concerns that Mr. Paulson, as the former head of
Goldman Sachs, was and continues to be in a position of
conflict of interest with respect to being able to make
decisions that would enhance the position of Goldman Sachs or
be able to make decisions that would adversely affect those who
might be in competition with Goldman Sachs? As a regulator, do
you have any of those concerns?
Mr. Dinallo. From what I witnessed in the 4 days and 5 days
that I was exposed to what I was exposed to based on my
personal knowledge, I don't have concerns. I can't personally
attest to Secretary Paulson's management of whatever conflicts
of interest.
Mr. Kucinich. So your answer is you don't know?
Mr. Dinallo. My answer is I don't feel I have the basis to
answer the question asked. I could give you reasons that I
think AIG was treated differently than Lehman. I could do
that----
Mr. Kucinich. Thank you, Mr. Chairman.
Chairman Waxman. The gentleman yields back his time.
The Chair now recognizes Mr. Souder.
Mr. Souder. Thank you, Mr. Chairman.
This unbridled greed, this callous abuse of trust of
hardworking Americans' savings is just so disgusting it's hard
to put into words. And the anger level in America is coming, as
it often has, directly at Wall Street but at everybody. They're
worried they're going to lose everything they've worked to save
because some people were living so high on the hog, so
disrespectful of what was going on. The issue of that hotel
wasn't the amount of money. It is the insensitivity of how
people behaved with our dollars. And it's just massive
discouragement to all of us that--I wanted to ask a few
questions about the State insurance fund first in New York.
Is there sufficient guidelines to wall off the divisions
from dipping in when they're dealing with these credit futures
and money market things and so on to the insurance reserves?
How is that walled off?
Mr. Dinallo. Yeah. That's what I--I think the system worked
well because there's a fairly strong regulatory moat around
each of the insurance operating companies versus the holding
companies. So I think that there is--there was kind of an
instinct at AIG that maybe there was more capital for liquidity
purposes than was really available. And that's how they got it
arguably into their liquidity crunch. So policyholders are
extremely well protected from the holding companies reaching
into the operating companies for capital and liquidity needs--
--
Mr. Souder [continuing]. Disclosure to stockholders at AIG
that in fact those assets are walled off and cannot be used,
and is part of the problem here that they discovered, the
insurance assets were protected, markets started to adjust and
caved AIG?
Mr. Dinallo. That's a very sophisticated statement. And I
think there is some truth to the--I don't know, because I'm not
in their minds. But certainly there is--there is a--I think a
good realization among policyholders across this country that
their--the operating companies are relatively walled off from
that kind of activity.
Mr. Souder. In your State insurance fund, we have--I met
with one company that's in danger of going under, an insurance
company, because they had too much Fannie Mae stock. Do you
have an inventory as a State insurance regulator of how exposed
your insurance companies are in Fannie Mae? Because right now
preferred stock's probably worth zero. Common stock certainly
is.
Mr. Dinallo. We do constant examinations of the company. We
have--one of the reasons I think insurance companies have done
well is there are fairly strict rules and accounting standards
which Lynn and I could try about what insurance companies can
buy and hold in their asset liability match. I will just tell
you right now, the worst exposure an insurance company can have
right now is some, but the percentages that we've looked at are
very low, some exposure to what had been AAA rated, CDOs, the
famous AAA rated mortgage-backed CDOs, but actually the default
levels of those are still relatively small, so if you hold them
to term, you may be OK for an asset liability match.
Mr. Souder. This insurance company I believe had 25 percent
liability in Fannie Mae. Do you have a guideline in New York on
Fannie Mae?
Mr. Dinallo. As I sit here today, I can't answer that. I do
know that we have a bureau that sort of specializes in
rehabilitation of distressed insurance companies.
Mr. Souder. If I was trying to go through the different
guarantee funds and so on, if insurance companies would start
to need to be rescued, do you have a fee much like do we for
FDIC----
Mr. Dinallo. Yes.
Mr. Souder. And others like the insurance companies would
kick in?
Mr. Dinallo. You are being very helpful. Thank you. Yes, we
have what's called a guarantee fund.
Mr. Souder. Do you have right now--because I would assume
everybody should be going, because one of the debates here is,
can the States do this as opposed to Federal?
Mr. Dinallo. Yes.
Mr. Souder. It sounded like you were looking at but do not
have a clear analysis of the Fannie Mae exposure but others
exposures that you have so that you could have an idea of your
kind of your plan at the State level if the economy continues
to tank, if more of these risky purchases that didn't seem so
risky, because even Fannie Mae just this summer was insured by
the Department of the Treasury, investors were told, hey, this
is great. And then all of a sudden, it collapses. How are you
dealing at the State level?
Mr. Dinallo. We have very frequent reporting through our
capital markets bureau. We regulate over a thousand companies.
So I can't, on any one company, I cannot sit here and tell you
what the numbers are. We do have in place a system where, if
there was a distress, we would bring the company into what's
called rehabilitation, which is a form of bankruptcy proceeding
to protect the policyholders so the capital is there to pay off
the loans. If there is a shortfall, there are, as you pointed
out, both life and property guarantee funds behind those.
What bothers me about the whole AIG episode the most from
what I do for a living is I think it's--it's a broad
misunderstanding bordering on the inappropriate that people
would use it as an argument that there needs to be Federal
regulation of insurance. I actually have been open to
discussion of Federal regulation of insurance. I've testified
several times in front of Chairman Kanjorski's committee, and I
think I am one of the more open to those ideas. But AIG is
Exhibit A for how well the States did, not how poorly they did.
And that has to be said clearly because it's bad for policy
holders if they think that actually their regulators did not
execute well on that part of the industry.
Chairman Waxman. Thank you, Mr. Souder.
Mr. Tierney.
Mr. Tierney. Thank you, Mr. Chairman.
Let me followup on that, Mr. Dinallo. And Mr. Souder makes
the point. You noted in your written statement that AIG is a
holding company and owns a variety of insurance and other
businesses. And Massachusetts' insurance commission was quick
to share with me the fact that the problems at AIG are really
those that deal not with its insurance subsidiaries but with
its operations and holding company, those in the Financial
Products Division, securities lending division and that area
there. The State-regulated insurance subsidiaries remain
solvent and able to that pay their claims, correct?
Mr. Dinallo. Yes, sir.
Mr. Tierney. And in fact, it's that solvency and ability to
pay their claims that really gives them the basis for the
Federal loan and the comfort that it will be paid back.
Mr. Dinallo. Absolutely.
Mr. Tierney. Now your office regulates insurance
subsidiaries, not the corporate parent. The only agency with
authority to regulate the corporate parent is, in fact, the
Federal Office of Thrift Supervision.
Mr. Dinallo. Yes. That was a choice by the company back I
think a few years ago. They could have chosen us.
Mr. Tierney. Yes, they could have chosen a regulatory
agency that would have been more difficult to deal with. And
then they probably would have supervised them better.
Mr. Dinallo. I didn't say that.
Mr. Tierney. They chose the Federal Office of Thrift
Supervision, which is not known for its expertise in this area,
and we should get that on the table.
But the committee has obtained a letter that the Office of
Thrift Supervision sent to the AIG board on March 10, 2008.
According to the letter, the agency criticized AIG's management
and AIG's oversight of its subsidiaries, including in
particular the Financial Products Division. I'd like to read
from you a part of the letter and get your reactions.
The letter says, we are concerned that risk metrics and
financial reporting provided to corporate management by AIGFP
and other key subsidiaries may lack the independence,
transparency and granularity needed to provide effective risk
management oversight.
It also says, a material weakness exists within corporate
management's oversight of AIGFP's super senior Credit Default
Swaps, CDS, valuation process and financial reporting.
Last, it says that AIGFP was allowed to limit access of key
risk control groups while material questions relating to the
valuation of the super senior CDS portfolio were mounting.
So it wouldn't let in the people that would deal with this,
and it kept that secret. Now, obviously, it says the oversight
in key divisions has failed and that AIG apparently didn't have
a full understanding of the risks taken by the financial
products division. As an insurance regulator, I imagine you
spend a lot of time assessing how well companies manage their
risk, so we ask you, do the problems identified by the Office
of Thrift Supervision sound serious to you?
Mr. Dinallo. If I authored such a letter as a regulator, I
would view those as very serious allegations, yes.
Mr. Tierney. The letter also says that the AIG's outside
auditor, PricewaterhouseCoopers, had reported the same
criticisms to AIG's risk management and the lack of
transparency issues. Things were so bad that the agency decided
to downgrade AIG's risk management rating, its earnings rating
and its composite rating.
Mr. Dinallo, can you tell us what that means in layman's
terms?
Mr. Dinallo. It means that they were--I guess if they--I
don't know where they downgraded it from and to, but it would
indicate that they had some kind of enterprise risk management
matrix and they brought them down at least a notch on how they
were managing those core risks, which would, again, be
something for concern.
Mr. Tierney. Mr. Turner, you indicated at the beginning of
your testimony, I think we ought to be looking at what went
wrong here; and I agree. What's your reaction to the agency's
conclusions about inadequate controls at AIG and what does it
tell us about the corporate governance there?
Mr. Turner. Given the fact that AIG had been going through
numerous restatements, literally since the beginning of the
decade have said they've had errors in their financials, to get
a letter like that out of an agency saying you had those type
of risk management problems I think is extremely serious. I
would agree with Mr. Dinallo on that. And I would say that
you've got a serious problem from the top down, tone at the
top. People just aren't giving it enough attention and aren't
serious enough about making sure these things are dealt with.
And in an organization this big that can bring an organization
down, and obviously there is a contributing factor here. So I
think it's very, very serious.
Mr. Tierney. So when our two next witnesses take the stand
and tell us it's all about mark to marketing and circumstances
beyond their control, in fact, management very much was a part
of this problem in your understanding, is that correct?
Mr. Turner. I would totally agree with that.
Mr. Tierney. Thank you very much.
I yield back, Mr. Chairman.
Chairman Waxman. Thank you very much, Mr. Tierney.
Mr. Turner.
Mr. Turner of Ohio. Thank you, Mr. Chairman.
Thank you both. I greatly appreciate your explanations,
your descriptions. This is very helpful, not only just for the
American people but for all of us in Congress as we're taking a
look at what do we do next and how do we approach what other
hearings are necessary.
In looking at your written testimonies, Mr. Dinallo, you
say that using its noninsurance operations AIG, just like many
other financial services institutions, invested heavily in
subprime mortgages.
And then, Mr. Turner, you say--and I love this paragraph in
your written testimony. You're talking about mark to market,
and that comes into play because of the issue of subprime
mortgages and the securitization of the mortgage-backed
securities that were having to be mark to market. You say, I
note the banks are requesting a moratorium on their fair value
report card, but they are also requesting $700 billion of
American's money to bail them out for the bad loans they've
made, and they want both.
Then you go on to say, it is a red herring, that obviously
if it was just mark to market they wouldn't need both the shift
on mark to market and the cash.
And then you conclude here, ultimately, it's no different
than someone who spends more than their paychecks each month,
indicating that the banks spent more on assets bought or
created than they are subsequently getting paid back.
And that brings us back to the subprime mortgages. So I
think it is so important that we have additional hearings on
Fannie and Freddie and the subprime mortgage area. And I've got
a question about that for you, and I want to tell you what the
experience is in my community.
Yesterday, when we had our hearing on Lehman Brothers, we
had a panel that spoke beforehand. And they say that this all
comes from a period of easy credit, housing prices escalating
and then declining, securitization of mortgages, people using
their houses as ATMs; and, of course, excessive CEO
compensation was cited. In my community, subprime mortgage
lending, predatory lending has had a decimating impact on
neighborhoods and families. We are at the forefront of the
foreclosure crisis.
In 2001, our community held a hearing on predatory lending.
A city commissioner, Dean Lovelace, pushed for this. There was
legislation passed to try to deal with it that was ultimately
knocked down.
But the community experience is about 5,000 foreclosures a
year, Ohio about 80,000 a year. Every 3 years, that's the size
of an entire congressional district that we see being
foreclosed.
But the experience we found in those hearings and what is
happening in Ohio is that, many times, these are loans where
the loan origination amount exceeded the value of the property.
It's not mortgage values declining, although they are now,
which is compounding the problem, but that there was systematic
efforts to give people loans that were in excess of the value
of their homes. Many times capitalizing the fees, many times
giving them terms that either had escalating rates or payments
that got them into difficulty, and then also economic
conditions causing them not being able to keep up with
payments. Then having a house that has a greater mortgage than
the value would result in abandonment and foreclosure.
Many of the things that we hear about in this, what we
should do and what has happened, fall in the category of bad
business judgments or areas of regulation. But to me loaning
people a loan greater than the value and then securitizing that
and not disclosing that there's a gap between the loan value
and the value of the ongoing asset should be, if it's not, a
crime; and I believe it is. And I think, ultimately, when we
start looking at all these things, we're going to find that
there were real crimes committed here that real people stole
and that had a big impact on our economy.
What are your guys' thoughts on the subprime mortgage
crisis that has brought this about? What are some of the things
that we should be looking at, or practices like this, that
might lead us to how we stop these practices? Because in the
bailout Congress did not stop the practices that got us here.
Mr. Dinallo. I would amend one of my earlier answers. I was
asked what are the things that I would have the Financial
Services Committee look at working with you, and I said CDSs,
and I said Gramm-Leach-Bliley. The third would be that there is
only so much good risk in any community. And we have permitted,
through securitization underwriters, to basically do a set of
loans to their community and then re-up the tank for doing more
loans an endless amount of times.
So the first set of loans that were CDO'd, the first set of
mortgages performed very well; and that banker probably said,
you know, there's at least twice as many loans that I would
have made, because I got great people in my community. I wanted
them to own homes, so I had to make some tough decisions. And a
banker on Wall Street securitized it, and the second set did
really well. And those were made with proper underwriting, due
diligence decisions.
After the sixth or seventh or eighth iteration, for however
we got there, I think that there is a basic, fundamental issue
with people not owning the underwriting risks of their
decisions. They have to have exposure to their underwriting
risks. And if you put into place a system where they no longer
have to worry about whether they get paid back on their loans
because they've handed it off to Wall Street who's handed it
over to investors seven, eight times, we will repeat this
again.
Mr. Turner of Ohio. Mr. Turner.
Mr. Turner. I would agree with Eric on this one, that this
intermediation that the banking regulators allowed to happen to
whoever was lending the money no longer had any skin in the
game and you got paid handsomely for doing those type of deals
is a major contributing factor here. And I think you got to go
back and look at the regulation of the mortgage brokers.
Certainly the appraisal process is going to be part of that.
But I think people have to go back and say, as a matter of
public policy, we all love securitization because it gave
everyone a chance to get into a home; and no one was
complaining about it when we gave everyone the chance to get
into a home. But when we loaned up 100 percent on those values,
and there were a lot of those homes, I think there's something
like 55 million of these of which 10 or 12 to 13 million are
now in foreclosure, clearly something wasn't working out about
them; and someone needs to go back to the banking regulators.
And they've done some work on this, but people need to make
sure that they've done enough work to make sure those type of
loans can't be made.
And then the bigger question of the role of
securitizations, which, quite frankly, Fannie and Freddie play
a big role in here, we have to reexamine that policy and say,
if there's securitizations, do we have enough safeguards? The
underwriting that occurred on them was undue diligence by the
investment bankers, was atrocious; and that played a role as
well.
Mr. Turner of Ohio. Thank you.
Mr. Chairman, I just want to make an additional point that
most of the loans that went into default in my community were
actually refinances where the family had the American dream but
that someone went back and sold them then a product that they
could not maintain. Thank you, Mr. Chairman.
Chairman Waxman. Thank you very much, Mr. Turner.
Mr. Higgins.
Mr. Higgins. Thank you, Mr. Chairman.
Gentlemen, I would like to talk to you about internal
audits of independent AIG auditors advising the CEO of AIG of a
precarious situation that wasn't reported to investors in a
conference call. In fact, the internal audits' warnings were
ignored and an optimistic picture was painted relative to AIG's
financial situation, which I think goes to the heart of
credibility and trust. Or, in this case, lack of credibility
and lack of transparency.
For example, there was an all-day conference on December 5,
2007. During this investor conference, Mr. Sullivan painted an
optimistic picture of the firm's management and fiscal health.
He said that we are confident in our marks and the
reasonableness of our valuation methods. We have a high degree
of certainty in what we have booked to date.
However, according to internal minutes from the audit
committee meeting on January 15, 2008, AIG's independent
auditor, PricewaterhouseCoopers, raised serious concerns before
this investor meeting took place. At this meeting, auditors
warned Mr. Sullivan personally back in November in preparation
for the investor conference. Here is what the minutes said:
Mr. Ryan, a PricewaterhouseCoopers' auditor, reported, in
light of AIG's plan to hold an investor conference on December
5th, PricewaterhouseCoopers had raised their concerns with Mr.
Sullivan and with Mr. Bensinger, the Chief Fiscal Officer, on
November 29th informing them that PricewaterhouseCoopers
believed that AIG could have a material weakness relating to
risk management in these areas. Mr. Ryan expressed concern that
the access that the enterprise risk management and the AIG
senior finance officials have into certain business units, such
as AIG Financial Products Group, may require strengthening. At
no point during the December 5, 2007, investor conference did
Mr. Sullivan mention these warnings from the auditors. He never
disclosed them.
Mr. Turner, you used to be a senior official at the
Securities and Exchange Commission. What do you think about Mr.
Sullivan's failure to disclose the auditor's warnings to
investors?
Mr. Turner. If you go back and look through the filings and
go back and look through the third quarter filing for the
period ending September 30th--and, Congressman, you raise an
excellent question--you don't see any notion of the fact that
this company probably doesn't have the necessary models to be
valuing this stuff. So if you look at September 30th filings,
there's no indication we don't have the ability to value these
things in the way we do or no indication that you don't have
controls. You're still saying things are fine.
You go then to the communication from
PricewaterhouseCoopers and then to an investors day meeting on
December 5th where we're saying things are OK; we don't have a
problem. If you're an executive and you've known by that point
in time that you've got these disclosures out at September 30th
saying in essence we don't have this problem--and while this is
going on keep in mind you also, as I understand it, have
counter parties to these derivatives starting to argue. And I
think in fact there's some disclosure by October 31st people
were questioning their valuations. So it's not only that you
got a September 30th cue out there, you've now got questions
from outside parties, not only the auditors but very well--you
know, Goldman Sachs might have been one of them raising the
questions.
Back to the questions that Mr. Kucinich was raising, if
you've got an outfit that is probably no one better in the
world at valuing this stuff like Goldman Sachs about these
values and your auditors are now raising your value, I think
it's unconscionable you go out to the investors on an investor
day and pretend like you've got yourself under control and you
know what all the numbers are and there's no problem. And
subsequent events turn around and I think pan that out when you
say you've got $5 billion in collateral at the end of December
and then up to $14 and now we've borrowed $61, it raises a
serious question about was anyone on top of this.
Mr. Higgins. I yield back, Mr. Chairman.
Chairman Waxman. Thank you, Mr. Higgins.
Mr. Yarmuth.
Mr. Yarmuth. Thank you, Mr. Chairman.
In the chairman's opening statement he said we were going
to ask questions about the compensation packages of the CEOs at
AIG, and so I'm going to ask that now.
You said in your written testimony that one of the problems
here is that we had CEOs walking away from a train wreck,
essentially, with huge severance packages. And we've seen or
heard many times now that in the fourth quarter of 2007 fiscal
year, 2008 fiscal year, the loss posted by AIG was $5.3 billion
and shortly thereafter that the compensation committee of AIG
met and extended the contract of CEO Martin Sullivan, including
a $15 billion severance package. And I guess my question that
most every American would have is, is there any way that the
compensation committee or corporation could justify that type
of activity as being responsible, in the best interest of the
stockholders if there was such a dramatic turnaround and loss
in the corporation and then granting a very generous package in
light of that?
Mr. Turner. I'm a believer that if a company has performed
well the executives should be compensated well for that. So I
have no problem with people if they've done very well and
created a lot of value--like I said, I am on the board of two
of these investment funds. If they created a lot of value for
our shareholder, I certainly am one that would support them on
getting tremendous compensation.
On the other hand, when you don't perform, having been an
executive, I don't believe you deserve a bonus. If you've had a
lousy year, you just shouldn't get a bonus. And then to walk
away and get paid millions for walking away and doing nothing
further to create value for us as shareholders I think is just
wrong.
In this case, the question probably goes back to did the
board agree to that agreement when they first put Mr. Sullivan
in place. That was probably not a high mark for this board.
Twice I flew to New York and met with their then chairman
of the board Frank Zarb and seriously questioned how they had
gone through the process. They didn't go through an outside
search for a new chairman. They just very quickly selected and
put in place with very little due diligence the next chairman.
And, quite frankly, then when you put in place a severance
agreement with the guy and agree to it at that point in time,
even if things turn out bad later on, you're committed to it
and you need to honor a contract. But for the board to have put
something like that in place just shows very, very poor
governance, very poor.
Mr. Yarmuth. And it was compounded subsequently because the
next quarter the loss was almost $8 billion. So that's $13
billion in two quarters. And at that point they terminated Mr.
Sullivan but allowed him to retire so that he could receive
that bonus. If they had terminated him for cause, then he
wouldn't have received it, as I understand it. Is that
something that you would consider to be in the interest of the
stockholders or in his interest?
Mr. Turner. Again, whenever you're paying someone for
walking away from the company where they're not creating any
further value and haven't been creating value, that's certainly
not in the best interest of shareholders.
Mr. Yarmuth. Thank you for that.
I have a question going back to these credit default swaps
that I would like to get some clarification on. We threw out
the number or you threw out the number $62 trillion that's out
there. Is that $62 trillion a potential loss, is it absolute
obligation, is somebody going to have to pay $62 trillion at
some point to somebody or is that just a potential loss and to
whom is that owed? I mean, in general, to whom is it owed?
Mr. Turner. The $62 trillion, which, by the way, I believe
has come down to the mid 50's at this point in time. It's only
$55 trillion or $57 trillion, you know. But you raise an
interesting question, because I don't think anyone really knows
what the real exposure is. That's the nominal value or the
amount of debt that these things have been written on, although
the actual amount of debt is actually substantially less than
this.
As Mr. Dinallo mentioned, some of this is nothing more than
wagers of bets against one another in trading, and that's a
fairly significant portion of that. But no one knows because
there's no disclosure. There's no central market.
And this isn't the first time this thing almost came apart.
The Fed in 2005 had to bring about 17 of these institutions
together because they had gotten so far late in just doing
their paperwork no one knew who owed one at that point in time.
