How the great AIG heist was pulled off

March 27, 2009

Alan Maass traces the rise and fall of insurance giant AIG--from the part it played in the mid-decade Wall Street financial boom, to its new incarnation as a government-backed conduit for transferring bailout money to the big banks.

IMAGINE YOURSELF at a casino where you start gambling on games of chance you don't understand, where the rules are being made up on the spot. You bet hundreds of times more money than you have, and you lose. You're not only broke yourself, but you're taking down other players who let you play with their money--and the casino itself, which didn't ask to see your chips when you made bets.

You'd consider yourself lucky to stay out of jail, right?

Ah, but you aren't a Wall Street executive!

In the world of high finance, the rules are a little different. When you lose, the federal government steps in to cover your losses. You get to keep paying yourself a nice bonus, more in a year than most people will see in a lifetime of work. And you--along with colleagues who've changed job descriptions and now work for the government--get to plan the "rescue" to your collective advantage.

Welcome to the world of AIGreed.

All of the corruption and arrogance of America's robber barons has been on display in the unfolding scandal of AIG--the world's largest insurance company, bailed out by the Bush administration last September as it plunged toward bankruptcy, now revealed to be paying bonuses to the executives who caused its collapse, and squandering far larger sums on payouts to other titans of the world financial system.

Former AIG CEO Martin J. Sullivan (left) hobnobs with the financial elite at an international banking seminar
Former AIG CEO Martin J. Sullivan (left) hobnobs with the financial elite at an international banking seminar

Meanwhile, the government "watchdogs" who are supposed to be reining in and punishing companies like AIG are being exposed as part of the problem. On Barack Obama's "economics team" are people, like Treasury Secretary Tim Geithner, who have spent their professional lives surrounded by Wall Street's casino culture, if not sitting at the tables themselves, and can't conceive of any action to do with the financial crisis that isn't on Wall Street's terms.

While Bush was still in the White House, Geithner, along with a handful of other big players on Wall Street and in Washington, set up the AIG bailout. He's displaying the same priorities--Wall Street's wealth comes first--in dealing with the company today.

Whatever the rhetoric from President Barack Obama or Geithner or other members of the administration, their actions--in transferring yet more riches to the same gambling junkies and bankers who caused the financial crisis--speak louder than words.

THE EPICENTER of popular anger is the bonuses at AIG--checks totaling $165 million that were distributed in March to the very same executives who presided over the company's disastrous collapse, prompting the government bailout last year.

AIG lost $61.7 billion in the last three months of 2008, the largest quarterly loss of any company in history. Nevertheless, the company this month paid out--and publicly defended--huge bonuses to its managers, including 73 checks in the $1 million-plus range, 11 of which went to people who don't even work for AIG anymore.

And that's just for the employees of the previously obscure financial products division that brought the company down with catastrophic losses. Company-wide, AIG--which so far has received $173 billion in federal bailout money--plans to spend more than $1.2 billion on rewarding its top employees in 2009 and 2010.

Even more incredible than these sums was the Obama administration's claim to be powerless to intervene. "We are a country of law," insisted Larry Summers, director of Obama's National Economic Council. "The government cannot just abrogate contracts."

But the government didn't care about "abrogating" contracts when the Big Three auto companies asked for federal loans to stay in business. Both Republicans and Democrats demanded huge mid-contract concessions from the United Auto Workers as an explicit condition for giving the automakers access to further loans.

"Apparently, the supreme sanctity of employment contracts applies only to some types of employees, but not others," wrote Glenn Greenwald at

But the bonus scandal is only the tip of the iceberg at AIG. "Seen by themselves, the payments are huge," the New York Times wrote in an editorial, "but they are less than one-tenth of 1 percent of the money already committed to the AIG bailout. And now we're starting to see who was pocketing the bulk of that money."

On the same weekend that news of the bonuses hit, AIG released a list of banks and other investors that it has paid off with the federal government's money.

