Where AIG Went Wrong

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Greenbert turned AIG into a giant, in part by insuring risk that few would touch Daniel Acker/Bloomberg News

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AIG, which had already paid record fines to regulators following its accounting woes, restated earnings, and ousted its chief to assuage regulators, was again under the microscope.

Over the spring, the stock fell. In June, former AIG director Eli Broad and two prominent investors—Shelby Davis of Davis Selected Advisers and Bill Miller of Legg Mason—sent a letter asking the board to name an interim CEO to replace Martin Sullivan. Among other things, the mounting subprime losses had caused AIG to report a record $13 billion in losses over the previous two quarters. Greenberg sent a similar missive and criticized his onetime protégé. Management had completely lost credibility, Greenberg argued, and the business was "in crisis." Coming from Greenberg, it was a damning assessment. (Phone calls to Sullivan's home in Chappaqua, N.Y., were redirected to AIG's public affairs office.) AIG Chairman Willumstad, a former Citigroup executive, was named CEO.

AIG's credit rating remained critical to its survival over the summer. Even as earnings declined, the company's ratings remained strong. For all its problems, few doubted AIG's ability to repay its obligations. It was still one of the world's most recognized corporate brands, with operations in 130 countries. Its enviable credit rating allowed subsidiaries such as International Lease Finance Corp., its aircraft leasing arm, to borrow on preferable terms. Without that advantage, the logic of staying within AIG would diminish. When AIG reported a $5.36 billion loss in August, talk of a spinoff grew louder.

CANDIDATE FOR EXTINCTION

Then the bodies began to pile up on Wall Street, with Lehman going into bankruptcy and Merrill selling itself to Bank of America. If AIG needed yet more cash, where was it going to find it? Washington said financial players were now on their own.

Ratings agencies began to downgrade AIG on Sept. 15, triggering terms in their derivatives contracts that required them to come up with an additional $14.5 billion in capital. Having already raised $20 billion in capital through stock and debt offers in May, and $4 billion in a private investment just weeks ago, options were limited. With its stock trading below the cost of Manhattan subway fare, AIG looked like the next candidate for extinction.

On Sept. 16, the Fed begrudgingly admitted it couldn't let that happen. AIG, with a swap portfolio valued at $441 billion, involving most of the world's major financial players, was too big to fail. But Washington, which issued a 2-year adjustable-rate loan starting out at roughly 11%, doesn't want long-term ties to AIG. Without knowing all the deal's terms, stockholders, fearing a dilution of their stakes, lopped $4.6 billion more from its market cap on Sept. 17.

The primary job of an underwriter is to spread risk around. In making bold bets on home prices, AIG left its business exposed to one terrible turn of events and is paying a steep price. For taxpayers, the question is how deep the mess can get—and how long it will take AIG to get out of it. Then there's the issue of whether $85 billion is enough to do the trick. The government has taken a bigger stake than is typical in bridge loans, experts say, exposing it to the risks of a company whose capital needs have been escalating. "I don't think anyone really knows the risks" says Vickrey. "If they say they do, they're fibbing."

Byrnes is a senior writer for BusinessWeek in New York.