Which goes back to your question then, does anyone really know
what's going on here? And the answer is probably no. No one can
tell you what's going on, there's no regulation, there's no
FASB, and no one can answer the questions with a high degree
ofcertainty because there's no place that gathers that data.
Mr. Dinallo. This is just a very overly simplistic
statement which will not hold in practice, but there's an
argument that the total notional value of CDSs should not
exceed the total face value of corporate bonds out there.
Because if you bought insurance for all corporate bonds that
anybody owned it would be--and I'm going to make up a figure.
I've heard something like $15 trillion, $17 trillion--$6
trillion, I'm being told $6 trillion.
Well, I'm an optimist. So if you think of it that way,
that's why we say 10 percent. Do you remember I said 10
percent? So if it's 10 percent of 62--so, yes, $6 billion is
the right number. Ninety percent of it is written on just going
to the track and putting a bet on whether Ford is going to fail
or not. It does not represent a securitized bond exposure to
the companies.
Mr. Yarmuth. If I can ask just one question in followup. So
this is one corporation, in this case AIG, betting against
another corporation on value that doesn't exist? I mean,
they're wagering money, wagering presumably shareholders'
money, and in this case it may turn out to be taxpayers' money,
on basically you and I betting on a football game.
Mr. Dinallo. Yeah. Just technically I'm going to correct
you to the extent it kind of went the other way. People, they
sold protection as a triple A or double A rated vehicle, they
sold their protection to those who wanted to take a bet on
whether Ford was going to say--I'm just making that up. I'm
picking on Ford. It's unfair--Ford was going to default or not.
And when they got downgraded--I think this is an important fact
that didn't really come out. When they got downgraded, the
reason they had the liquidity crisis that we've all discussed
is when they got downgraded they had to put collateral beyond
those obligations. When they were a certain high rating they
didn't have to post any collateral.
So getting back to the Congresswoman's point, I would say
all the more frightening about all this is there's no ``there''
there. There's no collateral behind any of these four A, double
A and triple A rated companies. And that's a big number that
there may not be backing for. Not the case for insurance.
Chairman Waxman. Thank you, Mr. Yarmuth.
Mr. Braley.
Mr. Braley. Thank you, Mr. Chairman.
Mr. Dinallo, I want to start with you.
Twenty-five years ago, I was a research assistant to
Professor Alan Whitus, who was updating the Keeton and Whitus
basic text on insurance law; and I think both Professor Whitus
and Professor Keeton would be rolling over in their graves
seeing what has happened to the industry that they were so
passionate about. I think you would agree with me that industry
has changed radically in the 25 years that I've been talking
about.
Mr. Dinallo. Yes. In particular going from mutual companies
to publicly traded companies.
Mr. Braley. And a lot of those demutualizations resulted in
a significant financial loss to policy owners who owned the
shares of those mutual companies--who owned the mutual
companies and during the conversion in many cases were screwed
out of their financial share of those companies.
Mr. Dinallo. I might not use the same verb, but I will
agree.
Mr. Braley. I think you get my point.
Mr. Dinallo. Well, I think it's important for everyone to
know there's a very strong tension between policyholders'
interest and shareholders' interest in a publicly traded
company. The board and management has a fiduciary interest to
shareholders under our law, fiduciary interest to shareholders,
but, at the same time, whenever they release capital to satisfy
that to get a bigger return on equity, they are necessarily
taking incremental protection against policyholders.
Mr. Braley. And you also have a fiduciary obligation to
policyholders under their contractual obligation with the
policyholder.
Mr. Dinallo. Yes. Sadly, there is some debate, actually,
because they've been so trained under our law and after Enron,
etc., to worry about fiduciary duty to shareholders that there
is a good argument that, although it's in their blood to worry
about policyholders, the legal requirements are a little bit
gray, actually.
Mr. Braley. Well, one of the things we know, in your
opening statement you said AIG was not strictly an insurance
company. And that's one of the big problems. Because insurance
companies are fond of talking to consumers about gaps in
coverage and how they should eliminate those gaps. But based on
both of your testimonies we've got a massive $63 trillion gap
in coverage where we've got a product that according to most
commonsense interpretations would be considered insurance.
We're not regulating in the State insurance commissioners'
offices. We've taken action in Congress before I got here to
declare that it's not subject to gaming regulations, which
again under the Constitution are historically made by States
rather than by the Federal Government, and you've eliminated
any oversight from the Securities and Exchange Commission,
which has the only Federal capability to exercise jurisdiction
over these companies. So how did we get here?
Mr. Dinallo. I wish I could have said it so clearly. I
don't know how we got here. We thought it was important to
permit leverage, we thought it was important to permit risk
mitigation, and we thought that mega holding companies were
accretive to shareholder value and to be competitive.
And I will say that we are--that one of the big issues is
after Basel II and what's called Solvency II we are in danger
of going the European route, which is a lot more holding
company control over the operating company, which is code for
much more ability to move around policyholder money--that's
what we are talking about--around for holding capital liquidity
purposes. If AIG had been under a Solvency II regime, I would
think we would be in much worse straits than we are today.
Mr. Braley. But one of the concerns I have is this blurring
distinction between financial services providers--real estate,
insurance, banking, other financial institutions--and how you
hold accountability when these holding companies are involved
in all these different financial services. Because clearly the
system we have in place now is not working.
Is it time for Congress to revisit the fundamental premise
of the McCarran-Ferguson Act and talk about a Federal
intervention that takes into account the need to have some
oversight of insurance companies that choose to engage in risky
financial propositions like the ones we've been talking about
today with no ability to have accountability to their
shareholders?
Mr. Dinallo. Earlier, I said we should--I think I would
recommend a revisitation of Gramm-Leach-Bliley and the concept
of supermarkets when you're dealing with policyholder money and
depository commercial--money. I'm not sure--I will just remain
agnostic--whether the solution is a Federal oversight or
continue with the States or some hybrid.
Because I think that it is important to have States in the
solvency business. They've done extremely well on that. They've
done not so well, clunky on other things like product
registration and licensing of the agencies. We're pretty clunky
on that. But the one thing we got right and the reason that
we're even here today to the extent there's optimism here is
because there was solvency done by State regulators.
Mr. Braley. And just to followup on Mr. Souder's comment
about the guarantee funds, you would agree that most State
insurance laws provide a cap on those guarantee funds typically
in the amount of $500,000 or surely $1 million or less. And
when you're talking about an exposure of $63 trillion that
would have no impact to protect taxpayers.
Mr. Dinallo. Actually, New York is one of the richest
guarantee funds; and I think the numbers you just described are
New York numbers. Most States--and this is not to be pejorative
to other States--but most States are substantially lower. Some
people think that lower is better because it stops the moral
hazard of writing bad policies because there's always the
guarantee fund behind it. But, yes, it would have been a real
stress on the system, undoubtedly.
Chairman Waxman. Thank you, Mr. Braley.
Mr. Davis.
Mr. Davis of Virginia. Thank you.
Do you think anybody ought to go to jail over this? Do you
want to take a stab at that? Do you think anybody should go to
jail over this?
Mr. Dinallo. To whom is your question directed?
Mr. Davis of Virginia. Both of you. I'm not asking you to
name anybody or build a case. But I'm just saying, looking at
the end results, how the companies operated, at this point,
were they all within the law or did somebody break some rules
along the way because nobody caught it?
Mr. Dinallo. I don't have sufficient evidence to have an
opinion about it.
The only thing I would say is I think that as a regulatory
society, so to speak, we all did kind of chase after mortgage
default numbers. In other words, some of what was described
earlier about the escalating losses at AIG were certainly a
default rate loss. In other words, we've all seen how the
rating agencies have hugely changed the ratings based on how
quickly the default numbers are coming in for mortgages.
And I'm not taking a position whether it's criminal or even
civil, but it is the case that a lot of us, including the best
rating agencies, some of the best securitization people in the
world and some regulators, got wrong what was going to be the
default rates, which it turned out our global economy was
hinged on.
Mr. Davis of Virginia. Well, if it wasn't criminal, was it
at least negligent in some areas?
Mr. Dinallo. I won't even opine on that. But I would say
that--I did say that the letter, if true, that I heard is
something that you would be concerned about.
Mr. Davis of Virginia. Mr. Turner, do you have any thoughts
on that?
Mr. Turner. Yes Congressman. I don't think you send people
to jail for making bad business decisions. That happens day in
and day out, and people shouldn't be prosecuted for that.
On the other hand, if someone knew there were problems in
the company and failed to comply with the security laws and
disclosed those to investors who bought them and are now seeing
their retirement savings go away and disappear, then, yes, I
would turn around and say a little time behind the bars would
probably be good.
Mr. Davis of Virginia. Well, let me ask this. How about the
people writing the mortgages? You talked about the first tier
and the second tier and how it got lax. I mean, at the end,
they weren't even asking tough questions.
Mr. Dinallo. I think the term is a NINJNA, no income, no
job and no assets, or something like that. It's unbelievable.
We were harvesting mortgages at a rate that I think is
completely unacceptable as a society; and we were in various
ways encouraging people to engage in underwriting decisions
that I find shocking, frankly.
Mr. Davis of Virginia. In fact, didn't AIG--they got caught
up in this. Their competitors were doing it. They started a new
line that they had no expertise in, used an insurance model,
and it just blew up on them. Is that basically what happened?
Mr. Dinallo. I think to a large extent people did not--this
is what I was trying to say before. We relied on historical
default rates in housing that maybe for the first two
iterations of loans was wholly appropriate. By the seventh or
eighth, we had basically injected--we correlated the system
because we weren't securitizing natural loans, we were
securitizing created loans.
Mr. Davis of Virginia. Now, your argument, as I understand
it, is that the Commodities Futures Modernization Act, in
retrospect, went too far. It was a mistake.
Mr. Dinallo. I think that's a fair implication of what I
said, yes.
Mr. Davis of Virginia. And that was signed just on the eve
of the 2000 election. I think it passed Congress. Fortunately,
I did not support it. But as I was looking at that, just going
through the votes and everything, it was signed right on the
eve of the 2000 election. Obviously, some modernization was
needed, because there was a huge congressional and, at that
point, administration consensus. But you think it just went too
far. You wouldn't have argued it shouldn't have been changed.
You just think in retrospect it went too far.
Mr. Dinallo. No, it was just absolute. It says this act
shall supercede and preempt the application of any State or
local law that prohibits or regulates gaming or the operation
of bucket shops other than anti-fraud provisions.
Mr. Davis of Virginia. I agree.
What about the reauthorization act this year, did you
follow that, that was reauthorized this year? Do you know how
they reauthorized it? They attached it to a farm bill, an
agriculture bill, which was vetoed by the President and
overridden in Congress. That's how a lot of these things get
done. So that's how a lot of this business gets done.
What about Gramm-Leach-Bliley in retrospect? Again, that
was done over 8 years ago. In retrospect, obviously, a need to
modernize Glass-Steagall. Would you agree with that?
Mr. Dinallo. Yes. Some in need, yes. But I've learned a lot
through this process.
Mr. Davis of Virginia. Well, let me finally ask, should the
SEC or should Congress have stepped in much earlier to suspend
the mark-to-market accounting rules as a way to head off some
of the problems we're experiencing today?
Mr. Dinallo. I think Mr. Turner would be better qualified
to answer that. I'll just say that insurance companies do it a
different way; insurance regulators do it a different way. It's
much more conservative and, fortunately, beneficial, I think,
to what we're talking about.
Mr. Davis of Virginia. Mr. Turner, do you have any thoughts
on that?
Mr. Turner. I don't think Congress should step into that.
As I mentioned in my testimony, the GAO found--actually
supported going to mark to market and believes that when you
suspend it--when you allow a bank to turn around and have
losses, OK, and not tell us as investors about it, I got to
tell you we ain't got any confidence in the system or trust.
And if Congress goes in and says, we're going to let you hide
those things from us, I got to tell you, you're going to see a
devastation in spark. We will not be investing in financial
institutions if you do that.
Mr. Davis of Virginia. OK. Thank you.
Chairman Waxman. Thank you, Mr. Davis.
Ms. McCollum.
Mr. Davis of Virginia. Mr. Chairman, can I ask unanimous
consent that Members be allowed to submit statements for the
record today?
Chairman Waxman. Without objection, that will be the order.
Ms. McCollum. Thank you, Mr. Chairman.
Mr. Turner and Mr. Dinallo, AIG didn't suddenly collapse
and need to be bailed out on September 18th. AIG's financial
situation had been growing increasingly dire with each passing
quarter, but AIG's executives kept telling shareholders that
their finances were in great shape.
And in fact, Mr. Chair, I would like to submit a New York
Times article dated September 28th which numerates time and
time again how these people have said AIG was in great shape.
[The information referred to follows:]
[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]
Ms. McCollum. In December 2007, for example, Mr. Sullivan
told AIG investors, ``we believe we have a remarkable business
platform with great prospects that represent tremendous
value.'' Two months later, AIG posted $5.3 billion losses for
the quarter.
February 2008, Mr. Sullivan said, based on our most current
analysis, we believe any credit impairment loss realized over
time by AIGFP would not be material to AIG's consolidated
financial condition. Then AIG posted $7.8 billion in losses for
that quarter.
On May 28th, Mr. Sullivan told investors, the underlying
fundamentals of our core business remains solid. The next month
the board voted to replace Mr. Sullivan.
Mr. Turner, I have a couple of questions. What do you think
of Mr. Sullivan's statements? Do you think they accurately
reflected AIG's conditions? And, Mr. Dinallo, I would like to
know if have you a view on that as well.
Mr. Turner, in your written statement you said--and I'm
going to quote you--trust and confidence in markets and in any
company begins and ends with transparency, transparency that
ensures investors can fully understand the assets and rewards
of investing in a company. You should be able to trust what the
CEO is saying.
So if you gentlemen could please elaborate.
Mr. Turner. As you go through these filings and you look at
the disclosures that start to occur and the timeframe in which
they are, the one thing I take away from this is I don't think
the company ever was honest with the investors about the
magnitude of the potential impact of these things. And I think
that's what is grossly missing here. And then, as things start
to go bad, they go bad very quickly; and we're finding out
about everything not prospectively here's what could happen.
Keep in mind, the SEC rules are very clear. They require
you to tell the investor right through the eyes of management
what's happening with the company. And I don't think we ever
get that out of here. I don't think the rules were followed.
I just think it's astounding that all of a sudden you're
borrowing $61 billion and yet you've never told the investors
up to that point in time, hey, we've got these credit
derivatives out there that could cause us such a problem that
we could come short.
And granted the market goes down, OK, and certainly people
were not wishing for the market to go down the way it was, but,
nonetheless, when you've got that type of exposure and that
type of potential, you owe it to me as an investor to tell me
that's the type of risk I'm taking on when I'm investing in
you. You've got this thing that may all of a sudden blow up and
cause you to need tens of billions and you can't get to it
because all the cash is in regulated subsidiaries that Mr.
Dinallo is appropriately trying to protect. And that's the
disclosure, the gist I cannot find in these filings.
The SEC and the DOJ I hope will go through, get the e-
mails, get the data and then everyone is entitled to their day
in court and due process. But, right now, there is a question
there that I can't answer for myself as to why we didn't get
that.
Ms. McCollum. Mr. Dinallo.
Mr. Dinallo. Obviously, I have to be sort of--I'm not
informed enough at the holding company level on some of the
disclosures to have a position about this.
I think I did say earlier that I witnessed sort of a very
shocking realization as to the liquidity needs of the company
on that weekend. I was surprised that some of the risk was
being rolled up at that--sort of contemporaneously at that
time.
I will say, just one observation that we just touched on,
which is one of the lessons learned. There are these things
called lines of credit that every company has, and they assume
they're there in these liquidity crunches. But what is kind of
interesting I think that the committee should know about, and
the Financial Services Committee should probably be told about,
is if you touch them you get a three-notch downgrade from the
rating agencies. And so they're kind of fictitious in some
ways.
I don't mean this badly, but people have them and they
convince us that they have this line of credit that will help
them through these tough times. But God forbid you need to hit
the $15 billion line of credit these companies have. The
consequences are such that you might as well not have them
because you might as well have gone through the downgrade
because you're going to go through it for touching the line of
credit. We're all learning together to some extent. And I think
that's one of the lessons that I would kind of inject in this.
Ms. McCollum. Thank you, Mr. Chair; and thank you for the
hearing because I think this is clearly showing people were
gambling--they weren't investing--with the dollars that these
investors had.
Chairman Waxman. Thank you, Ms. McCollum.
Mr. Van Hollen.
Mr. Van Hollen. Thank you, Mr. Chairman.
Thank you both for your testimony today.
Mr. Turner, I just want to followup on my colleague Mr.
Yarmuth's questions. He asked you about some of the golden
parachutes that were available for Mr. Sullivan and others at
AIG.
I want to talk about the regular compensation and bonus
plan. And as you state in your statement you talked about the
dangers that bonus plans that are, ``designed to pay executives
hundreds of times what their average employees made as they
engaged in business that would eventually cripple the business
that they ran.'' And you hear a lot of talk from some of the
CEOs about how they have these pay-for-performance plans, that
in the good times they benefit but when times are bad they take
a hit. And I think the more we look at these different
companies like AIG you find that they rigged the rules so in
good times they do well and in bad times they do well.
I would like to get your opinion of the actions of AIG's
former CEO Martin Sullivan at a meeting of the company's
compensation committee on March 11, 2008. The committee has
obtained documents of that meeting.
AIG has two bonus programs. The first is called the
Partners Plan, and that covers the top 700 executives. The
second is called the Senior Partners Plan, and that applies
only to the top 70 executives. Mr. Sullivan benefits from both
plans.
Now, according to the plans--and, again, if you listen to
what they're saying, rewards were supposed to be based on the
company's performance. But I want to show you or at least
mention to you--I don't if we have it on the screen, but we
have the internal minutes of the meeting that was held by AIG's
compensation committee on March 11, 2008; and, as you can see,
what those committee meetings show is that Martin Sullivan, who
was CEO at the time, personally urged the committee to waive,
to waive the bonus rules right after the company posted a
record loss.
And as you can see that what the minutes say is Mr.
Sullivan next presented management's recommendation with
respect to the earnout for the senior partners for the 2005
through 2007 performance period suggesting that the AIGFP--
that's the financial products division--that their unrealized
market valuation losses be excluded from the calculation.
Essentially what he's saying there is the rules, if we applied
them, wouldn't let me get my bonus, so let's change the rules,
isn't that right?
Mr. Turner. That's the way I would read that.
Mr. Van Hollen. And this comes on the heels of the February
8th--28 AIG posting of losses of $5.3 billion for the quarter,
which came primarily from the financial products division,
isn't that right?
Mr. Turner. Yes.
Mr. Van Hollen. And the record also makes clear that in
fact the board, not surprisingly, agreed with their CEO; and he
got his $5.4 million bonus, despite the fact that AIG ran up
$5.3 billion in losses in the quarter before.
I just have to ask you, you know, because people understand
when people get rewarded for doing well. But everybody else out
there operating in the economy, when they don't perform, they
get their pay cut. They get fired. These guys, there is
absolutely no accountability. So I would like you to comment on
the kind of changes that need to be made in your view to make
sure this kind of thing does not happen going forward.
And then, Mr. Dinallo, I would like any comment you've got.
Mr. Turner. As someone who has followed governance and read
many of these type of plans--quite frankly, when I was running
the research at Glass, Lewis, this is not an isolated
occurrence. We've seen this time and time again in corporate
America where you set up a pay for performance plan but then,
when you didn't hit the performance triggers, you changed the
triggers, you didn't change the compensation. And there's just
something fundamentally wrong with that.
And that's one of the reasons this institution, quite
appropriately so, I believe, last year voted and approved the
``say on pay proposal'' that is a middle of the ground proposal
and a very, very good proposal. It's unfortunate. I know it was
in one of the drafts of the bailout legislation and didn't stay
in it. That is very unfortunate.
But I think certainly we need to have in this country--give
the shareholders the vote and opportunity to pay on--or vote on
situations like this with full disclosure so you're aware this
type of stuff is going on; and I think only by doing that are
we going to get this reigned in. I think anything short of that
is going to leave these plans in place, leave this type of
behavior in place, and people are going to continue to be
outraged about it, and you're not going to get the changes that
you need.
So when we have say on pay as investors, when we invest in
the U.K., when we invest in Netherlands, when we invest in
Australia, but we don't even have that right as investors here
in the United States, there's just something fundamentally
wrong with it. So we need this institution, the House, and we
need the Senate, by golly, to follow your good leadership on
that and pass the say on pay proposal now, not a year from now,
but now.
Mr. Van Hollen. Thank you. Thank you, Mr. Turner.
Mr. Dinallo. I would only add that a lot of Wall Street and
traders--and I think AIGFP is analogous to this--are paid on a
revenue basis, as opposed to an end-of-year profit basis, and
there is something to that. And you can create a lot of
revenues without actually booking a profit sometimes. And so
that's something that people have written about recently, about
sort of changing that approach to compensation for certain
financial services activities.
Mr. Van Hollen. Thank you. Thank you both.
Chairman Waxman. Thank you, Mr. Van Hollen.
Mr. Sarbanes.
Mr. Sarbanes. Thank you, Mr. Chairman.
I'm trying to understand this in the context or in terms of
how we got all these toxic assets infecting the markets out
there which at the end of the day just gets back to this
insatiable appetite to generate new loans. And when there
weren't enough loans out there in the conventional market we
then had these people that were reaching into the
unconventional market, into a very risky market, and that
created this toxin that went up the chain.
So my interest in what AIG was doing is to the extent that
it was seen as providing the hedge/insurance backstop to these
Wall Street firms that were increasingly getting into the
business of trading in very unstable or risky security
products, with the effect, I take it--and I would like your
view on this--with the effect that it increased their risky
behavior, and that gets pushed down the chain. So they begin to
encourage more and more risk on the front end. And once you've
relaxed the underwriting standards on the front end of this
thing, it becomes very difficult to continue to manage the risk
up the line, because the original thing that you've created in
and of itself is unstable.
So talk to me about that. Talk to me how what the product
that AIG was offering basically led to riskier behavior on the
part of these Wall Street firms which in turn led them to
encourage risky behavior all the way down the chain. Mr.
Dinallo.
Mr. Dinallo. Well, I think, Congressman, you sort of said
it in there. They were arguably at the end of a chain of
exceedingly ridiculous optimism about the value of these
mortgages. So people harvested the mortgages. They securitized
them. The rating agencies rated those at the highest levels;
and, through CDO squared, triple A traders at various trading
houses held them. And then wanting to prudently, arguably, have
a default protection on those bought a credit default swap from
certain guarantors, AIG being one of them.
So I would say that at some level what AIG did was it
gave--kind of it was the last line of defense with its high
rating--I think it was double A at this time--saying, well, the
rating agencies rated it triple A, so we'll even guarantee it
against default.