The list shows that AIG--make that U.S. taxpayers--is absorbing losses generated by the collapse in housing prices and financial markets. But AIG's "counterparties"--the banks and other companies it did business with--haven't just recovered their original investments, thanks to the federal bailout. They're making huge profits.

SO HOW all did this come about? The roots of the AIG disaster lie in the Wall Street boom in investments based on debt, especially mortgage debt, over the past decade.

People's loans on their homes were packaged together by the thousands into huge "mortgage-backed securities," and sold to big investors. Mortgage-backed securities became an attractive profit opportunity for big Wall Street players--as people paid off their mortgages and other housing-related loans, investors in the bonds could expect to collect steady, and often large, returns.

With the thirst for these securities growing, the big banks encouraged the expansion in mortgage financing and refinancing. And the riskier the loans, the better, as far as the gamblers were concerned--sub-prime mortgages, with their hidden fees and ballooning interest rates, yielded a bigger return.

This is where AIG came in. Its financial products division became the primary seller of something called "credit default swaps." Basically, the swaps were a promise to investors that the company would cover any losses if the securities they were buying went bad.

Credit default swaps were marketed as "insurance" for banks and big investors, such as mutual funds, that were restricted from making riskier investments.

European banks in particular used AIG's credit-default swaps to avoid regulations requiring them to set aside money to cover potential losses. The bankers could, after all, point out that the mortgage-backed securities, despite containing risky sub-prime loans, had top grades from rating agencies--and in any event, they were covered against losses by the biggest insurance company in the world.

To AIG, the swaps looked like easy money: Sell the promise to pay off in the event of defaults, which never seemed to happen while the housing market was booming.

Credit default swaps also became a vehicle for straight-up gambling. This is because AIG didn't just sell swaps to bond buyers, but to any Wall Street player who wanted them. Thus, while a bank might buy a swap contract from AIG to cover against a potential loss, a hedge fund that had never purchased the security might buy a swap as a bet that the bond would default. In a sense, AIG was selling insurance that paid off if someone else's house burned down.

One example of how such schemes worked was revealed by a Wall Street Journal investigation in March, which showed that among the financial firms in line for payouts from AIG are hedge funds that operated through Deutsche Bank.

Essentially, these hedge funds decided in 2007 to bet that the mortgage boom would go bust. On their behalf, Deutsche Bank sought out the Wall Street firm Goldman Sachs to arrange a complicated set of financial transactions allowing their clients to "sell short"--that is, to make an investment that would succeed if the number of mortgage defaults grew. The deal Goldman Sachs set up included AIG swaps that would pay out if defaults rose above a certain level.

Now, the hedge funds are among the firms that AIG is preparing to pay off with money from the federal bailout. In other words, taxpayer dollars will end up in the pockets of financial speculators who bet on millions of homeowners' lives being ruined by a downturn in the housing market.

How much of AIG's credit default swap business involved pure speculation like this isn't clear. In any case, demand boomed. AIG sold half a trillion dollars worth of credit default swaps in seven years--and because the federal government didn't regulate swaps, AIG didn't have to keep in reserve even a fraction of the money that would be needed to cover the losses if the bonds defaulted.

The swaps remained profitable--until the housing bubble burst, and mortgage-backed securities started to go south. The final shoe to drop was when AIG's credit rating--representing its ability to cover its promises to pay out--was downgraded. The company was suddenly faced with requirements to put up billions of dollars it didn't have in additional collateral to cover its financial commitments.

ENTER THE federal government. In mid-September, with no way to come up with the additional cash, AIG's top officials were called in to the offices of the New York Federal Reserve Bank, then headed by Tim Geithner. George Bush's Treasury Secretary Henry Paulson was part of the negotiations, but he was preoccupied with another financial catastrophe that same weekend--the collapse of investment bank Lehman Brothers.

There was another face at the table when AIG sat down with the Feds: Lloyd Blankfein, the CEO of Goldman Sachs, and Paulson's former colleague when he headed the Wall Street giant before becoming treasury secretary.