And one of your points I thought you were sort of making
was maybe if anyone in that line of activity had acted with--
this will be a little bit impolite--but acted with common sense
instead of models they might have said this doesn't feel right
and I'm not going to put my reputation, assets, shareholder
value, rating at risk for this.
Mr. Sarbanes. Well, you had two things happening. You had a
bunch of people along the way who could keep off-loading the
risk to somebody further up the chain. So then they have no
incentive themselves to stop or curb their behavior,
particularly if they're making money off the deal.
Then you start getting to the end of the chain, right, the
people that are actually holding these securities at the end of
the line. And the way they, ``offload the risk is to go insure
against it.'' So they turn to an AIG as a way of doing that.
And I guess in the initial iteration of that maybe it made
sense. But then you have AIG basically opening a casino in
London, right, to start this other activity. So at what point
should the investors that were purchasing this as an insurance
policy, should they have known that AIG, their, ``insurer was
getting into this other risky enterprise?'' Did they know that?
Did they realize that they had opened the casino in London and
something else was going on that was putting their policies,
``at risk?''
Mr. Dinallo. I just want to clarify. I think we're mixing
the term insurance policy somewhat loosely. When you ask that,
you mean the people who had actual property--the common man and
woman who had life insurance policies and property polices with
AIG? Is that what you meant?
Mr. Sarbanes. No, no. I'm talking about the insurance
product that was the CDS, because it began that way, right?
Mr. Dinallo. But my understanding, Congressman, is it was
always out of financial products.
Mr. Sarbanes. Right. But I'm saying is it began as a
legitimate, ``hedge against the downside risk of this
particular security that you hold.'' But the reason it got up
to $55 trillion or $62 trillion or whatever it was is because
it became a betting house. And what I'm trying to figure out
is, at the point that happened, no longer should I as an
investor who is hedging against the security that I actually
own have taken any comfort from the fact that AIG----
Mr. Dinallo. I think I can answer that, yes. I think that
at AIG most of the activity in the CDS was off of covered,
nonnaked activity. These people really owned the CDOs. These
were traders that owned CDOs, and they wanted default
protection on the CDOs. But it is actually a profound
observation that the Governor has made that for the 10 percent
of people who thought that they actually had capital and some
kind of insurance protection behind those covered CDSs, it
turns out that possibly the continued unregulated activity that
is naked could seriously impact their ability to receive
payment. I think that's what one of the Congress people was--I
think that's what Congresswoman Maloney was very concerned
about before.
Chairman Waxman. Thank you, Mr. Sarbanes.
Mr. Welch.
Mr. Welch. Thank you very much.
I really appreciate your testimony. Very informative, very
helpful.
A couple of things. One, Mr. Turner, I think you said that
the SEC Office of Risk Management was reduced to a staff, did
you say, of one?
Mr. Turner. Yeah. When that gentleman would go home at
night, he could turn the lights out. In February of this year,
that we had gotten down to just one person at the SEC
responsible for identifying the risk at all the institutions.
Mr. Welch. So that included the $62 trillion credit default
swap.
Mr. Turner. That's correct.
Mr. Welch. And how did he do?
Mr. Turner. Well, I suppose he got the lights turned out
but didn't get the problems taken care of.
Mr. Welch. It reminds me we had a hearing earlier on in
this committee about these tainted toys kids were buying, or
they were getting toys that had lead paint. And it turned out
that the Consumer Product Safety Commission apparently had one
person--I hope it wasn't the same person--inspecting all the
Chinese imports.
Mr. Turner. In all fairness to the SEC, the staff over
there that I've dealt with over the years have been excellent.
But when you only have one person there's no way on God's green
Earth anyone, Chairman Cox or anyone else, could have even
imagined that this person could do the job. When you cut it
down to one, you know what you're doing. You know that you're
basically saying we're not going to do the job.
Mr. Welch. Was there a systematic depopulating of the
regulatory force so that it was impossible actually for
regulation to occur? If you have one person in that office--and
then I understand that 146 people were cut from the enforcement
division at the SEC. Is that what you also testified to?
Mr. Turner. Yes. I think there has been a systematic
gutting or whatever you want to call it of the agency and its
capability through cutting back of staff. We talked about risk
management, we talked about enforcement, but as well just in
some basic fundamental policies. The enforcement staff are now
asked to jump through many more hoops before they can proceed
with investigations, a change that's been written a lot about
in the media, and it's not a healthy change for the agency.
Mr. Welch. You in your testimony--and I think it was really
supported by Mr. Dinallo--identified a number of things that
have contributed--and there is plenty of blame to go around--
the executive compensation, people coming and going, making
money, the accounting standards being lax, cheap debt, this
whole unregulated casino-like $62 trillion credit default swap,
handcuffing of the SEC, lack of regulation at the holding
company level, failure of the Federal Reserve to tighten up on
credit and mergers that were too large.
But I want to get back--and that was quite a laundry list.
In all the things that we could act on, but on this specific
question of having public servants in the job so they can do
the job on behalf of the American public, would it be your
recommendation that we've got to boost the personnel levels at
these organizations to protect the consumer?
Mr. Turner. Unequivocally yes. I believe in the
Appropriations Committee over in the Senate Banking they've
given them about a $30 million increase. And I suspect that
falls short. It probably is going to need to be--if you really
want the SEC to do a job and you're serious about it, given the
cutbacks that have occurred in the last 3 years or so, you're
probably going to need an increase at the SEC realistically
more in the range of $50 million to $75 million.
Mr. Welch. And that's paid for by that SEC transaction fee?
Mr. Turner. Yeah. And, in fact, the SEC collects more in
transaction fees, substantially more in transaction fees from
businesses than they actually pay out for their costs and their
staff.
Mr. Welch. Let me ask you this. Some of us have suggested
that there be an SEC fee or transaction fee that would go into
an escrow account to offset any cost to the taxpayer of this
bailout. Is that something that you have an opinion on?
Mr. Turner. I've always believed that the SEC from a
funding perspective should be treated solely as an independent
agency and that the SEC be given the ability to collect its
fees and whatever it collect it spends on that and that those
fees don't go elsewhere. They just basically go to fund the SEC
so that they don't--you know, they get what they need but not
more than what they need.
Mr. Welch. Mr. Dinallo, how about you, both on this
question of personnel to get the job done and establishing
basically an escrow fund to help offset the cost of the
bailout?
Mr. Dinallo. Obviously, I'm a big fan of hiring regulators.
I think the department is--I think we're well--you know, we
have a lot of--there's hundreds of people who do what they do
at the New York State Insurance Department. It takes a lot of
people to regulate closely. I think it is definitely the case
that you can design a system. I certainly feel independent in
our work, but we are net, we are net, you know----
Mr. Welch. Thank you.
One last question for both of you.
Mr. Dinallo. So I think you can do it without costing the
taxpayer any money.
Mr. Welch. There are a number of companies that are going
to participate in this bailout program, and my question to you
is this: Do you believe it would be right and appropriate for
the taxpayers to have the right to claw back some of these
outrageous executive salaries and golden parachutes from
companies that have voluntarily opted to participate in this
bailout?
Mr. Turner. The provisions that are in the legislation, you
know, does under what I would consider to be limited situations
allow claw back. But people need to understand it's limited.
It's not everyone. I thought it should have been everyone,
quite frankly.
Mr. Welch. That's what I'm asking. We have another crack at
this. This was a gun-at-our-head piece of legislation we had to
pass, we were told, in order to avert a catastrophe. But we
have an opportunity to improve it, and we are going to have to.
So would you support a stronger claw-back provision?
Mr. Turner. Yes. And I communicated with Members of
Congress already that I think the claw-back provision, the
severance provision--there were three provisions there on
compensation, and they all could have been much stronger than
what was done the first go-around.
Mr. Welch. Mr. Dinallo, how about you?
Mr. Dinallo. I don't think I have enough of a basis to give
an opinion. I think Congress did a pretty good job the first
time around. But I would have to see some kind of proposal to
know for all such instances.
Mr. Welch. OK. Thank you.
Thank you, Mr. Chairman.
Chairman Waxman. Thank you, Mr. Welch.
Ms. Speier.
Ms. Speier. Thank you, Mr. Chairman.
Mr. Dinallo, I am one of those that believes that the
regulation of insurance companies should be at the State level.
And if there ever was a great example of why it works it is
AIG, because the insurance part of AIG is solid.
Now, having said that, you as a regulator have the
authority to conserve, to take institutions into
conservatorship. And once you do that my understanding is,
certainly is in California law, that all bets are off. The
contract is off. You are there to make sure that the corpus is
protected for the policyholders, is that correct?
Mr. Dinallo. Yes.
Ms. Speier. In this situation we now own AIG. The taxpayers
of this country for all intents and purposes own AIG. It's in
conservatorship. Mr. Cassano, who was the golden boy of the
casino in London, had his compensation very attractively
devised so that over the course of 8 years he actually earned
more money than the CEO, some $280 million, because he was
getting $0.30 back for every--on every dollar he was receiving
$0.30 back in terms of the products that were being sold. So he
also was eligible for bonuses. He was eligible for $34 million
of what were unvested bonuses.
But in February of this year he took that company, that
division, down by $5.3 billion. And yet he was fired the next
day, and the following week the committee has a copy of a
letter, that's a contract, I presume, here, that confirms this
agreement in which he was given the $34 million, and, oh, by
the way, he is now on contract as a consultant to the tune of
$1 million a year, and we, the taxpayers, are picking up that
tab.
So here's someone who brought the company down, the
taxpayers now own this company, it should be in
conservatorship, and this man is still getting $1 million a
year. Now, in conservatorship as an insurance company, you
would be able to void those contracts, wouldn't you?
Mr. Dinallo. Yes.
Chairman Waxman. Let me intervene just to say it's $1
million a month.
Ms. Speier. Excuse me. $1 million a month.
Mr. Dinallo. If those contracts were----
Ms. Speier. Thank you, Mr. Chairman, for that
clarification.
Mr. Dinallo. If those contracts were with an operating
company that we brought into rehabilitation, which you would
call conservatorship, we do have incredibly potent powers over
policies and contracts. The company, we basically step in and
become the management at our, you know, salary.
Ms. Speier. So that fancy conference in California could
have been stopped under those circumstances?
Mr. Dinallo. Yes. Although I presume--yes. Although again
we're talking about a holding company activity.
Ms. Speier. So Mr. Turner, knowing what we know, knowing
that Mr. Cassano now is getting a million dollars a month paid
for by the taxpayers even though he's no longer working there
and he did get his bonus even though he didn't earn it, do you
think we should claw back?
Mr. Turner. Well, there is always the legal question of
legally what you can or cannot do. Unfortunately, one of our
problems is we've paid out or investors are quite frankly going
to pay out now, as you mention taxpayers time and time again,
it's not just this situation, it's this situation as you aptly
describe, others at their institutions, Merrill Lynch,
Countrywide and the likes. If there's a way you could find
legally to go enact legislation that would allow clawbacks of
those sums where there was absolutely no pay and no
performance, if not destruction, I would be a big fan of it.
And the real question is legally whether or not you could do
that. I would certainly say though we've learned a lesson and
let's not repeat it again and let's go fix this going forward
as well. If you can do something in the past, I'm sure--I've
heard from a number of my fellow neighbors that they'd love to
see you go get what you couldn't back from the past as well.
Ms. Speier. One last question to Mr. Dinallo. You
determined to take $20 billion from the insurance company and
give it to the holding company.
Mr. Dinallo. Yes.
Ms. Speier. Explain to us why you did that. Did you think
that was going to be enough to hold them over?
Mr. Dinallo. Yes. So we didn't actually do it. But we did
at a certain point offer to do it as part of a holistic
solution. We did believe at the time that the liquidity problem
of the downgrade that I talked about before was on the order of
$15 billion, a need for liquidity. So there was a plan to take
what was excess surplus--this is an important point. There's
the asset liability match, promises versus assets held. There's
a statutory surplus above that. And then there's excess surplus
even above that which companies often have the right to decide
how to use. And we thought that prudently we could loan that
essentially through the property and casualty companies to fix
the liquidity problem on the basis that the life insurance
companies were going to be sold, which is part of the AIG plan,
or some companies to repay that loan. So at the time the
Governor thought given AIG's presence in the community, the
number of jobs at stake, etc., that was a--and given it was not
in any way going to put policyholder protection at risk, it was
a reasonable use of excess surplus.
Ultimately we didn't need to do to it. But that was the
beginning of that weekend where I was called in and the
Governor sent me in to understand how we could be pragmatic on
a liquidity basis, yes.
Ms. Speier. Thank you.
Chairman Waxman. Thank you very much, Ms. Speier. Ms.
Watson.
Ms. Watson. Mr. Chairman, I want to thank you for this
opportunity to have the public listen in as we try to
unscramble eggs. And Mr. Dinallo, Mr. Turner, thank you very
much. I don't know if your responses are really doing that, but
at least I hope at the end of the series of hearings, we as the
policymakers will have a little more clarity as to where we
need to go forward and what we need to do.
Mr. Turner, in your written testimony you told the
committee about AIG's disclosure on May 2005 that it had
inadequate internal controls. You also said the errors
overstated AIG's income by approximately $3.9 billion. And Mr.
Turner, AIG has had a history of internal control problems.
Would you say that's true?
Mr. Turner. Yes.
Ms. Watson. OK. As part of the committee's investigation,
we reviewed internal minutes from AIG's audit committee
meetings, which are not public, and these minutes show that the
company's independent auditor, PricewaterhouseCoopers warned
the company as recently as this year that there were
significant problems and that these problems were growing
worse. Now here are some of the examples, and they might be up
on the screen.
As of February 7th, the meeting of the audit committee, PWC
warned that the role and reporting of risk management needs a
higher profile in AIG. And at a February 26th meeting, PWC
indicated that the process at AIG seemed to break down, in
that--and it was kind of unlikely that other companies, where
there was good dialog at appropriate levels of management on
the approach, alternatives considered and key decisions--at AIG
only AIG-FP was involved in the December valuation process.
At the next meeting on March 11th PWC reported that there
is a common control issue and root cause for these problems and
that AIG does not have appropriate process or access or clarity
around the roles and responsibilities of critical control
functions.
Mr. Turner, as a former SEC accountant, do you consider
these deficiencies serious? Can you elaborate?
Mr. Turner. Yeah. Again going back into 2007, there's
obviously some questions about whether the company at a time it
had disclosed--and in all fairness to the company they had
disclosed that they had a half trillion in nominal value of
these derivatives. They didn't tell people just the magnitude
of what that could turn into, but they had told the public they
had a half trillion. But in light of that and the fact there
was some very, very serious concerns about the models and where
they could do the valuation right, which would raise the
question of could you actually disclose something with
integrity, I think the things that PWC is telling the company
here are extremely serious. If I was--I must say though if I
was sitting on the audit committee--and I've chaired a couple
of audit committees--one of my concerns would be obviously the
company has been doing credit derivatives for quite some period
of time. And now all of a sudden we're just seeing it from the
auditors for the very first time as we get down to a very
critical stage and things are in essence imploding on us. I
would have the question for AIG management, one, why hadn't you
solved the problem before now? Why didn't you have the systems
in place to make sure you could get your hands around these and
get the right disclosures? But I'd also have a question for
PWC, who had been for a number of years auditing the internal
controls, why are you just now coming and telling me about this
at December--November/December 2007 going into 2008? If I was
audit committee Chair, I would feel almost blinded that the
auditors hadn't come and told me about this beforehand as well.
So--and quite frankly, if the auditors were just coming and
telling me this as CEO, if I was sitting there in Mr.
Sullivan's position, I would be raising the same question with
the auditors.
Ms. Watson. OK. And I would just like to get Mr. Dinallo's
opinion on this, too, as well.
Mr. Dinallo. I think that those are--I think that those
would certainly get my attention. Whether they were rectified
or not, I can't say. So I think it's--I think it's important. I
think you want outside auditors and risk management to come in
and make those kinds of assessments. And the way you should--
this is my modest opinion. The way you should judge sometimes
is what the company did in response.
Ms. Watson. Thank you very much, gentlemen.
Chairman Waxman. Thank you, Ms. Watson.
Mr. Shays.
Mr. Shays. Thank you. Mr. Turner, Fannie Mae had assets
ranking at No. 2--only Citigroup had a larger asset ranking.
Freddie Mac ranked No. 5. Just to give you some perspective, GE
ranked No. 11, Goldman Sachs No. 12, Ford Motor Co. 15. That
was in the year 2002 when I introduce a bill to say they need
to be under the SEC. Did it ever strike you as curious that the
second highest ranking asset company in the marketplace and the
fourth were not under any oversight by the SEC?
Mr. Turner. I just think it was flat out wrong. That's the
only way to say it. I think that someone that's selling that
much of--you know in the securities market in trading and being
held by public investors, I think unquestionably it should have
been from the git-go underneath SEC regulation, nonexempted.
Mr. Shays. Would you take issue with Federal Chairman Alan
Greenspan's warning to Congress in 2005 about the growth of
Fannie and Freddie's portfolios when he said, so I think that
going forward, enabling these institutions to increase in size,
we are placing this total financial system of the future at a
substantial risk. Would you disagree with that?
Mr. Turner. At the beginning of 2007 I think these two
institutions were doing somewhere in the mid 30, 35 percent of
the total mortgage loans in the country. And by September or so
of last year it had gotten up to about 75 to 78 percent. There
is no question as that risk expanded--and keep in mind the
decision was made quite frankly going back into the late 90's
to allow these two institutions to grow the way they did. If
you allow them to grow, you have to make sure you've got
adequate controls and processes around them. And regulator. And
quite frankly----
Mr. Shays. And we had a weak regulator named OFHEO.
Mr. Turner. A very weak regulator.
Mr. Shays. The Federal Housing Enterprise Regulatory Reform
Act of 2005, under the previous Congress, passed and was sent
to the Senate. It would establish what we basically did in
2008. But when it got to the Senate, it was unanimously opposed
in committee by, candidly, the Democrats. And therefore it
never had a vote on the House floor.
When I introduced this bill with Mr. Markey, it had 22
cosponsors. And one of the individuals when we were talking
about having a stronger regulation in committee said that this
was a political lynching because we were questioning Frank
Raines and our oversight of this committee. I want to know, do
you think that somehow Mr. Raines who got $190 million, do you
think that somehow he should be exempt from coming before this
committee if we're going to have others with less
responsibility getting the same sums? If you don't want to
answer, you don't have to.
Mr. Turner. No, no. You asked the question, and the
question's fair, OK? First of all, I go back to what
Congresswoman Maloney said at the beginning. This is not a
partisan issue. And as I said, this issue needs to be dealt
with on a bipartisan basis. I think you need to drain the
entire swamp, Congressman, and I think you need to take a good
look at what went wrong at all of these institutions. Freddie
and Fannie are two humongous institutions that we've had to
bailout here and it has an impact. And having worked with OFHEO
on both of those institutions, I would encourage you to bring
the executives, the appropriate executives and appropriate
board members before the committee.
Mr. Shays. In that bill that we sent to the Senate we had a
clawback provision to be able to go back after these outrageous
salaries. Would you recommend that be part of any bill?
Mr. Turner. As I said earlier, I am a big supporter of the
clawback. What was in the bill was exceedingly weak to the
extent that Congress can determine that there is a legal--an
appropriate legal remedy to go back and give power to someone
to claw back. For prior severance where there was no
performance, I would certainly support that.
Mr. Shays. Thank you, Mr. Turner.
Chairman Waxman. The gentleman yields back the balance of
his time. I agree with you, Mr. Turner, that this should not be
a partisan issue. And that's why I was somewhat taken aback
when the Republicans on--some Republicans on this committee
started making a big deal about Freddie and Fannie. It is an
important issue. And they're right. And our committee staff has
already been looking into this thing, and we are going to hold
a hearing on it. So I think it's appropriate.
Mr. Shays. When?
Chairman Waxman. We'll have to negotiate that with the
minority to get a day that will be convenient for the staff.
But obviously we're going to do it.
Mr. Shays talked about a bill that he introduced which you
thought was a good idea. I'm a cosponsor of that bill. And some
of the proposals that have been put forward Democrats and
Republicans have supported. Unfortunately some of the proposals
have not been agreed to, as we were discussing with the
clawback provision in the Barney Frank bill that was just
adopted. We would have wanted it to be stronger. The
transparency provisions that we suggested to Chairman Frank as
well as some of the other provisions that you've mentioned that
we ought to adopt, we've also recommended should have been in
that bill. When you do legislation, you get what you can. You
don't always get what you want.
But I want to thank both of you for your presentation. I
think you've been superb witnesses. You've educated this
committee enormously. And I have to say about the members on
both sides of the aisle, I thought the questions had been asked
of the two of you in the conversation--more of a conversation
than anything else has been very, very constructive and
generally not partisan because these are not partisan issues.
Our country and our economy is at stake, and therefore we've
got to work together and not look for--even though we're a
short time before an election--opportunities to try to zing the
other party. These are not the kind of issues that ought to be
put out--in my view--on a partisan basis. They're the kinds of
things that we need to look at very carefully together. I don't
know that there's a Republican or a Democratic response to
abuses of shareholders and taxpayers. I don't think there's
going to be any difference as we look at those issues together.
And that's why we're holding these hearings to find out how we
got to where we are and what kinds of suggestions we want to
put forward for the future. We don't have the jurisdiction that
the Banking Committee has, but we certainly can put ideas out
there. And I would hope that on a bipartisan basis not only are
we going to hold these hearings but we may come out with some
suggested proposals that I hope the committees in charge and
the leadership of both the Democratic and Republican side of
the House and the Senate will entertain.
Mr. Shays. Would the gentleman yield for a question?
Chairman Waxman. Yes.
Mr. Shays. Thank you. I want to compliment this committee
on the way they have asked their questions. I do think we're
trying to get at the answer both on a bipartisan basis. What is
troubling to us though is we scheduled five hearings. And
Fannie Mae and Freddie Mac are not scheduled. And we didn't
hear that you were even doing this investigation, which our
side isn't a part of, until we raised this question. Is it fair
to assume that we will have this hearing within this five
hearing range? Or is it your intention to do it after the
election?
Chairman Waxman. Well, we'll have to look at the schedule.
We have, for the interest of the witnesses and the public, we
had a hearing yesterday on Lehman, which many people say
triggered the stampede. We had the hearing today on AIG. Next
week we're going to have a hearing on the rating--I think it's
the rating agencies. And we're going to hear--have a hearing
from the regulators. And what is--what am I missing?
Mrs. Maloney. Hedge funds.
Chairman Waxman. And we're going to have a hearing on hedge
funds, because they're involved in this whole new world that
our regulatory system did not anticipate. So while we've
scheduled those hearings, Members on the other side of the
aisle say, well, what about Freddie and Fannie, Fannie Mae and
Freddie Mac? Well, we're looking at that in preparation for
hearings. I will work with the Republican staff and Republican
Members to make sure that we have all the hearings that's
necessary and I think it's appropriate that we will look at
them and we will hold a hearing on it. And we will have to
discuss the date.
Mr. Davis of Virginia. Mr. Chairman, let me just add that
we look forward to working with you on that. I think Freddie
and Fannie are huge pieces of this puzzle, and our testimony
today illustrates that as well. It's a shame that the
committees of jurisdiction didn't hold hearings on this 18
months ago. I think we might not have been in the bind we're
in. But I very much appreciate you calling this now and that we
can examine what happened and what we might do as we move
forward in the future.
Chairman Waxman. Thank you. I do want to mention that one
of the reasons we hadn't scheduled that as the first hearing,
as some Members suggested, is that the committee of
jurisdiction just held a hearing on Freddie Mac and Fannie Mae
2 weeks ago with their CEOs. So we thought we would go into
this in a different direction.
Mr. Shays. Would the gentleman yield just for a second
question?
Chairman Waxman. Yes.
Mr. Shays. We have 360 degrees jurisdiction over every
activity of government for investigation. We have no
jurisdiction in any of these issues to promulgate legislation.
So I just don't want there to be the impression that somehow we
don't have jurisdiction over Fannie and Freddie. We have total
jurisdiction to examine anything they have done.
Chairman Waxman. I don't think anybody would deny that.
Mr. Davis of Virginia. We don't have jurisdiction over
anyone. We have oversight.
Chairman Waxman. Oversight jurisdiction. I think that's
what the gentleman from Connecticut was referring to.
You've been very generous in your time and in your answers
to the questions.
Mr. Davis of Virginia. Mr. Chairman, can I just say thank
you very much. I think they're great witnesses. I think you've
added a lot to both sides of the record.
Chairman Waxman. And let me ask unanimous consent of the
committee that all the documents and exhibits that have been
referred to by members of the committee be made a part of the
hearing record.
Mr. Davis of Virginia. Mr. Chairman I also just ask
unanimous consent to have AIG's PAC contributions over the last
decade be put in the record as well.
Chairman Waxman. Without objection, they will be put in the
record as well.
Thank you very much. We will move on to the next panel, but
we will break for sufficient time for these witnesses to leave
and for the next two witnesses to come to the table.
[Brief recess.]
Chairman Waxman. The committee will please come back to
order.
We're pleased now to welcome to our committee hearing
Martin Sullivan, who served as the CEO of AIG from March 2005
until June 2008. Before being named CEO, Mr. Sullivan served as
vice chairman and co-chief operating officer of AIG. And Robert
Willumstad, who served as CEO of AIG from June 2008 until
September 2008. Prior to being named CEO, Mr. Willumstad served
as chairman of AIG's Board of Directors beginning in November
2006. He was first elected to AIG's Board of Directors in
January 2006.
We're pleased to welcome both of you to the hearing. It's
the practice of this committee that all witnesses who testify
before us do so under oath. So I'd like to ask if you would to
please stand and raise your right hands.
[Witnesses sworn.]
Chairman Waxman. The record will indicate that both the
witnesses answered in the affirmative. And before we even
begin, I'd like the police officer in charge to take the person
who's holding up a sign and let's get that cleared out of the
room right now. That woman who was holding up the sign, who
intends to hold up a sign and to make a raucous. I don't think
it's appropriate in a congressional committee.
Gentlemen, your prepared statements will be in the record
in full. And we want to recognize you for any oral presentation
that you wish to make. While we usually give 5 minutes and I
know you're mindful of that, I don't want to limit you in any
way in the amount of time you have to make your statement.
Mr. Sullivan, why don't we begin with you?
Mr. Sullivan. Thank you very much, Mr. Chairman.
Chairman Waxman. There's a button on the base of the mic.
Mr. Sullivan. It's on. Is that much better? OK. I have it
now. Thank you.
Chairman Waxman. OK. That's better.
STATEMENTS OF MARTIN J. SULLIVAN, FORMER CHIEF EXECUTIVE
OFFICER, AIG; AND ROBERT B. WILLUMSTAD, FORMER CHIEF EXECUTIVE
OFFICER, AIG
STATEMENT OF MARTIN J. SULLIVAN
Mr. Sullivan. Thank you, Mr. Chairman, and a very good
afternoon. My name is Martin Sullivan. As you said, from March
2005 until June of this year, I was president and chief
executive officer of AIG. Though I was no longer with the
company as the events of last month unfolded, I'm here today to
assist the committee in understanding the events that led to
the Federal rescue of AIG, how the example of AIG fits into the
broader financial crisis currently plaguing the world economy,
and the regulatory lessons that we can learn from AIG's
experience.
People around the world are reeling from the financial
tsunami that has ravaged the global economy. While we had all
hoped the unfortunate collapse of Bear Stearns this past spring
would be an isolated incident, instead the financial storm
gained momentum and many of the world's most respected
financial institutions crumbled one after another. The Federal
Government took control of Freddie Mac and Fannie Mae, Lehman
Brothers and IndyMac declared bankruptcy and Washington Mutual
and Wachovia had to be taken over to avoid a similar fate.
Meanwhile, other prominent institutions sought additional
capital, merger partners and redefined their corporate status.
Of course AIG avoided potential bankruptcy only with the help
of the government.
Now the U.S. Government is establishing a $700 billion fund
to provide additional relief to threatened financial
institutions.
I hope that my testimony about these events that occurred
during my tenure at AIG can help the committee understand the
formation of what is best described as a global financial
tsunami. While we're all struggling to understand how this
crisis happened in the first place and to find out what might
have prevented it, there are no simple answers to these
questions. I'm not an accountant nor an economist. I've been an
insurance man all my life. However, many factors appear to have
been at play, including lending and borrowing practices,
illiquid markets, the absence of credit, loss of investor
confidence, and even accounting rules which require companies
like AIG to take billions of dollars of unrealized mark-to-
market losses.
When in 2005 the AIG board asked me to step into the role
of Chief Executive Officer, the company was straining under the
weight of several crises very different from the financial
crisis currently threatening our financial institutions. I
became COO of AIG at a time when the company was in the midst
of governmental investigations that had cast a cloud of
suspicion over the company's future. In the face of that crisis
my responsibility was to stabilize the ship and improve our
relationships with our regulators. I think I succeeded.
It was against that backdrop that I began my tenure as CEO
of the company. I'm very proud to say that in spite of these
challenges AIG emerged as a successful and resilient company.
In 2006 and in early 2007 AIG was enjoying great success, and
those of us within the company's management had tremendous
confidence in our company's future.
However, as we now know, the different storm was gathering
over the global financial markets. No disaster as massive or as
unforeseen and as unprecedented financial market disruption
that has occurred over the past year is the result of a simple
or single cause. The world's current economic challenges are
obviously related to multiple actions by multiple parties.
To assist the committee, I would like to focus on one
particular factor, the role played by one accounting rule
applied to corporations. The accounting rules require that
certain assets be mark to market. In other words, companies
must declare the value of those assets on a quarterly basis at
the price such assets could sell for on the market at that
point in time. Companies must declare these values on their
books even if they have no intention of or immediate need to
sell the assets or even if they have not realized any actual
gain or actual loss.
FAS 157, which was adopted relatively recently, set out
specific guidelines as to how companies must determine the
market price of certain categories of assets. However well FAS
157 operates under any reasonably foreseeable market conditions
in the unprecedented credit crisis which began in the summer of
2007, FAS 157 had, in my opinion, unintended consequences. In a
distressed market where assets cannot be readily sold companies
are forced to declare the value of those assets at fire sale
prices.
Just last week the SEC made changes with respect to the
application of FAS 157 when entire markets stop functioning. Of
course AIG did not have the benefit of this guidance during my
tenure. At AIG I encountered FAS 157's unintended effects
through the credit default swap portfolio of AIG financial
products, the business that my predecessor had established and
funded many years earlier. These credit default swaps
essentially provided insurance to counterparties in the case of
default on underlying bonds. The underlying bonds were very
highly rated and the risk of default was viewed as extremely
remote.
Finally, the credit default swap business had since its
inception in the late 1990's generated a reliable and steady
source of income for AIG-FP. In fact, AIG-FP intended to retain
its derivative interest in these highly rated bonds until they
reach maturity. When the credit market seized up, like many
other financial institutions, we were forced to mark our swap
positions at fire sale prices as if we owned the underlying
bonds even though we believed that our swap positions had value
if held to maturity. The company nevertheless began reporting
billions of dollars of unrealized losses on the basis of then
current market valuations. Suddenly a company with a trillion
dollars of assets was reporting unrealized losses on its income
statement that ultimately climbed into the tens of billions. As
AIG's reported losses mounted, there was a domino like series
of repercussions. Although we had raised approximately $20
billion in capital, it appears that even this precaution was
not sufficient protection in the face of the overwhelming and
unprecedented market crisis that exists today. AIG nevertheless
suffered credit rating downgrades which triggered billions of
dollars in collateral cause leading to the most recent events.
Of course by the time the board was presented with the
Federal plan, I had been out of the company for 3 months. In
fact, just last week both the Securities and Exchange
Commission and this Congress recognized the effects of FAS 157.
The SEC recognized that FAS 157 can have unintended
consequences for financial institutions where markets seize up.
The SEC has attempted to provide more flexibility for companies
operating and reporting under the rule.
In the recently passed legislation Congress directs the SEC
to further examine mark-to-market accounting and grants the SEC
authority to suspend mark-to-market accounting requirements.
These measures make a lot of sense to me.
I have spent my entire adult life in service to AIG, and I
am heartbroken as to what has happened. I hope to see the
company and indeed the entire global economy emerge from this
crisis.
I hope that my testimony today has been helpful to the
committee, and I will do my very best to answer any questions
you may have. Thank you, sir.
[The prepared statement of Mr. Sullivan follows:]
[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]
Chairman Waxman. Thank you very much, Mr. Sullivan. Mr.
Willumstad.
STATEMENT OF ROBERT B. WILLUMSTAD
Mr. Willumstad. Good morning, Chairman Waxman, Ranking
Member Davis, and members of the committee.
AIG remains a great company, and I want to stress that
AIG's problems never threatened AIG's policyholders. The crisis
that required AIG to accept assistance from the Federal Reserve
is a crisis in confidence that has affected the entire global
economy. When I became CEO of AIG in June of this year, the
decline in the U.S. housing market had already been underway
for months. Though most homeowners were still making their
mortgage payments, there was an unexpected and unprecedented
breakdown in the market for mortgage-backed securities that
were held by many banks and other financial institutions.
Mark-to-market accounting rules forced AIG along with
Citigroup, Merrill Lynch, and others to book tens of billions
of dollars in accounting losses. By the end of the second
quarter of 2008, AIG had booked $50 billion of losses. AIG was
downgraded by the major rating agencies in early May. And AIG's
stock price fell from a high in 2007 of $72 per share to $26
per share this June. This decline occurred despite raising $20
billion in new capital and the vigorous actions of AIG's board
and Martin Sullivan before I became CEO.
In June 2008, the board asked me to replace Martin Sullivan
as CEO. I was initially reluctant to do so. However, the board
ultimately persuaded me that my experience in the financial
services industry, including my time as President and Chief
Operating Officer of Citigroup, put me in a position to lead
AIG in this difficult period.
On my first day as CEO I publicly announced that I would
present my plan for AIG in 90 days. It became apparent that if
the markets continued to decline and if AIG were further
downgraded by the rating agencies, AIG could potentially face a
liquidity problem.
I met with the rating agencies in July, and they told me
they would not review AIG's ratings until after I announced our
plan, which was then scheduled for September 25. Even so, I
immediately took steps to cut expenses and further protect AIG
in the event of a liquidity problem.
We identified nonstrategic businesses, retained financial
advisers and began the process of selling those businesses to
raise cash. To conserve cash, we stopped discussions relating
to a number of acquisitions. We were negotiating a transaction
with Berkshire Hathaway that would have protected billions of
dollars of AIG's liquidity.
In late July I met with the President of the Federal
Reserve Bank of New York to discuss the situation. These were
precautionary steps. Through the first week of September we
believed AIG could weather the difficulties in the financial
markets. When the market meltdown began the week of September
8th, the rating agencies indicated they would no longer wait to
review AIG's ratings until September 25. AIG was in a vicious
circle. The rating agencies were considering a downgrade
largely because of market-driven liquidity concerns. But it was
a downgrade or the threat of one that would trigger a liquidity
crisis.
We worked around the clock during the week of September 8th
to take measures that would provide AIG the liquidity needed to
make it through the crisis, but the private markets simply
could not provide enough liquidity. On September 9th I met
again with the Federal Reserve Bank, and during the rest of the
week I stayed in contact with the Federal Reserve and the
Treasury Department.
On Tuesday, September 16, 2008, AIG was preparing for the
unthinkable, bankruptcy. That afternoon the Federal Reserve and
the Treasury Department told AIG they would provide the
necessary liquidity because an AIG bankruptcy would have
massive negative effects on the stability of the entire
financial system. Terms of the offer were nonnegotiable. After
a long discussion and with the advice of counsel and our
financial advisers, the AIG Board of Directors accepted the
Federal Reserve's plan as the best available option.
As part of that plan I was asked by the Treasury Department
and the Federal Reserve to step down as CEO, and I did so.
Looking back on my time as CEO, I don't believe AIG could
have done anything differently. The credit default swap
contracts had been in place for years. The market seizure was
an unprecedented global catastrophe. We and our advisers
explored every avenue. There was no private market solution to
AIG's situation.
I regret the pain that events in the market have caused AIG
employees and its shareholders. I'm grateful that the Treasury
and the Federal Reserve and, most important, the American
people offered their assistance to preserve a vital part of the
financial system and a great American institution.
Because my 3-month tenure as Chief Executive Officer did
not provide me the opportunity to execute my restructuring plan
and in light of the fact that AIG shareholders and employees
have lost so much value, I have notified the company I do not
intend to accept the payments available to me under the AIG
severance plan.
Thank you.
[The prepared statement of Mr. Willumstad follows:]
[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]
Chairman Waxman. Thank you both very much. We are now going
to have questions for members of the panel. And without
objection, the chairman and the ranking member will be allotted
10 minutes each to use as they see fit. And without objection,
that will be the order.
Both of you seem to be saying that these events had nothing
to do with your management. It had to do with the tsunami of
activities over which you had no control. And we're trying to
assess whether that's true or whether there was mismanagement
by the executives at AIG.
Now I want to submit for the record a disturbing letter
that I've received from Joseph St. Denis. He's a very reputable
man. He was Assistant Chief Accountant at the SEC Enforcement
Division. He was hired by AIG to address material weaknesses
cited by AIG's auditors and to provide greater visibility and
control with respect to the operations and accounting policy
process of AIG-FP. Mr. St. Denis says that in 2007--and without
objection, his letter will be made part of the record--he says
in 2007 he became concerned about the valuation model used by
AIG's Financial Products Division. But when he tried to audit
this division he was blocked by Mr. Cassano, who was the head
of that division. Mr. St. Denis wrote the committee that the
only--what Mr. Cassano said was that I have deliberately
excluded you from the valuation of the super seniors because I
was concerned that you would pollute the process. That's what
Mr. Cassano said to Mr. St. Denis. And Mr. St. Denis said to
the committee, the only pollution Mr. Cassano was concerned
about was the transparency I brought to AIG-FP's accounting
policy process.
[The information referred to follows:]
[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]
Chairman Waxman. Mr. Sullivan, you were the CEO at the
time. Mr. St. Denis was hired to give you insight into Mr.
Cassano's activities. And he said he was blocked from doing
that. And he resigned.
Were you aware of this?
Mr. Sullivan. To the very best of my knowledge, sir, I
don't believe I ever saw the letter. But I do recall the
content being brought to my attention. And I understand that a
very thorough investigation both from our compliance people and
from I believe the audit committee--I'm not sure on that. But
certainly compliance and legal looked into what Mr. St. Denis
was saying. Of course at that time we were already putting in
place compensating controls to make sure that our valuation
process was obviously accurate.
Chairman Waxman. You were trying to put these controls in,
but the man who was hired by your company to give you the
information as to what controls were needed was fired because
he was told he couldn't look into what was happening in this
particular division of AIG, the FP Division, from which all the
problems seemed to arise.
Mr. Sullivan. From the very little I know about Mr. St.
Denis, and I have no reason to believe he's not a first-class
individual, I think he resigned, sir. I don't think he was
terminated.
Chairman Waxman. He resigned because he was blocked from
doing his job.
Mr. Sullivan. Exactly. And I think, as I said, from what I
recall about the letter, it was investigated from the legal and
compliance people. But at the same time obviously we were
trying to put compensating controls in there to make sure that
our results were as accurate as possible.
Chairman Waxman. He said he reported Mr. Cassano's actions
to AIG's independent auditors. He also said that he spoke with
AIG's Director of Internal Audit Michael Roemer. Mr. Roemer
thought this was a serious matter, and on November 6, 2007, he
personally briefed the board's audit committee on Mr. St.
Dennis' resignation, according to minutes from that meeting.
Mr. Willumstad, you were the chairman of the board at this
time. What steps did you and the board take to investigate this
matter?
Mr. Willumstad. I actually don't remember the comments in
the audit committee.
Chairman Waxman. You do not remember?
Mr. Willumstad. I do not.
Chairman Waxman. Well, we don't have a full record of the
committee. But we did request all the minutes of the audit
committee. And there's nothing we can see that indicates that
AIG took any action to respond to Mr. St. Dennis' concerns. So
it looks like you both brushed it aside. Is that an unfair
characterization?
Mr. Willumstad. I don't recall the audit committee or the
comments. So I can't answer that.
Chairman Waxman. And you were the chairman of the board at
that time?
Mr. Willumstad. I was.
Chairman Waxman. And Mr. Sullivan, you were the CEO. And
you don't have much recollection of this either.
Mr. Sullivan. Other than I believe I recall that it was
investigated by legal-compliance, and as you refer to, the
internal audit division, sir.
Chairman Waxman. Well, the reason of course why this is
significant is that this man was brought in to find out about
these kinds of problems which ended up bringing AIG to its
knees, and it could have given you that information except he
was blocked by the fellow in London, Mr. Cassano, who didn't
want him to know what Mr. Cassano was up to. So I just find
that very disturbing.
I'm going to reserve the balance of my time and recognize
Mr. Davis.
Mr. Davis of Virginia. Thank you, Mr. Chairman. Mr.
Sullivan, according to the documents obtained by the committee,
on March 11, 2008, it was recommended that losses in AIG-FP not
be considered when calculating your compensation package. How
do you justify this while also advocating pay for performance
as a prudential standard for executive compensation?
Mr. Sullivan. First of all, sir, can I just clarify that my
compensation was obviously discussed in executive session and
with the compensation committee. And they ultimately made a
recommendation to the board at large who ultimately had to
approve my compensation. From what I can recall, and if--if
you're referring--it would be helpful if I could know the
minutes you're referring to, but some were put up on the screen
earlier. But if you're referring to the discussions we had on
the super senior--the senior partners and the partners plan, is
that what you're referring to, sir?
Mr. Davis of Virginia. We asked the staff to get that. I
will go on for another question.
I was just looking at your resume. And I saw that you went
to the Sydney Russell School and were very generous to them
afterward. Did you have further education after that?
Mr. Sullivan. I put myself through night school, sir, and
became a chartered insurer. I received my associateship at the
Charter Insurance Institute in the United Kingdom.
Mr. Davis of Virginia. OK. You joined AIG in 1971?
Mr. Sullivan. Yes, sir, when I was 17.
Mr. Davis of Virginia. When you were 17 years old.
Mr. Willumstad, can you tell us how the mark-to-market
accounting rules affected AIG's position and do you think it
contributed to the deterioration of the company?
Mr. Willumstad. Well, I would like to make a couple of
comments. I have no concern or problems----
Mr. Davis of Virginia. Could you move that closer to you?
Thank you.
Mr. Willumstad. I would make a couple comments about mark
to market. One, I have no concerns about the validity of mark-
to-market accounting. I think the concerns that I've shared in
my written statement is that when there is no market, the
ability to value securities based on FAS 157 becomes somewhat
difficult and requires a fair amount of judgment. There are, as
I said, no specific market for these securities. And the
company, along with others, has to go through a process which
uses formulas and other indicative prices to come up with these
values. So accordingly, it's very difficult to determine
whether the values are actually correct.
According to the procedures that AIG followed, there were
very substantial writedowns in these securities.
Mr. Davis of Virginia. So did it help or hurt you?
Mr. Willumstad. Well, it obviously resulted in substantial
writedowns, which were obviously not helpful to the company.
Mr. Davis of Virginia. Your statement alludes to the fact
that in 2005 AIG stopped writing policies on multi-sector
credit default swaps. So somebody I guess at AIG saw that there
were problems or questions with this portion of the business.
Why did AIG stop writing these policies?
Mr. Willumstad. I don't know. I was not on the board at
that time.
Mr. Davis. Mr. Sullivan, do you know why?
Mr. Sullivan. Sorry, sir?
Mr. Davis of Virginia. In Mr. Willumstad's statement he
talked about that AIG in 2005 stopped writing policies on
multi-sector credit default swaps. Obviously they did that--
somebody recommended this inside and this was an early warning
signal. Can you tell us----
Mr. Sullivan. Yes. From the best of my recollection based
on what I understood, because obviously at that time I was very
focused on resolving the regulatory issues that AIG was facing
and making sure that we got our accounts issued. Obviously
there was a big delay in 2005 in our issuing our accounts. From
what I understand on investigation, that decision was made by
AIG-FP in conjunction with the risk management--the risk--the
chief risk officer and chief credit officer of AIG.
Mr. Davis of Virginia. So they saw a problem obviously.
Mr. Sullivan. Again, from what I understand, they saw a
deterioration in pricing and were beginning to get concerned
about credit quality. So they took a very proactive step in
2005.
Mr. Davis of Virginia. Did AIG rely heavily on the
mortgage-backed assets of Fannie Mae and Freddie Mac? And did
their demise play a role?
Mr. Sullivan. I don't know the answer to that, sir.
Mr. Davis of Virginia. Is there any linkage between AIG and
the GSEs in terms of what was happening with Freddie and Fannie
buying these with implied government backing?
Mr. Sullivan. I'm not aware of what our exposure was to
Freddie or Fannie off the top of my head, sir.
Mr. Davis of Virginia. OK. I have your statement up here on
the board. And I'll ask you----
Mr. Sullivan. Thank you for putting that up. I appreciate
that.