If others at the meeting thought the presence of another company's top executive was strange, the reason wasn't too hard to figure out--Goldman Sachs turned out to be the biggest single customer for AIG's financial products division, with $20 billion at stake. "If AIG went down, there was a good chance Goldman would not be able to collect," analyst Eric Salzman told Rolling Stone's Matt Taibbi.

As Taibbi concludes, "The AIG bailout, in effect, was Goldman bailing out Goldman. Eventually, Paulson went a step further, elevating another ex-Goldmanite named Edward Liddy to run AIG--a company whose bailout money would be coming, in part, from the newly created [Troubled Asset Relief Program], administered by another Goldman banker named Neel Kashkari."

But the other player in the room as the AIG bailout was put together was Geithner--now Barack Obama's Treasury Secretary, and the man responsible for running the bailout today.

That fact certainly casts doubt on the administration's claims that it didn't know what was going on at AIG--either the company's bonuses to current and former executives, or the lavish payouts that have gone straight into the coffers of the biggest names in the financial world, both in the U.S. and around the globe.

This is the less-talked-about scandal: AIG is using bailout money to make good on its debts from selling swaps--and at full value. It isn't even requiring buyers to eat a part of the loss from investments that were a toxic time bomb waiting to go off.

According to the Financial Times, AIG has paid out nearly $50 billion related to losses on credit default swaps. Recipients include U.S. firms Merrill Lynch, Morgan Stanley, Bank of America and Citigroup; European banking giants Barclays, Deutsche Bank, Société Générale, among others; and various municipalities.

But the biggest recipient of all, so far, to the tune of $12.9 billion, is...none other than Goldman Sachs.

"This comes after months of claims by Goldman that all of its AIG bets were adequately hedged, and that it needed no 'bailout,'" the Wall Street Journal wrote in an editorial. "Why take $13 billion then? This needless cover-up is one reason Americans are getting angrier as they wonder if Washington is lying to them about these bailouts."

THERE'S MUCH more to the AIG scandal--and other revelations sure to come. But one point in the bigger picture shouldn't be lost amid the mind-numbing details.

The Obama administration continues to claim that it has no choice but to bail out Wall Street, or face an implosion of the financial system. But the question is: Why should a company like AIG be saved?

No one could possibly claim that what AIG did contributed to the greater good of society. It's a zombie company today because of its part in high-stakes gambling at the world's most exclusive casino.

Now that the bets have gone disastrously wrong, Wall Street--with the connivance of its "partners in government," as AIG CEO Edward Liddy put it in congressional testimony--has determined that its system has to be saved on the bankers' terms. So they keep coming back for more and more taxpayer money.

AIG is only the most outrageous example of a financial bailout that's already run into the trillions of dollars--and not only is the money going to the same people who caused the crisis, but those funds could be used for things that are urgently by the rest of society.

For example, Geithner's latest bailout plan for the wider banking crisis comes with a price tag of another $1 trillion. That's almost twice as much as Obama has proposed spending on a plan to reform the health care system over 10 years.

Why keep dumping federal money down the Wall Street sinkhole, knowing--as we do from the AIG scandal--that these huge sums will only end up in the vaults of banking giants like Goldman Sachs?

The rational solution would be for the federal government to act like what it is at AIG--the owner--and start calling the shots. The Treasury Department should clear out the executive suites and install its own administrators, who could exercise veto power when Goldman Sachs comes asking for $12.9 billion to cover its gambles.

And given that the U.S. government now controls the world's largest insurance company, why not turn it into a publicly owned, not-for-profit company that does something socially useful?

But even modest measures along these lines quickly transgress the boundaries of the capitalist system, with its priorities on profit and protection of property rights.

This explains why the Obama administration has been so accommodating to Wall Street in its plans for the bailout. Whatever Obama may say to try to win popular support, he's ultimately a mainstream politician in the Democratic Party--a party committed to upholding a system dominated by Corporate America and the wealthy.

If the Obama and his administration ever do take sterner measures against Wall Street, it won't be because they want to, but because they have to--because they have to respond to mobilized outrage among the majority of working people who are tired of seeing the interests of the rich come first.

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