When I was talking to the compensation committee on March
11th, what I was proposing there was the--what they--proposing
what they should actually award the partners and the senior
partners. And as I think somebody mentioned earlier, there was
700 partners and there were about 70 senior partners. And I was
making a recommendation--and by the way, I should stress,
nobody in AIG-FP participated in this partners plan or senior
partners plan. And what obviously I was anxious to do was to
make sure that we retained our key people. See, shareholders
would expect me to be focused on retaining our key people in
those parts of the business, the insurance businesses and other
sectors of the businesses that were performing well whilst
these unrealized losses but nonetheless losses--nobody is
differentiating between----
Mr. Davis of Virginia. So what you are saying is with these
sectors, they were meeting their goals, they were doing their
job. In other sectors they weren't.
Mr. Sullivan. Not everybody was hitting targets. Some were
exceeding, some were not exceeding, as you would expect in a
business. But what I was anxious to do is to make sure that we
retained the 700 key executives that, you know, were running
other parts of our business and participating in other parts of
our business and were not in AIG-FP. The important distinction
there is nobody is in AIG-FP participated in these programs.
Mr. Davis of Virginia. Mr. Willumstad, you don't see any
relation between what was happening with Freddie and Fannie and
what was happening with AIG then? Do you agree with Mr.
Sullivan?
Mr. Willumstad. I do not.
Mr. Davis of Virginia. Did the accounting scandals there
raise a red flag, that you were insuring investments that could
be tainted that were coming out of there?
Mr. Willumstad. I'm sorry. Could you----
Mr. Davis of Virginia. You were buying, you were getting
into some of the business. Did the accounting scandals at
Fannie and Freddie raise any red flags as to whether you were
insuring investments that might be tainted?
Mr. Willumstad. No.
Mr. Davis of Virginia. OK. Let's take you both to the early
2000 timeframe. Is there anything in government regulation
going back to this early timeframe that would have changed your
business model and would have prevented this catastrophe?
You were somewhere else at that point, Mr. Willumstad. But
with Citigroup.
Mr. Willumstad. That's correct.
Mr. Davis of Virginia. Mr. Sullivan.
Mr. Sullivan. Can I just clarify? You mentioned the year
2000, sir?
Mr. Davis of Virginia. In that timeframe, yes.
Mr. Sullivan. Maybe it's helpful for the committee there.
But from the best of my knowledge, the CDS portfolio started to
be underwritten in the late 1990's, 1998. And obviously as I
testified----
Mr. Davis of Virginia. But the rules were changing as we
speak. What happened in that timeframe of course is you had
several rule changes taking place at Congress statutorily.
Mr. Sullivan. Well, if you're referring to my comments
regarding FAS 157 in particular?
Mr. Davis of Virginia. Well, no, I'm talking about the
regulatory framework on the commodities futures and Glass-
Steagall repeal, those kinds of things.
Mr. Sullivan. Right. I don't think anything in the
regulatory field to the very best of my knowledge would have
changed what occurred. You're going back to 1998.
Mr. Davis of Virginia. That's what I'm asking.
Mr. Sullivan. I don't.
Mr. Davis of Virginia. I'll reserve the balance of my time.
Chairman Waxman. Mr. Sullivan, just so I have this correct,
you asked that your bonus based on performance not count the
losses at AIG-FP, is that right?
Mr. Sullivan. No, sir. What I was referring to here was
what should be paid under our partners and senior partners
plan.
Chairman Waxman. You were included in that.
Mr. Sullivan. I was included in that. But at the time I was
speaking----
Chairman Waxman. So everybody in that group, including you,
got the bonuses as if you performed very well because you
didn't count the losses?
Mr. Sullivan. But with respect, sir, the compensation
committee of our board sets my remuneration and it's then
discussed with the board at large. They could have.
Chairman Waxman. But you requested the board to take that
position?
Mr. Sullivan. On behalf of the employees of AIG, yes, sir.
Chairman Waxman. Including yourself?
Mr. Sullivan. But trust me, I was focusing on them more
than me.
Chairman Waxman. AIG-FP, they were getting paid bonuses
that were even higher than the bonuses you were getting, isn't
that correct?
Mr. Sullivan. In certain instances, yes, sir. In most
instances.
Chairman Waxman. So everybody did really well even though
there were losses. You didn't get penalized, you and the others
you represented. You are getting penalized because of the
losses, even though your bonus was dependent on--getting a
bonus higher if you got earnings, higher earnings, higher
bonus. You got lower earnings and therefore you still got the
bonus. And AIG-FP got their bonuses because they were being
handled in a different way even though they were the ones
bringing on the losses. Is that a fair statement?
Mr. Sullivan. Just for clarity, sir, with regard to my
bonus it was substantially reduced in 2007 by AIG's Board of
Directors, which I concurred with. With regard to AIG-FP, I
don't believe--and again, this is from the very best of my
recollection--that they received their bonuses in 2007. I think
we put in place a deferred compensation plan--again I'm doing
this from memory. But they certainly received their bonus for
2006 and prior.
Chairman Waxman. OK. Mrs. Maloney.
Mrs. Maloney. Thank you, Mr. Chairman. We heard from our
first panel that one of the key factors that caused this
financial mess was not accounting rules that shed light on
these risky exotic tools that you were investing in, have no
value and that people don't want to buy them. What the first
panel said was that one of the key factors was inadequate
deregulation of so-called credit default swaps. And it is a $58
trillion market, double the size of the entire New York Stock
Exchange. The market is four times larger than our national
debt. But unlike the stock exchange, the swap market has no
transparency, no rules and no oversight.
The result of the failure to regulate these credit default
swaps seems pretty clear. AIG had to be bailed out by the
taxpayers because of your risky investment in credit default
swaps. And I for one don't think any of the management deserves
a bonus or any pay from the taxpayers' purse and certainly not
an exotic weekend to discuss the future of AIG, which was a
great company.
You have cost my constituents and the taxpayers of this
country $85 billion and run into the ground one of the most
respected insurance companies in the history of our country.
And the company's failure has tremendous implications in our
entire economy. I got hundreds of calls from constituents
concerned about AIG because of their interaction with this
company.
So I would like first to ask you, Mr. Sullivan, do you
believe the swaps markets should be regulated?
Mr. Sullivan. Well, obviously with the benefit of
considerable hindsight, if there is good regulation that can be
put in place, personally I would support that.
Mrs. Maloney. And Mr. Willumstad, do you believe that a
swap market should be regulated?
Mr. Willumstad. Yes.
Mrs. Maloney. Could you give to this committee how much AIG
lost in these swaps? Do you have any idea? Out of the $58
trillion, how much is held by AIG? Could you get to us back in
writing? Maybe that is something you would need to look at.
I would also like to ask you, Mr. Sullivan, that if the
same rules that had applied to your insurance company where you
had some backup and some reserves, would this have avoided the
bailout that AIG is confronting now?
Mr. Sullivan. Well, Congresswoman, at the time I left the
company I believed it was well capitalized and had the
liquidity to work its way through.
Mrs. Maloney. But the swaps had no capital behind them. Do
swaps have any capital behind them?
Mr. Sullivan. Well, only the capital ultimately of AIG.
Mrs. Maloney. Pardon me?
Mr. Sullivan. Only the capital ultimately of the holding
company.
Mrs. Maloney. I'm talking about the swaps. There was no
capital reserve behind those swaps, right?
Mr. Sullivan. That's right.
Mrs. Maloney. So you were gambling billions, possibly
trillions of dollars.
Mr. Sullivan. Well, I wouldn't refer to it as gambling.
These transactions were individually underwritten very
carefully. And maybe I can provide some more background to you
that may be helpful.
Mrs. Maloney. If they were carefully underwritten how come
no one wants to buy them? And our first panel said when you
securitize them the first time, maybe the second time they had
value. But when you get to the sixth and seventh time that
there's no value there. That's what the first panel said. And
you did not follow the insurance rules of having any collateral
or capital behind these risky swaps.
Mr. Sullivan. Maybe it would be helpful--because there was
a lot of generalization in the first panel. Maybe it would be
helpful if I just explain. And as I say, I'm not an accountant.
Mrs. Maloney. But you did make a good decision not to sell
them anymore after 2005?
Mr. Sullivan. Or underwrite. To accept any more swaps after
2005.
Mrs. Maloney. You must have realized that they didn't have
any value. And what I'm angry about now is when you blame
accountants for coming forward looking at a product and saying
it has no value because absolutely no one in the entire world
wants to buy it. It's not their fault. You want them to say
there's value there when there's none? I believe in the fair
market value. If no one wants to buy it, I think there's an
indication that there's no value there, that you were
generating fees, making all of your employees rich, wrecking a
great company, and tearing down our economy, and now turning to
the taxpayers and asking us to bail you out.
I think you should be apologizing to the American people
for your mismanagement.
Mr. Sullivan. Well, maybe it would be helpful if I can.
First of all, I'm not blaming accountants. I said in my
testimony----
Mrs. Maloney. You said the mark-to-market rules, which is
how accountants determine whether there is fair market value,
they have determined no one wants to buy it. Therefore, it does
not help their market value. That--I believe they're shedding
light on the problem. And there have been many memos from many
executives saying they should change the accounting rules and
say there's value there when there is no value.
Chairman Waxman. The gentlelady's time has expired.
Do you want to make any comment?
Mr. Sullivan. With the utmost respect, what I said in my
testimony was the unintended consequences of FAS 157. I have
never criticized FAS 157. My concern, which ultimately the SEC
and this Congress have concurred with, when I made my remarks,
I started making these remarks back in March of this year, was
the unintended consequences of trying to mark to market these
assets in an illiquid market.
And one of the concerns I had, if I may, again which may be
educational, is back many years ago, many of you may recall the
Piper Alpha exploded in the North Sea, if you remember the
tragic circumstances of Piper Alpha exploding. There was
something in the London market insurance area that was called
the London market spiral. And what Piper Alpha precipitated was
a spiraling effect throughout the market that forced the market
ultimately to collapse. The London market insurance fire was no
longer there.
What I saw in early 2008 was what I believe was an
unintended consequence of FAS 157. I wasn't attempting in any
way, shape, or form to criticize it. What I was trying bring to
everybody's attention and what I'm trying to bring to
everybody's attention today was the unintended consequence of
trying to mark to market assets that had value, that you were
happy to hold to maturity, that interest was being paid,
dividends were being paid, but you couldn't mark to market in
an illiquid market. And that was, with the greatest respect,
the point I was trying to make.
I don't think there is any one individual, any one entity,
any one body that you can point the finger to. I think when you
look back and see these great institutions that we are
addressing today and this committee has addressed in the past,
if you look at the German Government guaranteeing bank
deposits, you look at the Irish government----
Chairman Waxman. Mr. Sullivan, we're going to have more
questions.
Mr. Sullivan. I'm terribly sorry, but I'm trying to bring
it in perspective if I may. I'm not trying to point the finger
at accountants or FAS 157; I'm trying to raise the issue of
unintended consequences.
Chairman Waxman. Mr. Davis you wanted to say something
else?
Mr. Davis of Virginia. I yield myself a couple of minutes
because I'm still puzzled by both of your comments about not
relying on Freddie and Fannie.
My understanding is people would buy these secondary
mortgages. And you had said you would sell them credit default
swaps; isn't that what happened?
Mr. Sullivan. Yes. We were selling, to the very best of
knowledge----
Mr. Davis of Virginia. But you weren't relying on the fact
that this government-backed group was insuring them and that
had bought them originally. That had nothing.
Now let me just tell where you I'm going with this. In
documents submitted to the committee, a former AIG CEO Hank
Greenberg asserts that in the 8 years from 1988 to March 2005
AIG wrote credit default swaps on only about 200 CDOs; those
are collateralized debt obligations. Only a handful, he says,
of these were exposed to subprime mortgages. He goes on to
assert that after his departure from AIG, the company under
your leadership, Mr. Sullivan, wrote about 200 CDO credit
default swaps in just 10 months, from March to December 2005,
but that these, unlike his CDOs, were heavily exposed to
subprime mortgages.
Essentially, as I read it, Mr. Greenberg is blaming you for
exposing AIG to the most risky credit default swaps. Do you
agree with that assertion or not?
Mr. Sullivan. Clearly not, sir. But what I again would
point out, that these CDS swaps were being written since the
late 1990's, not just in 2005----
Mr. Davis of Virginia. I know they were written in the
1990's. But my question here is, he's saying that in the early
stages, it was not heavy on subprimes; that after this, it
became very heavy with subprimes.
You claim Freddie and Fannie have nothing to do with this,
is what I heard you saying. You weren't relying on the fact
that they were buying these up and that they had government
backed. But you went ahead with this, according to Mr.
Greenberg, and that in the 10 months before you stopped, that
the alarm went out, that you were buying these up and that he
says that's basically what put you at risky credit default
swaps.
In fact, in earlier testimony from Mr. Willumstad, he notes
that the FP wrote a large number of instruments called credit
default swaps over time, that they wrote insurance bank swaps
on bonds with a face value of over $500 billion. Is that
correct?
Mr. Sullivan. From recollection, I don't believe the number
got to $500 billion, but it was certainly in totality around
$400 billion, yes.
Mr. Davis of Virginia. And what are they actually worth?
Mr. Sullivan. Well, that's the notional value, sir. Let me
just point out if I may. Up until the time I left AIG, to the
very best of my knowledge AIG had not suffered $1 realized
loss.
Mr. Davis of Virginia. They're still holding them, aren't
they?
Mr. Sullivan. They're still holding them. At the time, this
valuation can come back. As these contracts mature, and they
have an average tenure of 4 or 5 years, as these contracts
mature, the valuation, assuming there is no loss under the
contract, the valuations would come back.
Mr. Davis of Virginia. But you carry them on the books as
zero.
Mr. Sullivan. Well, I'm not sure they're carried at zero,
sir. They're mark-to-market valuation. But coming back to the
point of 2005, I don't want to underestimate the fact that AIG
was in a different sort of crisis in 2005. We had advised the
market that they couldn't rely on our accounts. We had major
regulatory issues that were dominating the focus of my
attention. I had to negotiate with the SEC, the DOJ, my friends
at the New York Insurance Department, as well as the New York
Attorney General. And we had to stabilize a ship that could
have come very much unglued. During that process of time
obviously the capital markets division, AIG-FP, continued to
write their business. Nobody had any concerns about the
profitability of that business at the time. And as they
progressed through 2005, as the Congresswoman said, you know,
fortunately, you know, those people involved in the
underwriting of that, including the corporate risk and
corporate credit offices, made the determination that the
market was deteriorating, not only in pricing but in credit
quality, and made the decision fortunately to stop. That's the
point I would like to make.
The day I left the company, sir, all of these losses to the
best of my knowledge were unrealized at the time, nonetheless
losses but unrealized.
Chairman Waxman. Thank you, Mr. Davis.
Mr. Cummings.
Mr. Cummings. Thank you very much, Mr. Chairman.
Mr. Sullivan, are you, like Mr. Willumstad, considering
giving back some of that money?
Mr. Sullivan. No, I'm not, sir.
Mr. Cummings. After the bailout on September 16th, the
taxpayers in effect became the owners of AIG. That should have
meant a change in its approach to executive compensation and
benefits, but apparently, it did not. The committee has learned
that a week after the bailout, executives from AIG's main life
insurance subsidiary, AIG American General, held this week-long
conference at an exclusive resort in California. Are you all
familiar? Are you familiar with that at all?
Mr. Willumstad. I am not.
Mr. Cummings. The resort is called the St. Regis Monarch
Beach Resort. We've gotten somepictures, and we put them up.
And let me give you a sense of how exclusive the resort was.
Rooms start at $425. Some cost as much as $1,200. And it's
interesting, they've got, 5 nights they had a room for, a
Presidential suite, for $1,600. And then they had 5 nights the
royal suite, really nice and swanky, another $1,600 for 5
nights; that was $8,000. And we contacted the resort, and we
got a copy of the bill. AIG spent $200,000, $200,000, Mr.
Sullivan, for rooms and $150,000 for banquets. They spent
$23,000 for the hotel spa. I don't know whether you heard me
asking the experts questions earlier. And of course, that was
for the pedicures manicures facials massages and whatever they
do in the spa. And they spent about $1,400 at the salon. The
guests in the spa and salon actually had different amenities.
They had all kinds of things at St. Regis. But they spent
$7,000 on something very, very, important; that is green fees
at the golf course. And then, I'm not even sure what this
charge means, but my colleagues tell me that the $10,000 for
leisure dining was for drinking.
Mr. Willumstad, you're no longer CEO, and I understand
that. When this all happened, do you--I mean, what's your
opinion? I mean, you seem to be a very honorable man. Would you
have gone along with that?
Mr. Willumstad. Absolutely not.
Mr. Cummings. And what do you think of it.
Mr. Willumstad. It seems very inappropriate.
Mr. Cummings. And it seems kind of--a very bad thing when
you think about the fact that the U.S. taxpayers would be
basically ending up paying for this, was that not correct?
Mr. Willumstad. I'm not aware of the facts, but I'll take
your word for it.
Mr. Cummings. But could you understand why taxpayers would
be upset?
Mr. Willumstad. Of course.
Mr. Cummings. And, Mr. Sullivan, I'm curious what were your
views on this?
Mr. Sullivan. Well, obviously I share Mr. Willumstad's
comments. You know, obviously, I left the company many months
earlier prior to Mr. Willumstad.
Mr. Cummings. I understand.
Mr. Sullivan. But if I had seen bills like that, I can
assure you, as the CEO, I would have been asking questions. At
the time I left, AIG within its travel department had a unit
that organized conferences that were supposed to, obviously,
get the best rates and make sure that the conferences were
being held in appropriate locations. This is obviously some
months later.
Mr. Cummings. But you can understand why taxpayers would be
very upset, wouldn't you? Couldn't you?
Mr. Sullivan. Yes, sir.
Mr. Cummings. I'm going to contact the AIG to find out who
was responsible for all of this, because I think that person
ought to be fired don't you.
Mr. Sullivan. Well, without knowing the full facts, you may
reach that conclusion when you reach those facts, but I don't
know the facts, sir. I had left many months earlier.
Mr. Cummings. One of the experts earlier said they wanted
to make sure these kind of things did not happen again. What
kind of--now that we the taxpayers of America are part of this
process, what kind of things and procedures can we put in place
to make sure these kinds of things don't happen again?
Mr. Sullivan. Well, I think you have to look, and I think
with respect to, Mr. Dinallo mentioned this at the time, that
you need to look at for what purpose is this conference being
used. You know, obviously, the company at that stage had gone
through a transition. Maybe they believed it was an appropriate
thing to calm everybody down. I think Mr. Dinallo made some
reference to that.
But as you look going forward as a manager, you would look
at the appropriateness of, one, what's the reason for the
conference? Is it appropriate? And what's the benefit to the
company? And what's the appropriate cost that should be
associated with that, as you would do with any management----
Mr. Cummings. I do find it interesting that Mr. Willumstad
knows nothing about it, but this came just a week after you
left. Did you know that, Mr. Willumstad?
Mr. Willumstad. I've heard you say that, but I was totally
unaware that there was any plan for any conference.
Mr. Cummings. So you wouldn't have been aware of this
subsidiary spending some $500,000----
Mr. Willumstad. I was not aware of that.
Mr. Cummings [continuing]. In a week.
Mr. Willumstad. I was not aware of it. And had I been aware
of it, I would have prevented it from happening.
Mr. Cummings. Thank you very much.
Mrs. Maloney [presiding]. Mr. Cummings' time is expired.
The Chair recognizes Mr. Souder.
Mr. Souder. Thank you. One of the big frustrations that
anybody watching this across America has is, both of you used
the term market driven, financial tsunami, as if you weren't
part of it. Do you feel you have any responsibility for what's
happened in our economy with a huge company that the taxpayers
now have put $61 billion in with $85 going, do you feel you
have any personal responsibility?
Mr. Sullivan.
Mr. Sullivan. I take responsibility for everything that
occurred as my tenure as AIG's president and chief executive.
And that's the role of a president and chief executive----
Mr. Souder. In other words, you're acting like, during your
period, you were doing fine. You were having all these nice
profits, and that somewhere between July and September, your
company lost $61 billion that we've already had to bail out
that--and you're claiming that the accounting rule which was
the law, it was just a matter of interpretation of how to apply
it, and I basically don't agree with how it was enforced and
like many others have argued that was a wrong enforcement, but
quite frankly, what it did was it showed up that your assets
didn't have great value. And do you acknowledge that you are
part what triggered the financial tsunami? That your risky
strategies in your company--let me ask you another question.
Your insurance division is fine, correct?
Mr. Sullivan. To the very best of my knowledge at the time
I left, certainly.
Mr. Souder. Mr. Willumstad, wouldn't you say your financial
division, we heard earlier, your financial division appears to
be in good shape--I mean your insurance division.
Mr. Willumstad. That's correct.
Mr. Souder. Now, if your insurance division is in good
shape, it means that this is concentrated in your financial
services division. And your insurance division, which is also
investing assets, chose not to invest in as risky of assets
that didn't yield as much but were less risky. Is that not
true? Or how would you explain that one division in a short
period of time could have had $61 billion in taxpayer
investment and your other division not needing it when your
other division, as insurance companies do, also invests in
properties, also have been struggling with mark to market, have
also had, but have more regulation on the value of those assets
prior to that decision? Why does not your risky strategies in
the financial services show that, in fact, to get higher return
you went for more risk in that category?
Mr. Sullivan.
Mr. Sullivan. Well, again, what I would like to point out
is that we actually stopped running that business, thank
goodness, in 2005. That's a point I would like to, because I
don't think it was made clear in the first session that,
fortunately, we had been in that business for some 10 years.
But as my colleagues determined that market--you know, the
credit quality was changing and the pricing of these----
Mr. Souder. Let me clarify, because you referred to this
several times. Are you saying that the $61 billion that we put
in is mostly of things that were pre-2005.
Mr. Sullivan. I don't know what the $61 million is, sir.
Mr. Souder. $61 billion is what the taxpayers have already
put in of the 85 to cover the losses of AIG. And are you
maintaining that this is just to rescue bad decisions pre-2005,
or is any of that money because you had questionable decisions
between 2005 and 2008? Do you bear any responsibility? That's
what I'm asking.
Mr. Sullivan. Well, I want to be clear----
Mr. Souder. You asked for raises because you said you were
making profits a little bit ago. You said that you were making
profits, that you hadn't lost any money. But yeah, but you had
a shell that was anchored in less than secured mortgages that
had been leveraged multiple times. Your insurance division,
which also presumably has mortgages and other types of
investments, seems fine. The question is, why weren't you
warning your stockholders? Why weren't you making declarations
that would leave your company--I mean, I have a business
background, an MBA, just a small town business guy. But at the
same time, you took incredible risk without warning people, and
the evidence of that risk is that, one accounting--by your own
explanation, one accounting rules change put your company
under, and the taxpayers are putting $61 billion in; how in the
world does an executive leave their company so vulnerable that,
when they leave, all of a sudden they go broke when they were
claiming they were making money before, and they act astounded
like everything was just fine if they hadn't done this one
accounting rule, which I don't agree that you have to balance
out when the assets are going to be sold, I understand that,
you're holding them long term. But the reason they're trying to
do some of this kind of thing is we might have had a complete
collapse if we hadn't done any mark to market here, we hadn't
done any of these kind of accounting changes. Our assets were
deteriorating, and we would have had an even bigger blowup
later potentially. We needed some kind of a mix in there. But
in effect, you left your company so exposed that when a little
bit of softness came to the economy and it started down and
they do an accounting change, you go belly up and stick
everybody else in America with it, and you're saying, oh, it
was a market tsunami, as if you didn't help cause it.
Mr. Sullivan. Again, if I may, sir, with the utmost
respect, in my testimony, if I emphasize FAS 157 as being the
only cause, it was not, again with the greatest respect, I was
not criticizing FAS 157. I was referring to its unintended
consequences, which of course this Congress has now and the SEC
have now recognized.
There were many other reasons that have affected many other
companies and many other countries around the world. It's not
just the United States. This tsunami that many have referred
to--others have mentioned the equivalent of financial Pearl
Harbor, you know, much more intelligent people than I. There
were many issues that contributed to this. As I mentioned,
whether it was inappropriate lending or borrowing, whether it
was lack of investor confidence, whether it was the freezing of
the credit markets, I just in my testimony to be helpful to the
committee focused on what I believed back in my tenor as AIG
something that I was concerned about, which was the unintended
consequences of FAS 157.
And I responded to the Congressman earlier, at the time I
left, as Mr. Willumstad articulated in his testimony, we had
taken substantial unrealized losses, losses nonetheless. But at
the end of the day, these CDS transactions at the time I had
left the company had not incurred, to the best of my knowledge,
$1 of realize. That's not to say they wouldn't as the situation
progressed. But at the time I left the company, this was
multiple issues, not one entity, not one individual. And that
was the point I was trying to make. If I referred to FAS 157
too much in my testimony, it was only because that was
something I was particularly concerned about as--not being an
accountant, but as, again, like you. Sir----
Mrs. Maloney. The gentleman's time has expired.
I yield 1 minute to the ranking member.
Mr. Davis of Virginia. I guess the thing to all of us is
puzzling is, how come you get bailed out, Lehman doesn't? Who
makes these choices? It is kind of mysterious, I think, to a
lot of us. The regrettable thing here is that you get bailed
out. Your employees get to stay. Your shareholders take a bath,
but you're bailed out because there would be a lot of
collateral damage if we were to have not stepped in. That's at
least the rationale that we are hearing from Treasury. But,
frankly, given the quality of some of the decisions that were
made, you deserve to fail.
And it is, I think for a lot of us, puzzling why you were
singled out and kept your doors open, your employees kept
moving, while other companies were left to fail and just fall
on their sword. And I think that's what's troubling to me and I
think to a lot of other Members up here. And I think we'll
explore more of that in the testimony and the questions as we
follow.
Thank you.
Mrs. Maloney. Thank you.
The Chair recognizes Congressman Kucinich for 5 minutes.
Mr. Kucinich. I thank the gentlelady.
It appears that in the last month this country has taken
steps, unprecedented circumstances, unprecedented steps. We
interfered in the free market. We bailed out Wall Street. The
market is not responding. We see today's headline in the Wall
Street Journal, ``Markets Fall on Doubts Rescues Will
Succeed.'' And I think what this does is I think it raises
questions as to whether it was wise for government to intervene
directly in the markets and whether or not a financial rescue
plan should have addressed the core problem, which is, tens of
millions of Americans losing their homes, needing government to
get a controlling interest in these mortgage-backed securities,
so that we can work out a plan where people can get a break on
their interest rates, on their principal, extended terms of
their loan, and help people save their loans. We had other
choices of priming or pumping the economy. We didn't do any of
that.
Now, questions are raised. For example, you talk about mark
to market. AIG went into the government's hands on about
September 18th. Interesting, mark to market was basically
suspended on the 30th. I think the timing of that needs to be
explored a little bit more carefully. We know it went into
effect on November 15th. We've got a bailout plan by the
Secretary of the Treasury which clearly is not working, and
we've got--which the taxpayers are paying for, and we've got
another $85 billion of a bailout for AIG.
And according to the testimony submitted to this committee
by former CEO of AIG Mr. Greenberg, he raises questions as to
whether or not a government bailout of AIG was absolutely
necessary. In fact, he admits there was a liquidity crisis that
required action. But he goes on to say in his testimony, the
action was, it was not necessary to do a government bailout. He
said that it was not necessary to wipe out virtually all of the
shareholder value held by AIG's millions of shareholders,
including tens of thousands of employees and many more
pensioners and other Americans on fixed income. He said that
perhaps they could have filed bankruptcy, limited the parent
company, and that millions of stockholders would have fared
better. This goes back to a question of my friend that the
stockholders would have fared better. But he says that other
stakeholders, like AIG's Wall Street counterparties, would have
fared worse.
So, according to the testimony of another CEO of AIG,
private sector solutions for AIG were rejected. He talked about
the tens of billions of capital that were offered. He talked
about the State of New York ready to permit AIG to use $20
billion in excess capital of its insurance subsidiaries, plus
he says there was no effort made for a temporary and limited
bridge fund from the government; plus we have this mark-to-
market problem, and plus you have, without the mark-to-market
problem, you have possibly $1 trillion that could have been
pledged to secure an, instead of trying to secure an $85
billion loan from the government.
Now, instead, the government takes over. AIG, now we have
85 percent ownership of AIG. Here's what's going on with AIG.
AIG is paying interest on undrawn capital. They're paying
interest on money it doesn't borrow. The company is encouraged
to draw down the full amount of the loan even if it doesn't
need the money. Now, in order to service the principal and
loan, the AIG has to engage in a fire sale of profitable
assets.
Who buys though assets, Mr. Sullivan, who buys AIG assets.
Mr. Sullivan. Well, obviously, I can't comment on the
events that----
Mr. Kucinich. Who buys their assets?
Mr. Sullivan. Well, if you recruit investment bankers, they
will go out and I assume get the best deal that they possibly
can for the assets for sale.
Mr. Kucinich. Mr. Willumstad, you were involved with
negotiations with Treasury Secretary Paulson. Why do you think
AIG was bailed out while Lehman Brothers was allowed to fail?
Mr. Willumstad. I'm not sure why Lehman Brothers was
allowed to fail. I think it was understood that the
consequences to the financial system if AIG failed would be
very significant.
Mr. Kucinich. My time is expired, Madam.
Mrs. Maloney. The Chair recognizes Congressman Bilbray of
California for 5 minutes.
Mr. Bilbray. Thank you, Madam Chair.
You know, Madam Chair, I do an editorial note. I'm not
going to ask you gentlemen from prepared statements that
somebody else has written up before this hearing. I'm going to
ask questions that basically respond to your testimony.
Madam Chair, I do have to point out that it's sort of
interesting the way we throw around terminologies. And somebody
born and raised on the ocean and spent some time in the water
myself, I find it funny that we use the terminology like
tsunami. We can't even use plain language like tidal wave. But
maybe because some people don't understand some of the words
they're using.
Gentlemen, the term tsunami or tidal wave is not just a
wave coming in. You land lovers and people that don't surf may
not understand that long before that crest breaks, there's an
indication that something is going on. Granted, usually
tourists see the tide going out and think it's a good time to
go out and pick up seashells. And a lot of people seem to have
seen that the tide shifting and the major changes that were
happening were an opportunity to go in and clean out, and they
got caught below the high water mark.
I hope the Chair doesn't mind me using that analogy, but as
an old surfer, I just can't go back addressing that. When
Freddie and Fannie went from 30 percent to 70 percent of a
certain part of the market; when we saw major portions of our
oil money that's going overseas coming back and buying up paper
and inflating a market; don't you think that we should have
seen some concern there, when we say--well, let me just ask it
out.
When Freddie and Fannie went from 30 to 70 percent, how
much of the problem should have been seen by all of us that we
have a portion of the market that was very, very vulnerable,
and did that vulnerability have an effect to your operation and
the problems we're facing with AIG, with Freddie and Fannie?
Mr. Sullivan. Would you like me to respond, sir?
Mr. Bilbray. Yes.
Mr. Sullivan. First of all, I don't believe, with the
greatest respect, I'm qualified to comment on Freddie and
Fannie and the implications thereof.
But what I did say in my testimony was one of the factors
that I think has contributed to, and the tsunami equivalent, I
defer to your expertise, sir, but what's contributed to what
has impacted the global financial economy is, you know, one of
the things could be inappropriate borrowing and lending. And if
that correlates to your analogy of Freddie and Fannie, maybe
that's helpful, I don't know. But I certainly don't know enough
about Freddie and Fannie to pass any qualified opinion.
Mr. Bilbray. And I apologize, I had to fly back from the
West Coast just to be here at this hearing, and I just got to
look at the waves and didn't get to enjoy them at all this
weekend, so we're here getting our work done.
Let's just talk about the mark to market. We developed a
concept based on the Enron model of how to address Enron. Now,
would you agree that when it applies to mortgage-backed
securities, when there's real estate involved, the existing or
the traditional accounting process with mark to market really
didn't reflect the real value, the real assets, and the real
situation on the ground and gave an artificial appearance of
volatility that scared the hell out of the market in a lot of
ways that maybe it shouldn't have.
Mr. Sullivan. I would agree with that statement.
As I testified, sir, I think what occurred was when FAS 157
of mark-to-market accounting was put in place, you know, it was
really the ability to mark to market in an illiquid market when
there is no visible valuation. And again, maybe it's helpful if
I can just give an example. It's like owning an apartment
block. And the valuation of that apartment block goes up and
down. But all of the tenants, you're the owner of that
building, and you've got it fully occupied. Everybody is paying
their rent on time. You can pay your mortgage, and you can pay
your--any capital expense you have in repairs or whatever. And
you don't have to sell that building. You can hold it for as
long as you want. It doesn't really matter what the valuation
of that building is because you can hold it, and you'll get in
all the cash that you need in from that.
And what's occurred in the illiquid markets is that you're
trying to value assets that are still paying their rent,
they're still providing you with the cash-flow that you need,
but there isn't a valuation that--you know, response to that in
an illiquid market. And that was the point--that's a very
simplistic example. But that was the point I was trying to make
about the unintended consequences.
Mr. Bilbray. So, in other words, our theory of trying to go
in and correct the Enron, we need to go back and readdress it
because we've moved too far the other way to where it doesn't
reflect the reality. And I think one of the things a lot of
people were interested in those mortgage-backed securities
because they always knew that there was real estate involved,
but the accounting process doesn't reflect that reality.
Mr. Sullivan. Well, I think, obviously, as I said, it
wasn't a criticism of FAS 157. I think there was an unintended
consequence that I am pleased that Congress and the SEC have
agreed to at least take a look at.
Mr. Bilbray. Thank you, Mr. Chairman.
Chairman Waxman [presiding]. The gentleman's time has
expired.
Mr. Tierney.
Mr. Tierney. Thank you, Mr. Chairman.
Gentlemen, I think people are a little bit baffled here. We
look at Mr. Greenberg's testimony, and it's not his fault;
according to him, it all happened after his watch.
Mr. Sullivan, you say no mistakes were made as events
unfolded.
Mr. Willumstad, you say AIG couldn't have done it any
differently.
And yet I think that people really expected the management
of the company, you as the leaders of the company, would have
seen what risk you were taking and been able to just know what
they were and assess them.
We took a look at the internal minutes from your audit
committee meetings. They're not public, but we were able to get
them. They seem to tell a different story on that. And let me
just go down.
On January 15th, the audit committee minutes say this:
Ongoing discussions revealed that PricewaterhouseCoopers
believes to be an expectation gap among key parties, including
the board, management and the internal control functions.
The next month, on February 7th, the audit committee
meeting: PWC warns the role or reporting of risk management
needs a higher profile at AIG.
At a February 26th meeting: PWC says, indicated that the
process at AIG seemed to break down and that, unlike other
companies where there was a good dialog and appropriate levels
of management on the approach, alternatives considered and key
decisions, at AIG, only AIG-FP, the Financial Products
Division, was involved in a December valuation process.
And that may have something to do with the chairman's
letter that he received from Mr. St. Denis that he brought it
to people's attention, and he couldn't get by that office over
there.
Then you have March 10, 2008, you get the Office of Thrift
Supervision. They weigh in on this, and they say that your
management of the company and your oversight of AIG
subsidiaries, including in particular the Financial Products
Division led by Mr. Cassano, should be criticized. And they
also say that supervisory concerns regarding the corporate
oversight of key AIG's subsidiaries exist, and they write that
we are concerned that corporate oversight of AIG Financial
Products lacks critical elements of independence, transparency
and granularity.
And the next day, PricewaterhouseCoopers reports that there
is a common control issue, the root cause for these problems,
and that AIG does not have the appropriate access or clarity
around the roles and responsibilities of critical control
functions.
Gentlemen, that seems to stretch from January 15th all the
way to March 11th, your own internal audits, your own
PricewaterhouseCoopers group and the Office of Thrift
Supervision repeatedly saying the serious lapses are there.
They describe them, both the auditors and the regulators. Don't
you think that management has some responsibility for what went
on here?
Mr. Willumstad.
Mr. Willumstad. Yes, management has some responsibility.
Mr. Tierney. Mr. Sullivan, do you agree?
Mr. Sullivan. Yes, I would also say that, at the same time,
we were putting compensating controls in place. You read the
chronological list there, but we had put compensating controls
in place that enabled us, obviously, to issue our financials
for 2007 with a clean audit.
Mr. Tierney. I guess the problem is, people expect
management to be ahead of the curve, not to wait for the
regulators and PricewaterhouseCoopers to start blowing the
whistle late. The salaries that you gentlemen pulled down, you
and your team on that, means to us that you anticipate these
things and that you start putting those things in place before
the whistle is blown, before these people come in and point out
the seriousness of the situation.
And I think that's what disturbs people on this and what
continues to be a theme through here that it's not--and Mr.
Chairman, I would like unanimous consent to put copies of the
audit reports and the minutes, as well as the Office of Thrift
Supervision letter of March 10, 2008, in the record, because I
think it shows clearly that this is not something that external
factors are responsible for solely on this; it's a fundamental
failure here of management. And I'm glad that you both take
responsibility for it. I hope your whole management team does,
because certainly the price is extremely high on that.
Chairman Waxman. Without objection those documents will be
made part of the record.
Mr. Sullivan. Can I just respond on one point?
One of the things that we set out to do in March 2005 was
to make tremendous investments in a number of areas that
previously had been underinvested. So we added a lot of staff
in internal audit and legal compliance, risk management etc. So
I wanted you to at least know there were compensating controls
put in place.
Mr. Tierney. And I appreciate that, if I may, Mr. Chairman,
except these are reports from January, February and March 2008.
So, obviously, not enough had happened even remotely close to
settling the qualms of the regulators and the auditors on that.
So I think it shows some management issues there.
Chairman Waxman. And if the gentleman will yield to me. And
Mr. St. Denis, who was working for you to alert you to these
problems, tried to get through in November 2007, and neither of
you remember him complaining or know anything about his
concerns. So you did have an alarm, even in the previous year.
Mr. Turner, I think you're next.
Mr. Turner of Ohio. Thank you, Mr. Chairman.
Yesterday we had a hearing concerning Lehman Brothers, and
there was a discussion that Lehman Brothers had it's own
subprime lender, BNC Mortgage I believe it was, where they were
issuing subprime loans. With AIG, my understanding is that you
were an insurer and you also traded mortgage-backed securities.
I'm not certain, though, did you also have a lending function
of subprime mortgages? And also, then, did you package loans,
issuing them, selling them as mortgage-backed securities. In
the subprime crisis that we're seeing, what activity in the
subprime market did AIG have?
Mr. Sullivan. We did have a--they do have--sorry. It is
hard to differentiate when you've been there 37 years. AIG does
have a consumer finance that's called AIG.
Mr. Turner of Ohio. Then you also packaged and sold those
loans as mortgage-backed securities; you also traded in them.
Mr. Sullivan. What I was going to point out is that
fortunately, AGF did not participate in, it is my
understanding, any of the exotic mortgage products during that
period of time and didn't participate in lending in what we're
seeing to be the hot markets that we now discover. So whilst
their results have not been at the level that we would normally
expect them to be, they have not been as bad as others in their
industry.
Mr. Turner of Ohio. Because the first panel indicated that
you were invested heavily in subprime mortgages. So that's
direct. That's not mortgage-backed securities. That's in the
mortgages themselves?
Mr. Sullivan. I'm sorry, sir, I don't quite understand the
question.
Mr. Turner of Ohio. The first panel indicated that part of
AIG's problems were that your financial services institutions
invested heavily in subprime mortgages. In what form was that
investment held?
Mr. Sullivan. Again, I think that's the clarity that's
required. These are super senior credit default swaps. These
are the transactions that AIG-FP participated in, so there
are--and we've made very, very fulsome disclosure on this. In
fact, we've been complimented by the investment community and
others about the fulsome disclosure that we've made. It's all
on our Web site and has been for many quarters. Is that they
were effectively insuring, and I'm no expert on this, but
effectively insuring the super senior level of the transaction.
So there are tranches of bonds, the CDOs below that, whether
they are equity, triple B, double A minus, double A, triple A,
and then there's another layer of protection before you get to
the super senior. And what you're doing, and again, I'm no
accountant, but you're valuing the assets that are underlying
the super senior transaction. So that's, what FP wrote was a
super senior credit default swap portfolio.
Mr. Turner of Ohio. My concern that I have mentioned in
many of these hearings is--I'm from Ohio. We're one of the
leaders in foreclosures. You can go drive through neighborhoods
in my community, and you can see the abandoned houses that are
there. Our experience has been that predominantly these are a
result of refinances where the loan, ultimately where the
consumer gets in trouble, the value of the loan exceeds the
value of the house at origination; that there are terms many
times capitalization of the fees. There are terms that
ultimately caused the home owners to get into trouble.
Sometimes it's financial circumstances of the consumer that
causes that they can't keep up with the payments. But usually,
it's something to do with the mortgage product itself that
causes the initial stress and a realization by the consumer
that the mortgage value is higher than the house value itself.
So they don't even have the ability to sell the home, which you
would find in normal then real estate transactions, to escape
their liability. They are in effect trapped and have the only
recourse, not having the financial resources themselves to make
up the gap, of abandoning the property, causing therefore the
foreclosure because they're not able to keep up.
In the county in which I reside, it's about 5,000
foreclosures a year now in a community of about half a million
people. The State of Ohio is experiencing somewhere around
80,000 a year. Every 3 years, that's a geographic size of one
full congressional district.
It's been interesting listening to you, Mr. Sullivan, about
your discussion of mark to market because I was actually, until
you began talking about it, kind of leaning toward perhaps
maybe it was a policy that was a problem. But after hearing
your statement on giving bonuses based upon excluding losses
and your statement of these aren't really realized losses, that
mark to markets, as you said, unintended consequences followed,
I'm beginning to think that the advocates for significantly
reducing mark-to-market applications are trying to say that we
shouldn't look at value without looking at current value, which
is kind of like your bonus description.
So my concern here, though, is that if mark to market is a
process that people get concerned with when markets fluctuate,
if we have a situation where the loans are originated at a
higher than the value, the mark to market on day one would tell
you that the underlying mortgage security is not properly
collateralized. In your discussions on the subprime effect,
mortgage-backed securities, as you were saying with the swaps,
did you ever have any discussions in your company where you
heard that in fact some of these mortgages perhaps exceeded the
value at loan origination?
I would like you both to answer.
Mr. Willumstad. Not to my knowledge.
Mr. Sullivan. Not to my knowledge, sir.
Chairman Waxman. The gentleman's time is expired now.
We go to Mr. Yarmuth.
Mr. Yarmuth. Thank you, Mr. Chairman.
I think it was Mr. Bilbray earlier asked a question if you
knew why AIG was bailed out and not Lehman. I'm going to ask a
little bit more direct question.
Mr. Willumstad, did Goldman Sachs have anything to lose if
AIG went under?
Mr. Willumstad. Goldman Sachs was a significant
counterparty for AIG.
Mr. Yarmuth. To what extent are the relationships
intertwined, and how much do you think Goldman Sachs would have
suffered financially? What kind of stake was there for Goldman
Sachs and AIG's survival?
Mr. Willumstad. I can't tell you what losses Goldman Sachs
might have suffered because I don't know. The only thing I can
tell you is that Goldman Sachs was a counterparty on
approximately $20 billion worth of credit default swaps that
AIG-FP had.
Mr. Yarmuth. So it's a significant interest in AIG's
survival it sounds like.
Mr. Willumstad. Again, I don't want to jump to that
conclusion. I don't know how those securities carried on
Goldman Sachs' books, and I don't know whether they were hedged
by Goldman Sachs, so it would be very difficult to draw that
conclusion.
Mr. Yarmuth. It sounds like a question we need to ask, Mr.
Chairman.
Several comments have been made about the fact that AIG was
too big to fail. And we saw, I think you were in the room
earlier, when the statement of Alan Greenspan about size and
the question of whether we let companies get too big. Clearly,
by your own admission, in this case the implications of AIG's
failure on the financial markets would be substantial. Is this
something that troubles you, that companies are able to reach
the size where they can disrupt an entire economy? And I guess
the corollary question or the followup question is, what
benefits to society, our society, get by letting a company get
so big that it puts the entire Nation's financial system at
stake or at risk?
Mr. Willumstad. I'm sorry, I'm not sure I understand the
question.
Mr. Yarmuth. Well, I mean, you're running a company now,
albeit for just a few months--Mr. Sullivan ran the company for
several years--that apparently was so big that its failure
went--the implications of its failure, potential failure went
far beyond its shareholders and its employees, and that's why
our government decided that it needed to step in, because of
that impact. Do you think that it is good that corporations can
get to that size in our economy where their mistakes don't just
affect them? And do you think there are benefits--you know, if
we're going to allow companies to get that big, that their
failures and their mistakes can affect all of us, then what
does society get in return for allowing the company to get so
large?
Mr. Willumstad. Well, again, I think the size of AIG and
the interconnection between AIG and the rest of the capital
markets are really the issue. I'm not sure purely size by
itself is the determinant factor. I would say also that there
have been plenty of benefits to AIG's size, its ability to
serve broad markets, to provide a competitive marketplace so
customers and policy holders can get a good deal if you will,
that AIG was a strong well-capitalized insurance operation that
provided many benefits to its customers and consumers that did
business with it.
Mr. Yarmuth. And then that's the question I was asking,
because we see this now in--we've seen it in many situations
recently where companies that are so large that their failures
just impact taxpayers throughout the system. And I think the
question we have to ask as a society is, are the benefits of
that size, whether it's a competitive--whether it's competitive
pricing or whatever, adequate to justify the risk of a company
disrupting, a company making a mistake and disrupting the
entire economy. But that's something that's a little bit of a,
I guess a 30,000-foot issue in this particular case. Just a
quick question again. We've had some testimony about the fact
that only $60 billion has been drawn down of the $85 billion.
What specifically was the $85 billion needed for?
Mr. Willumstad. The $85 billion number was a number that
was obviously determined by the Federal Reserve. The $85
billion, I believe, was intended to be a loan to cover
liquidity needs inside the company. It's been characterized
before as covering losses which I think is not an accurate
representation. Again, the loan was taken down after I left the
company, so I can't be specific about it. But what happens in a
crisis of confidence like this and what was happening to AIG
was not a question of losses. AIG has had a lot of money
borrowed over the years. And when you go through one of these
crises, people who have loaned you money in the past stop
lending to you. People who give you money or put money on
deposit with you want it back; that in another environment,
without this crisis of confidence, AIG could have easily met
all of those obligations. But when you have a series of
counterparties who have decided for reasons of concern about
the viability of the company stop doing business with you, the
company can no longer meet its obligations.
It's not very much different that if all the consumers of a
particular bank showed up 1 day and asked for all of their
money back, there's no bank in America that could provide that.
Those dollars of deposits that were given to that bank are
loaned out in the communities to small businesses, consumers,
credit cards. The whole system is driven around confidence and
viability. And once that breaks down, there is no company,
certainly in the United States and I think anywhere around the
world, that can sustain a run on the institution.
Chairman Waxman. The gentleman's time has expired.
Ms. Watson has requested that she be recognized next. Does
anybody object to that? If not, the gentlelady is recognized.
Ms. Watson. Thank you so much, Mr. Chairman.
I think you just about answered my question, but it's about
the $85 billion, Mr. Willumstad, that has been given to bail
out. And as I understand, last Friday, AIG reported it had
already drawn down $61 billion of the $85 billion loan. Does
that align itself to what you were just describing, that people
want their money now?
Mr. Willumstad. Again, I don't know what the use of the $61
billion was for because I wasn't there. I'm not there. But I
would say, generally speaking, my assumption would be that's
exactly what it was used for.
Ms. Watson. In fact, AIG has drawn down the funds so
quickly that credit rating agencies have now begun downgrading
AIG again. And back on September 16th, AIG said that the
bailout would prevent further rating downgrades. And we know
that you're not at the company anymore, and I'm sure you're
surprised by how quickly the $85 billion line of credit has
been consumed. So one question that my constituents, and I'm
sure that all American taxpayers, are asking, can you explain
or try to how AIG could burn through $61 billion in just 3
weeks?
Mr. Willumstad. Well, again, I don't know what the source
for the use of that money was. But I'm assuming that
counterparties who would normally lend money to AIG are no
longer lending money to AIG, and consequently that's where the
money is going.
Ms. Watson. The new CEO of AIG, Edward Liddy, publicly
suggested that AIG might take a piece of the $700 billion
bailout package that we just passed. So that would be in
addition to the $85 billion that AIG already received. And my
question would be to those who can look forward down the
economic road, when is this going to end? Will it end? How much
are we going to have to spend of the taxpayers' money to keep
AIG afloat? Would you have any idea now that you're not
actively with the company?
Mr. Willumstad. I'm sorry, but I do not.
Ms. Watson. OK.
Well, I appreciate the going out of line, and I appreciate
the gentleman coming here and being straightforward. A little
honesty would help us very much.
Thank you so much, Mr. Chairman, for accommodating me.
Chairman Waxman. Thank you very much, Ms. Watson.
Mr. Braley.
Mr. Braley. Thank you, Mr. Chairman.
Mr. Sullivan and Mr. Willumstad, I would like to ask you
about the compensation paid to one particular AIG employee
Joseph Cassano. Mr. Cassano was president of AIG's Financial
Product Division, the unit that sold the credit default swaps
that helped bring down AIG. During his tenure at AIG, Mr.
Cassano repeatedly denied that these swaps posed any risk to
AIG or its shareholders.
And I'm going to quote to you from a September 28, 2008,
article in the New York Times by Gretchen Morgenson which
attributes this comment to Mr. Cassano in August 2007: ``it is
hard for us, without being flippant, to even see a scenario
within any kind of realm of reason that would see us losing $1
in any of these transactions.''
The committee has examined Mr. Cassano's pay, and we were
shocked to find that AIG paid him more than it paid its CEOs.
Over the last 8 years, he earned a total of $280 million in
cash, and most of that money came from a bonus program. For
every dollar that Mr. Cassano's unit made $0.30 came back to
him and the other Financial Products executives.
On February 28, 2008, AIG posted losses of $5.3 billion.
The main reason for these losses was the $11 billion lost by
Mr. Cassano's division. The very next day, February 29th, Mr.
Cassano was terminated from his position as president of the
Financial Products Division. But when AIG terminated Mr.
Cassano, it took two actions that, quite frankly, are hard for
your new partners, the U.S. taxpayers, to comprehend. First,
AIG let him keep up to $34 million in uninvested bonuses. And
second, the company amazingly hired Mr. Cassano as a consultant
for the sum of $1 million a month.
So, Mr. Willumstad, let me start with you. As CEO of AIG,
you had authority until September 17, 2008, to cancel Mr.
Cassano's consulting agreement for cause, but you never did
that, did you?
Mr. Willumstad. No.
Mr. Bilbray. Mr. Sullivan, as CEO for AIG during the period
from March 11, 2008, when this severance agreement was signed
between AIG and Mr. Cassano, through June 15, 2008, you had
authority to cancel Mr. Cassano's consulting agreement for
cause, but you never took that action, did you?
Mr. Sullivan. That is correct.
Mr. Bilbray. Mr. Chairman, I'm going to offer as part of
the record the consulting agreement of March 11, 2008, which
provides the CEO of AIG to terminate the consulting agreement
for cause. And I certainly think that in light of what we've
heard here today there was ample justification based upon the
misrepresentations made by Mr. Cassano and based upon the
financial peril he created for this longstanding company of
great reputation and our entire financial marketplace, that
option should have been exercised and something should have
been done for the taxpayers of the United States.
Chairman Waxman. Without objection, the document will be
made part of the record.
Mr. Braley. And Mr. Chairman, I agree that this is not a
partisan issue. But there have certainly been some partisan
comments made about the investigation by this committee of
Fannie Mae and Freddie Mac.
And I would just like to read for the record a portion of a
Financial Times article dated September 9, 2008, titled,
``Oxley Hits Back at Ideologues.'' This is an article
interviewing the former chair of the House Financial Services
division, Mike Oxley, who, instead of blaming Fannie Mae and
Freddie Mac, headed the Financial Services Committee and blames
the mess on ideologues within the White House as well as Alan
Greenspan, former chairman of the Federal Reserve. In fact, he
talked about the GSE reform bill that passed the House
overwhelmingly in 2005 and could have prevented the current
crisis.
And here's what he says: ``all the handwringing and
bedwetting going on now without remembering how the House
stepped up on this, he says, what did we get from the White
House? We got a one finger salute.''
And finally, he says, we missed a golden opportunity that
would have avoided a lot of the problems we're facing now if we
hadn't had such a firm ideological position at the White House
and the Treasury and the Fed, Mr. Oxley says.
And I would offer that as part of the record as well.
Chairman Waxman. Without objection, that will be made part
of the record.
[The information referred to follows:]
[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]
Chairman Waxman. Will the gentleman yield?
Mr. Braley. Yes I would.
Chairman Waxman. Why didn't you fire Mr. Cassano? You had
the ability under the rules under which your corporation
operated to fire him. And he's been kept on at a million-
dollars-a-month retainer. He was discharged. Why didn't you
fire him?
Mr. Willumstad.
Mr. Willumstad. Well, again, I was not the CEO at the time.
Mr. Sullivan had recommended to the board and the compensation
committee that Mr. Cassano's assistance in helping unwind, if
you will, or work down the exposure in FP would be valuable to
the company and that, as part of his agreement, he would have a
noncompete, nonsolicitation agreement. It was important to keep
the existing employees in FP to help work through the sizable
exposure.
Chairman Waxman. You were the chairman of the board.
Mr. Willumstad. I was.
Chairman Waxman. And you could have insisted that he be
fired, but Mr. Sullivan told you not to fire him so he wouldn't
go out and compete with you. I would have thought you would
want him to go to some other corporation the way he had put
yours so deeply in the hole.
Mr. Sullivan, why didn't you fire him?
Mr. Sullivan. I recommended that course of action to the
board, and Mr. Willumstad articulated the reasons very well.
One of the things that I wanted to ensure is that we
retained the 20-year knowledge that Mr. Cassano had about the
businesses. These are long-term transactions. These are not
transactions that go on the books and expire 12 months later.
They're very long term, and you want to make sure that the key
players and the key employees within AIG-FP, that we retain
that intellectual knowledge.
Chairman Waxman. What would he have to have done for you to
feel that you should fire him? He put you in a situation where
you had to come up with $60 billion immediately, and you
couldn't do it. Isn't that enough reason to feel that the guy
shouldn't be kept on at a million-dollars-a-month salary just
to be available?
Mr. Sullivan. Well, at the time, you know, obviously, we
made that decision. Mr. Casanno decided to retire, and I
believed--and I made the recommendation, as Mr. Willumstad
articulated, that his services be retained and----
Chairman Waxman. When I retire, I want to come to work for
you at $1 million a month. What a good deal that is. And what a
good signal that is. The man goes out on his own in these
derivative deals that bring down AIG, and he gets $1 million a
month retainer in case you need his advice. Is that what you're
telling us?
Mr. Sullivan. Well--and, in addition, Mr. Willumstad
articulated all the reasons there, that he had a noncompete
nonsolicitation so that we could retain the key employees in
AIGFP, bearing in mind these are multi-year contracts. This
wasn't the entirety of FP's businesses. There were other
sectors that they were in as well.
Chairman Waxman. Ms. Norton, I think you're next on the
list.
Ms. Norton. Thank you, Mr. Chairman.
I'd like to ask both of you questions about your statements
as the company was collapsing. Because it didn't suddenly fall,
suddenly collapse. Mr. Sullivan, let me ask you first.
In December 2007, you said the following: We believe we
have a remarkable business platform with great prospects that
represent tremendous value. How many superlatives in that
sentence? And then you posted $5.3 billion in losses for the
quarter. That was December.
Move just a few months to February 2008, and then you said,
based upon our most current analysis, we believe that any
credit impairment losses realized over time by AIGFP would not
be material to AIG's consolidated financial condition. Then you
went on to post $7.8 billion or more in losses for the quarter.
A few months later, May 2008, you said, ``sir--the
underlying fundamentals of our core business remain solid.''
The next month the board voted to replace you.
Let me ask you, Mr. Sullivan, what was the source of those
glowing statements as you were posting loss after loss, quarter
after quarter?
Mr. Sullivan. Well, I think, because you made a reference
to a number of statements there, I need to break down my
answer, if I may.
First of all, my reference to the corporation is talking
about AIG's global franchise. Because, obviously, AIG is in a
number of businesses, not just the super senior credit default
swap arena. Obviously, we have leading market positions in many
other businesses. I'm talking current. I keep on saying ``we.''
I'm no longer there, but for 37 years I was there. They have
market leading positions.
Ms. Norton. Of course, there were the credit default swaps
that were collapsing your fundamental business. Go ahead, sir.
Mr. Sullivan. That's correct. But I'm just trying to
clarify some of my remarks, because you've taken--there's
different topics being covered there.
So one is referring to the core franchise and the market
leading positions that AIG holds in a number of businesses
around the world. The other comment is trying to differentiate
between the realized loss potential of that portfolio as
against the unrealized loss potential.
As I mentioned earlier, at the time I left the company, to
the very best of my knowledge, certainly to the best of my
knowledge at the end of the first quarter, I don't believe AIG
had suffered any realized losses. That's not to say they
wouldn't suffer realized losses as the market continued to
deteriorate; and, in fact, we made very fulsome disclosure. As
I mentioned earlier, we had a tremendous amount of information
on our exposures to the U.S. residential housing market on our
investor Web site.
Ms. Norton. Would not be material--credit losses realized
over time would not be material to AIG's consolidated financial
condition.
Mr. Sullivan. Based on what I knew----
Ms. Norton. That is a pretty blanket, across-the-board
statement. That's a pretty across-the-board, blanket statement.
Mr. Sullivan. But I was trying to differentiate there, to
the very best of my knowledge, the difference between the
realized loss situation or the potential realized loss
situation against the amount of unrealized loss----
Ms. Norton. It didn't occur to you, Mr. Sullivan, that in
parsing your words this way that you might be misleading your
shareholders?
Mr. Sullivan. Absolutely not.
Ms. Norton. Do you think any of them were misled?
Mr. Sullivan. No. I would refer you--and I'm sure you've
been supplied with this information--very, very fulsome
disclosures of our exposures not only in the CDS portfolio but
in our mortgage insurance company which was clearly causing me
some concerns in the early part of this situation when the
issue was----
Ms. Norton. Well, you had departed very substantially from
your core business. Are you saying to me that you believe your
shareholders expected to be bailed out by the Federal
Government at some point?
Mr. Sullivan. Certainly not. As I testified earlier, when I
left the company I believed the company was in a position where
it would certainly not need intervention from the government.
But when--if I may go back to the disclosures that we made, one
of the things that I set out to do in March 2005, given the
challenges that we had with all of our regulators, we had----
Ms. Norton. You mean disclosures of the losses?
Mr. Sullivan. No, no. When I took office, AIG was facing,
as I mentioned, a crisis very different from the financial
crisis. But I made it clear at day one that we were going to
have an open and transparent relationship not only with our
regulators but with our investors as well. We put very
fulsome--I would encourage you to look at that information--we
have put very fulsome disclosure on our Web site.
Ms. Norton. So you believed these were fair and honest
characterizations and that your shareholders were not misled by
any of the three statements even after they saw the losses
posted?
Mr. Sullivan. Absolutely. I believe what I said at the time
to be truthful, very truthful based on all the information I
was receiving and clarifying, you know, the difference between
realized and unrealized losses.
Ms. Norton. Mr. Chairman, I'm going to yield back the
balance of my time.
But my question went to misleading; and I must say, in
concluding, that it's difficult for me to believe that
shareholders were not misled at least by the way in which you
parsed your words and framed the condition--phrased the
condition of the company.
Thank you, Mr. Chairman.
Chairman Waxman. The gentlelady yields back the balance of
her time, and I now recognize Mr. Van Hollen.
Mr. Van Hollen. Thank you, Mr. Chairman.
Gentlemen, I want to followup on some of the questions
regarding executive compensation, including the bonus
structure. And, Mr. Sullivan, let me start with you and ask
about your actions at the meeting of the AIG compensation
committee that took place on March 11, 2008.
According to the documents that this committee has
received, AIG has two bonus programs to reward executive
performance. The first is called the Partners Plan. It covers
the top approximately 700 AIG executives. And the second is
called the Senior Partners Plan, which applies to roughly the
top 70 executives. Now, as CEO, you're paid under both those
executive compensation plans, is that right?
Mr. Sullivan. That is part of my compensation.
Mr. Van Hollen. Now as I understood it and looked at the
rules that AIG had set, they tried to align pay with good
performance. Rewards were supposed to be based on the company's
performance. If performance went down and the company lost
money, bonuses would be reduced or cut entirely. That was what
was supposed to happen in 2007. And as a result of the
disastrous fourth quarter results in 2007, bonuses under both
those plans would have been cut under the normal rules.
But according to the minutes of the meeting that took place
on March 11th, the meeting of the compensation committee, you
personally urged the board to rewrite the rules. And according
to the minutes--and I don't know if we're going to post them on
the board. We had them earlier. But let me just read from the
minutes of that meeting.
It said, Mr. Sullivan next presented management's
recommendation with respect to the earnout for the senior
partners for the 2005-2007 performance period, suggesting that
the AIGFP unrealized market valuation losses should be excluded
from the calculation.
I think it's important to point out that just weeks
earlier, on February 28th, AIG just posted a record fourth
quarter loss, as we've heard about, of $5.3 billion as a result
of the AIGFP division. My question is very simple. You have
referred to the unintended consequences. The question is, why
did you change the rules, the compensation rules that were
supposed to pay for good performance? Why did you change them
to give yourself and other executives a bigger bonus?
Mr. Sullivan. If I may, just for clarity, this was not the
bonus structure for AIG. These were long-term compensation
programs for AIG executives. So just to clarify that for you,
sir.
And, second, I was not asking the compensation committee to
rewrite the rules. I was asking them to use their discretion,
which I believe existed under both programs.
Coming back to--I testified earlier or responded earlier
that my concern was that these 700 people that participated in
the Partners Plan and the 70 in the senior Partners Plan, none
of them were in AIGFP. They had their--as others have
mentioned--their own compensation plan. And my concern was
that, you know, other parts of the business that were not being
impacted by the events in the credit markets, you know we would
lose key individuals if we didn't at least acknowledge in their
remuneration, which was a long-term remuneration. They didn't
get their money until some time later----
Mr. Van Hollen. If I could ask, you, I understand, despite
the fact that you left approximately June of this year, you
received the $5.4 million bonus, isn't that right? Is that not
correct?
Mr. Sullivan. The reference to a bonus--if that was a
number under the Senior Partner Plan, I don't have the numbers
in front of me. That may be the number, but it's not referred
to as a bonus.
Mr. Van Hollen. But you received this payment under the
Senior Partners Plan, did you not?
Mr. Sullivan. It's paid out over a number of years.
Mr. Van Hollen. The question's pretty clear. Your company
had just taken a record loss. Pay for performance is supposed
to be based on how the company performed. And yet you went
before the board of directors and specifically asked them to
ignore those losses for the purpose of a compensation plan
which had the direct result of giving you about $5.3, $5.4
million extra compensation.
If I could just ask you, Mr. Willumstad, because the
minutes say you were present----
Mr. Willumstad. That's correct.
Mr. Van Hollen [continuing]. At this particular
compensation meeting. I have to ask you, in your role as a
fiduciary to the stockholders, how does that payment, including
the payments to Mr. Sullivan and the other executives, ignoring
the losses that had just taken place, how does that conform to
the rules for pay for good performance? And how does that
benefit any stockholder?
Mr. Willumstad. If I could clarify some of the things you
said. There are actually three components to the incentive
compensation plan for Mr. Sullivan. It was the Partners Plan,
it was the Senior Partners Plan and there was a discretionary
bonus. Mr. Sullivan received a $9 million discretionary bonus
in 2006 when the company had an exceptional year. Mr.
Sullivan's bonus was reduced to in 2007 from $9 million to $2.5
million. So to put----
Mr. Van Hollen. I understand that, Mr. Willumstad. I'm
referring to a particular request that was made at the board
meeting with respect to the senior partners program. And the
request was made and complied with by the board, accepted by
the board at a time of record loss. And my question is very
simple. How did that decision help the shareholders at this
particular point in time, which is the responsibility of the
board, is it not?
Mr. Willumstad. The Senior Partners Plan was a plan that
recognized the performance over a 3-year time period. 2007 was
one of those 3 years. Mr. Sullivan's recommendation was to
postpone the recognition of those losses because they were
deemed to be unrealized losses. The understanding that the
committee had and the board had is that, as Mr. Sullivan
mentioned, there were 70 employees who were part of the Senior
Partners Plan, none of which had anything to do with the FP
operations. It was only Mr. Sullivan who had any direct
responsibility for that. So his intention and I think the
board's response was not to penalize the other 68 or 69
employees for the result of one business unit.
Mr. Van Hollen. Well, Mr. Chairman, just to conclude, I
mean, it seems that pay for performance means you get paid
whether it's bad performance or good performance and you change
the rules when it doesn't work out the way you intended. If
that's what part of the unintended consequences of this have
been, I've got to say a lot of people are scratching their
heads when they look at how in good times you stick with the
general scheme for pay for performance but in bad times it gets
reinterpreted in a way that benefits executives. Anyway----
Chairman Waxman. Would the gentleman yield to me?
Mr. Van Hollen. I would be happy to yield.
Chairman Waxman. Just so we can get this straight, Mr.
Sullivan, you were the CEO of the whole company, which included
the FP in London, right?
Mr. Sullivan. That is correct.
Chairman Waxman. OK. And when it came to the question of
the bonuses for the 70 employees, which included you, you asked
the board, upon which Mr. Willumstad sat as the Chair, to
disregard the losses so that 3-year bonus wouldn't be reduced.
Is that right?
Mr. Sullivan. What I recommended to the compensation
committee was that for the purposes of the Senior Partners Plan
and the Partners Plan that they use their discretion in the
calculation of the 2007 year, particularly----
Chairman Waxman. Not to count the losses. Just to count the
earnings but not the losses.
Mr. Sullivan. The unrealized losses.
Chairman Waxman. The unrealized losses. Now isn't it also
the case that AIGFP changed the rules as well so that the
bonuses there did not calculate the losses, unrealized as they
might have been?
Mr. Sullivan. Um----
Mr. Willumstad. I don't think that's correct.
Chairman Waxman. Well, I have a document that says so. This
is the minutes of the meeting of the Compensation Management
and Resources Committee of the board of directors. And it
says--explained that AIG's Mr. Dooley presented management's
recommendation and explained that AIG management believes it is
critical to provide a special incentive to assure retention of
the AIGFP team, while recognizing the serious effects of the
valuation losses and described the proposed terms of the
alternative arrangements.
Then it goes on to say, no individual received compensation
exceeding $1.25 million and employees affected by the reduced
compensation would be eligible for the deferred compensation.
It just--that's the way we read this document. I'll put it
into the record, and we'll be able to look at it.
But you've got this FP--you've got the bonus. You've got
the 3-year partners compensation. Did you get an ordinary
salary as well?
Mr. Sullivan. Yes, sir.
Chairman Waxman. And how much was that?
Mr. Sullivan. $1 million a year.
Chairman Waxman. So you got $1 million a year. Then you got
a bonus that was reduced from $9 million to $2.5 million, is
that right?
Mr. Sullivan. That's correct, sir.
Chairman Waxman. Then what else did you get?
Mr. Sullivan. My participation in the Senior Partners and
the Partners Plan.
Chairman Waxman. And how much money was that for that
period of time?
Mr. Sullivan. I can't recall.
Chairman Waxman. Take a guess. More than $1 million? More
than $2 million?
Mr. Sullivan. I think my colleague here mentioned $5
million. Yeah. I don't have the schedule in front of me.
Chairman Waxman. We'd like to get it for the record.
Let me tell you one person that didn't get a bonus while
everybody else was getting bonuses. That was St. Dennis--Mr.
St. Dennis, who tried to alert the two of you to the fact that
you were running into big problems. He was blocked by the
people in London from even understanding what was going on so
he could report to you. He quit in frustration, and he didn't
get a bonus.
So the one guy that was really trying to do his job--and
there may have been others as well--lost out on his bonus
completely and was frustrated and felt he couldn't do his job,
so he left.
I thank the gentleman for yielding.
Mr. Sullivan. May I suggest, Chairman, with respect that
the company clarify the content of the compensation committee's
reports so that you have an understanding? My view, obviously,
and I think Mr. Willumstad may concur, was that was actually
penalizing the FP folks at the time and trying to put a
compensation structure in place that they would get rewarded as
and when the marks came back.
Chairman Waxman. That's not our understanding from the
document.
Mr. Sullivan. That's why I suggest, sir, for the subject of
clarity it may help if the company explained it.
Chairman Waxman. Whatever penalties you imposed upon them,
it's hard to see how difficult it is when you have Mr. Casanno
not doing any work but getting $1 million a month in case you
need him in addition to whatever else he got by way of bonuses
and salaries and other money sharing agreements. This is really
quite a good deal.
Mr. Van Hollen. Mr. Chairman, I would just say--I mean,
obviously, as CEO, you oversaw the whole FP division as well;
and yet you received a bonus despite the fact that they had
these huge losses. And so, again, it's just people have to
scratch their heads and wonder what pay for performance means
when you have that kind of compensation structure and going
before the board.
Anyway, my time is up. Thank you, Mr. Chairman.
Chairman Waxman. Thank you.
Mr. Sarbanes.
Mr. Sarbanes. Thank you, Mr. Chairman.
I'm just fascinated by this guy Joseph Casanno, because it
appears to me that he single-handedly brought AIG to its knees
and was the reason that taxpayers have had to step in with an
$85 billion loan. So----
Mr. Shays. Mr. Sarbanes, could you speak a little louder?
Mr. Sarbanes. Yeah. I was just talking about Joseph
Casanno. Is your office in New York?
Mr. Sullivan. When I was with AIG, yes, sir.
Mr. Sarbanes. Was in New York?
And your office was in New York?
Mr. Willumstad. Yes.
Mr. Sarbanes. And Casanno's office was in London?
Mr. Sullivan. He spent his time between London and the
Wilton offices, Wilton, Connecticut.
Mr. Sarbanes. So how often would you see him?
Mr. Sullivan. Certainly at the FP board meetings and,
obviously, occasionally when he was in town. He was not a
direct report to me. He reported to Mr. Dooley, who was
referenced earlier.
Mr. Sarbanes. And how did--I mean, you weren't there, I
guess, when the FP thing got started, right?
Mr. Sullivan. Well, I was certainly with AIG but in a
completely different division, sir.
Mr. Sarbanes. OK. You weren't heading the company up.
Mr. Sullivan. No. This is 20-odd years ago.
Mr. Sarbanes. What's the company lore on how that happened?
Did Mr. Casanno come to the powers that be and say, I have this
really neat idea of what we can do over in London. We can get
into this new product line. And off he went? What's the story
there?
Mr. Sullivan. Oh, no, no. I think from what I know--you say
folklore, but from what I know is that a number of executives
came out of Drexel and were recruited by AIG at that time to
form the capital markets division that became known as AIGFP. I
don't believe Mr. Casanno was leading that at the time. He was
one of the team that came in, and there were some management
changes thereafter where ultimately Mr. Casanno became the head
of capital markets. But I think there were two other executives
prior to Mr. Casanno who ran that division.
Mr. Sarbanes. Well, you've probably heard me refer to that
office in this hearing before as the London casino, because I
think that terminology captures as well as anything what was
happening over there.
What I can't understand is why you were allowing these huge
losses to buildup with apparently no consequence for Mr.
Casanno. So I'm just curious, in December 2007, Mr. Casanno is
telling the investors, with the data that you have in front of
you, you can play this power game. And then, within weeks, AIG
posts a loss of $5.3 billion. I assume most of that related to
the activities of FP, right?
Mr. Sullivan. The unrealized loss, yes.
Mr. Sarbanes. So when that happened--and this term
``unrealized losses'' which you are very careful to keep
restating----
Mr. Sullivan. It's a loss.
Mr. Sarbanes. Yeah. They turned out to be realized in a big
way, it seems. Certainly the taxpayers are realizing these----
Mr. Sullivan. Just to clarify, at the time I left, as I
said earlier, none of it realized. What has happened since, I
don't know. But just for clarity.
Mr. Sarbanes. I understand. So $5.3 billion. So then,
obviously, you immediately get on the phone to Mr. Casanno and
you say, what's going on over there at FP? Right?
Mr. Sullivan. Well, in the December----
Mr. Sarbanes. I'm just assuming somebody calls him up or
catches him the next time he's in town for a meeting and says,
$5.3 billion of unrealized losses for the last quarter. What's
happening over there, Mr. Casanno?
And what does he say that gives you comfort? Does he tell
you the same thing he was telling the investors? Well, we've
got all this data, and we can play this power game. So then you
say, OK, fine, we'll keep you in there.
And then the next quarter he posts losses at $7.8 billion.
And apparently that's still not enough for him to be put on the
hot seat. So off he goes to the quarter after that and posts
$5.5 billion of losses.
I just don't understand, in terms of the company and your
stewardship of the company, how you can let this guy run up
these huge losses, apparently with no consequence to himself in
terms of the compensation. So just internally what was going on
during that period? What was the discussion with Mr. Casanno?
Mr. Sullivan. Well, clearly, at the time of December 2007,
there was a lot of discussion taking place within the
organization on the whole issue of the CDS super senior
portfolio. There's no question about that.
Don't forget--and I just want to point out that this
business, that's been stopped writing in 2005. So effectively
this portfolio was in run-off. These contracts were mature over
a period of time. And as I said earlier, as they mature, if
there's no loss, you know, on those contracts, that unrealized
loss will then come back into the income statement of AIG. So I
mean that's the point I wanted to make here. This business was
stopped in 2005. I think that's an important thing.
And, clearly, in December 2007 a lot of dialog is taking
place between FP. There's additional resources going in there
to make sure that we're--you know, we obviously have the
compensating controls in there that I referenced to one of your
colleagues earlier. So in December 2005, there's a lot of
interaction taking place between FP and the corporation.
Mr. Sarbanes. So what you're saying is by that time--by
December 2007, when the losses first started appearing, it was
too late. You were already on a downward slide. And yet Mr.
Casanno, having set off that situation, is still getting paid
$1 million a month?
Mr. Sullivan. What I'm saying is the portfolio stopped
writing in 2005. And, obviously, as the credit market is
starting to freeze and the subprime issues are coming through,
then the losses started to emerge.
Chairman Waxman. The gentleman's time has expired.
Ms. Speier.
Ms. Speier. Thank you, Mr. Chairman.
To both of you gentlemen, I want to applaud you for the
stiff upper lip that you have shown today under intense
questioning. But I've got to tell you that you make a shameful
profile of corporate America. To you, Mr. Willumstad, I will
say thank you for foregoing your golden parachute. And to you,
Mr. Sullivan, shame on you. The shareholders of that company
have nothing, and you walked away with $50 million.
Now I'd like to ask a question of you, Mr. Willumstad. In
the final days, evidently Goldman Sachs' CEO was in on
meetings. Is that correct?
Mr. Willumstad. That's my understanding.
Ms. Speier. You were not in those meetings?
Mr. Willumstad. I was only at one meeting when the CEO of
Goldman Sachs was there.
Ms. Speier. And he was there. And what was he saying?
Mr. Willumstad. This was a meeting that took place on
September 15th at the Federal Reserve. The Federal Reserve had
gotten Goldman Sachs and JPMorgan together to try and find a
private solution to AIG's liquidity issues. That meeting was to
discuss how much capital the company might need. That meeting
lasted for about an hour and a half and then the meeting was
adjourned.
Ms. Speier. So they weren't interested in a private
solution?
Mr. Willumstad. I'm sorry?
Ms. Speier. The CEO of Goldman Sachs was not interested in
purchasing AIG----
Mr. Willumstad. No. He was there to participate in looking
for a private solution.
Ms. Speier. Now you said that Goldman Sachs was one of the
counterparties----
Mr. Willumstad. Yes.
Ms. Speier [continuing]. Of AIG and that they are owed
about $20 billion, is that----
Mr. Willumstad. No. No. As a counterparty, if the
securities defaulted, AIG would have to pay that counterparty,
Goldman Sachs, the amount of the insurance premium or the
credit default swap.
Ms. Speier. So they would receive about $20 billion,
though. I used that term earlier. You actually referenced that
amount of money.
Mr. Willumstad. I did. That's the correct number.
Ms. Speier. Now AIG has since taken up the taxpayers on $61
billion. Has $20 billion of that $61 billion gone back to
Goldman Sachs?
Mr. Willumstad. I don't know.
Ms. Speier. Mr. Chairman, I think that's a question we may
want to ask subsequently.
Mr. Willumstad, do you believe that naked short selling was
part of the problem?
Mr. Willumstad. Well, AIG stock was down to about $26 in
June. Up until September 12th, AIG stock was at $23. So during
the course of--from late June to early September, there was not
much movement on AIG stock. In the last week from September 8th
to September 15th, AIG stock went from $23 to $4. I actually
don't know that it was necessarily driven by short sellers,
although I would assume there's been some short selling in
there.
Ms. Speier. The rating was AA on Friday, and 2 days later
you needed a total bailout. How did you go from being AA on
Friday to needing a total bailout 2 days later?
Mr. Willumstad. Well, the AA minus rating that was provided
by S&P and Moody's was the ratings. I had met with the rating
agencies actually the prior week and reviewed what our plan
was. They were considering a downgrade at that time. And on
Friday after 4 S&P put out a negative watch that indicated they
might reduce their ratings anywhere from one to three notches.
And then I believe it was the following Monday or Tuesday--I'm
not sure exactly which--both rating agencies downgraded the
company.
I'm not sure I've answered your question. But I'm not sure
what your question is.
Ms. Speier. I was trying to understand how you can be rated
as AA on Friday and the following week you need a $85 billion
bailout. I don't know how you go from being--that kind of
rating doesn't make sense to me.
Mr. Willumstad. You'd have to talk to the rating agencies
about that.
Ms. Speier. All right. One last question, Mr. Chairman; and
this gets back to Joseph Casanno. In August 2007, he says, it's
hard for us with--and without being flippant to even see a
scenario within any kind of realm of reason that would see us
losing $1 in any of these transactions. It's a lot of bravado.
In December 2007, he said, we have from time to time gotten
collateral calls from people, and then we say to them, well, we
don't agree with your numbers. And they go, oh, and they go
away; and you say, well, what was that? It's like a drive-by in
a way.
Also in December--and this is a real difficult one to
believe--he says, there are some morbid questions we get about
what happens if the world rolls off its axis and the world goes
to hell in a hand basket? But with the data that you now have
in front of you, you can play this power game.
Mr. Sullivan, you were on that same call. You knew that the
company was in trouble. You allowed Mr. Casanno to make these
statements, and you didn't stop him. You didn't suggest that he
was overstating the case.
Mr. Sullivan. Well----
Ms. Speier. Is that transparent? Is that what you should be
doing on behalf of the shareholders of the company?
Mr. Sullivan. The December 5th meeting which you refer to
there I think laterally we made a very fulsome presentation to
the investor community on AIG's full exposure to the U.S.
residential housing market and made reference to not only to
AIGFP but our mortgage insurance company, our consumer finance
company and our investments.
And I don't want to take any of Joe's comments out of
context, but we've put a lot of information into--you know,
made available a lot of information to the investor community
at that time. And I don't want to take the comments he's making
out of context without seeing the slides that he was referring
to at that moment in time.
You know, obviously, what we told the market--what I truly
believed was accurate at the time, based on all the information
I had available.
Ms. Speier. I yield back.
Chairman Waxman. Thank you, Ms. Speier.
Mr. Shays, I want to recognize you to close out the
questioning. But before I do, I ask unanimous consent that we
can put in the record a letter that was sent today to Secretary
Paulson.
This is a letter telling Mr. Paulson that we're concerned
about the profligate spending at AIG, including the $1 million
a month that's being paid to Mr. Casanno. Mr. Casanno received
up to $34 million, and even today he's getting paid as a
consultant for $1 million a month, and we think this is unfair
to the taxpayers of this country. AIG received $85 billion of
taxpayers' money, and it's lavishing these kinds of perks on
Mr. Casanno and the event that was taking place shortly after
the government took over.
Without objection, the letter will be entered into the
record.
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Mr. Kucinich. Mr. Chairman, could I ask who signed the
letter?
Chairman Waxman. The letter has been signed by Mr. Braley,
Mr. Cummings, Ms. Speier and myself.
Mr. Kucinich. I would like to be associated with that
letter.
Chairman Waxman. OK.
Mr. Kucinich. Thank you.
Chairman Waxman. Mr. Shays, you are now recognized.
Mr. Shays. Could we make it bipartisan and add my name to
it?
Chairman Waxman. We certainly will.
Mr. Bilbray, do you want to join us?
Mr. Bilbray. Yes, Mr. Chairman.
Mr. Shays. Mr. Willumstad and Mr. Sullivan, thank you for
being here.
There's one thing I think there is unanimity on on the part
of Members from both sides of the aisle, that we're deeply
troubled by the compensation that has been paid to executives
who, frankly, were not experiencing success and we don't think
it was truly the executives' money to take.
Ripples from defaults on subprime loans underwritten by the
toxic twins, Fannie and Freddie, grew to a tsunami that helped
swamp Lehman Brothers and others, including AIG; and Fannie and
Freddie were able to launch more than $1 trillion of bad paper
into the private market because regulators and Congress let
them do it. Now what I want to do is ask you----
And Mr. Chairman, I have a question for you as it relates
to the testimony of Mr. Greenberg. Mr. Greenberg--my reading of
his comments and testimony--Mr. Chairman, my reading of the
testimony from Mr. Greenberg that was submitted to the
committee is basically accusing the two individuals who are in
front of us for all the problems of AIG. And I'm thinking how
convenient we don't get to question him. And my question is, do
we swear in the individual to make sure that their statement is
under oath and that they are held accountable for what they
say?
Chairman Waxman. Well, if the gentleman would yield, we
invited to Mr. Greenberg to testify. He responded that he was
not well enough to come. He did submit information, testimony
to us, which will be part of the record.
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Chairman Waxman. While he wasn't here to take the oath and
no oath was administered to him, there are laws that say if a
congressional committee is doing an investigation and someone
knowingly misleads or gives misinformation, that would be
tantamount to a crime in and of itself.
Mr. Shays. Thank you, Mr. Chairman.
Let me ask you to respond to his comments. He said,
moreover--and this is his testimony to the committee. Have you
read his testimony?
Mr. Willumstad. No, sir.
Mr. Sullivan. No, sir.
Mr. Shays. Moreover, unlike what had been true during my
tenure, the majority of the credit default swaps that AIG wrote
in the 9 months after I retired were reportedly exposed to
subprime mortgages. By contrast, only a handful of the credit
default swaps written over the entire prior 7 years had any
subprime exposure.
So later on he says, how did this happen? I was not there,
so I cannot answer the question with precision. But reports
indicate that the risk controls my team and I put in place were
weakened or eliminated after my retirement.
I would like to ask each of you, is this true? Were they
weakened?
Mr. Sullivan. Well, I think there's two parts there. I
don't know what constituted the subprime exposure on the
contracts written when Mr. Greenberg was CEO and thereafter. So
I can't comment on that. All I can tell from you a risk control
standpoint----
Mr. Shays. I don't understand that statement. I mean, you
run the company. You are not aware of the exposures you had
earlier on?
Mr. Sullivan. What I said is, I haven't got an analysis at
hand as to what the percentages were in response to Mr.
Greenberg's statements. Sorry, sir. What I can tell you from a
risk control standpoint, it was exactly the same risk control
procedures that were in place when Mr. Greenberg was in office
that continued thereafter, both at the subsidiary level and at
the parent company that ultimately resulted, obviously, in the
decision taken to stop writing that portfolio.
As I said, at that time I was focused on other issues
that----
Mr. Shays. So he preceded you, correct?
Mr. Sullivan. Preceded me, yes, sir.
Mr. Shays. But he is basically blaming you primarily and
he's blaming Mr. Willumstad as well for the short time that you
were on the board and so on and so on. So he's blaming both of
you. Your testimony is that you did not change any of the
controls that existed before him.
Mr. Sullivan. In fact, what I would say from when I took
office, as I mentioned earlier in response to one other
question, I set out with the support of AIG's board to actually
put in additional resource and enhance systems not only in our
risk area but in our legal, compliance, finance and accounting
areas.
Mr. Shays. So the point is, you take issue with the
statement?
Mr. Sullivan. Yes, sir.
Mr. Shays. Mr. Dinallo who testified--and I thought it was
very interesting there, about four paragraphs, but he says,
that brings us to the issue of what happened at AIG. The
history has been well reported in the press. Using its
noninsurance operations, AIG, just like many financial service
institutions, invested heavily in subprime mortgages; AIG's
financial products unit and noninsurance companies sold
hundreds of billions of dollars of credit default swaps and
other financial products. As with other financial service
companies, AIG was forced to mark to market and so on.
But your credit default swaps were basically--how did they
relate to the subprime mortgage? Weren't you--you didn't buy
subprime mortgages but you basically--my understanding is you
insured them in a sense, correct?
Mr. Sullivan. Correct. What I tried to explain to the
previous question that I had is that what we were underwriting
was the super senior portion of the CDS.
Mr. Shays. I know you're trying to tell me you were trying
to secure the best ones.
Mr. Sullivan. We actually wrote the super senior----
Mr. Shays. I understand. But you know what? They all were
terrible.
Mr. Sullivan. The bonds--the way the structures flow--and
it's not easy to explain in a few minutes--is that you're
writing a swap on lots of bonds that sit below you. And they
can be--it can be an equity tranche. It can be a triple B
tranche. And the way these were structured was that AIG swaps
sat over and above the triple A and a little bit more
additional protection. That is why, with respect, I've been
trying to differentiate between the unintended consequences and
the realized losses when you've had to mark to market in a
liquid market.
Mr. Shays. Let me just--we're going to deal with this in
the Financial Services Committee, and it's probably going to
scare the hell out of you. Because this committee, I'm sure, is
going to look at how we dice and slice all these mortgages so
it's very hard for people to have any sense of what their
values truly are. And I don't know what that will do to the
marketplace. But, clearly, we are going to be looking at that.
And what I want to establish on the record, though, is that
you were involved in the subprime market and you did have
credit swaps relating to the subprime market. And you can give
me the refinement of that. And I don't want to listen to a long
dialog. But isn't that true?
Mr. Sullivan. To the best of my ability----
Mr. Shays. You can say no or yes, if you want.
Mr. Sullivan. Some of the bonds below the tranche that we
were writing could have been in the subprime area.
Mr. Shays. Thank you.
Let me just ask you, as it relates to the compensation
committee, I am absolutely convinced that it's one person
scratching someone else's back. You're on the board of one
company. You serve as a CEO of another. Do either of you serve
on the boards of any other companies?
Mr. Sullivan. Public companies, no, sir. No public
companies.
Mr. Shays. You are the exception, not the rule. But the
question I want to ask you is, describe to me the compensation
committee.
Mr. Sullivan. The compensation committee, the structure of
it, sir?
Mr. Shays. Yes.
Mr. Sullivan. As I mentioned earlier, there was a base
salary.
Mr. Shays. I want to know who appoints the compensation
committee. Are they employees of the committee?
Mr. Sullivan. No, sir. The compensation committee consists
of independent directors of the board.
Mr. Shays. They are members on the board, correct?
Mr. Sullivan. Independent members, yes.
Mr. Shays. Not employees of the company.
Mr. Sullivan. That's correct.
Mr. Shays. How are they appointed?
Mr. Sullivan. From what I can recall--and you can defer to
my chairman at the time--the recommendation of the committee
membership is made by the nominating governance committee to
the board at large, I believe is the process.
Mr. Willumstad. That's correct.
Mr. Shays. My sense is is that it's a club, and the club
basically rewards their friends.
Chairman Waxman. Would the gentleman yield to me?
Mr. Shays. Yes.
Chairman Waxman. We've held a couple hearings in this
committee about these compensation committees that are
appointed or consultants that are selected by the boards, and
oftentimes the people that are selected are doing other
consulting work for the corporation that's much more profitable
for them. And, of course, they receive that from the management
of the corporation. So they're then deciding what the
compensation will be for the management of the corporation with
clear understanding that they may well have a conflict of
interest.
I think it's an issue that we need to continue to explore
on this committee, and I thank you for raising it.
Mr. Shays. Thank you. Would you allow me one more minute to
close?
Chairman Waxman. Yes, sir.
Mr. Shays. We all have our constituents. I have a friend
who just wrote me, sent me an e-mail, and he said, my wife and
I are among those investors who got badly burned with Lehman
bonds. I am sure many in your district have a similar
experience. We are prudent investors who must rely on the store
of capital we have accumulated over the years to live decently.
We always save more than we earn. Unlike the country and most
citizens, we are completely debt free. We invested very
significant amounts in what the so-called rating agencies
called triple A, double A Lehman Brothers bonds. It now turns
out that our trust in the rating agency was sadly misplaced.
Either through incompetence or criminal fraud they led honest
investors astray. Bonds that we bought are at par and now worth
10 or 12 cents on the dollar.
This is why we're having these hearings. Because you may
see your shareholders hurt, but there were far more than your
shareholders that are hurt. And I won't read the rest of it,
but you should see what it says about what it means to him to
see CEOs of companies getting huge sums when they are working
on 10 cents on a dollar on money they saved for most of their
life.
Chairman Waxman. Thank you, Mr. Shays.
I want to thank the two of you for being here. You came
here voluntarily. You've been here for many, many hours. You
have been very generous. I know it hasn't been easy for you.
But we very much appreciate it.
That concludes our business, and we stand adjourned.
[Whereupon, at 3:05 p.m., the committee was adjourned.]
[Additional information submitted for the hearing record
follows:]
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