Below is the latest issue of The Institutional Risk Analyst. We did a lot of work on this one. Look forward to your comments.

Also, check out the earlier writings of Lucy Komisar on offshore shenanigans of AIG and the offshore transaction set:


– Chris

“What do many corporate buyers of insurance have in common with American International Group? Perhaps more than they would like to admit. Like AIG, many companies in the past few years have bought finite insurance, which transfers a prescribed amount of risk for a particular liability. What regulators now want to know is, how many companies, like AIG, have used finite insurance to artificially inflate their financial results?”

Infinite Risk?

CFO Magazine

June 1, 2005

“In the regulatory world, a ‘side letter’ is perhaps the most insidious and destructive weapon in the white-collar criminal’s arsenal. With the flick of a pen, underhanded executives can cook the books in enormous amounts and render a regulator helpless.”
Fraud Magazine

July/August 2006

PRMIA Event: Market & Liquidity Risk Management for Financial Institutions

First, a housekeeping item. On Monday, May 4, 2009, in partnership with the Federal Deposit Insurance Corporation (FDIC) & the Office of Thrift Supervision (OTS), the Washington DC chapter of Professional Risk Managers’ International Association (PRMIA) is presenting an important day-long conference on managing liquidity and market risk for financial institutions. Speakers include some of the leading risk practitioners, investors, researchers, bank executives and regulators in the US financial community. PRMIA free and sustaining members may register on the PRMIA web site. Members of the regulatory community may register via the FDIC University. IRA co-founder Christopher Whalen will participate in the conference and serve as MC. See the PRMIA web site for more information on the program and speakers.

And yes, our favorite bank regulator is making the opening remarks. ;)

For some time now, we have been trying to reconcile the apparent paradox of American International Group (NYSE:AIG) walking away from the highly profitable, double-digit RAROC business of underwriting property and casualty (P&C) risk and diving into the rancid cesspool of credit default swaps (“CDS”) contracts and other types of “high beta” risks, business lines that are highly correlated with the financial markets.

In our interview with Robert Arvanitis last year, “‘Bailout: It’s About Capital, Not Liquidity; Seeking Beta: Interview with Robert Arvanitis’, September 29, 2008,” we discussed the difference between high and low beta. We also learned from Arvanitis, who worked for AIG during much of the relevant period, that the decision by Hank Greenberg and the AIG board to enter the CDS market was, at best, chasing revenue. No rational examination of the business opportunity, assuming that Greenberg and his directors were acting based on a reasoned analysis, could have resulted in a favorable decision to pursue CDS and other “high beta” risks, at least from our perspective.

In an effort to resolve this conundrum, over the past several months The IRA has interviewed a number of forensic experts, insurance regulators and members of the law enforcement community focused on financial fraud. The picture we have assembled is frightening and suggests that, far from just AIG, much of the insurance industry has been drawn into the world of financial engineering and has thus become part of the problem. Below we present our preliminary findings and invite your comments.

One of the first things we learned about the insurance world is that the concept of “shifting risk” for a variety of business and regulatory reasons has been ongoing in the insurance world for decades. Finite insurance and other scams have been at least visible to the investment community for years and have been documented in the media, but what is less understood is that firms like AIG took the risk shifting shell game to a whole new level long before the firm’s entry into the CDS market.

In fact, our investigation suggests that by the time AIG had entered the CDS fray in a serious way more than five years ago, the firm was already doomed. No longer able to prop up its earnings using reinsurance because of growing scrutiny from state insurance regulators and federal law enforcement agencies, AIG’s foray into CDS was really the grand finale. AIG was a Ponzi scheme plain and simple, yet the Obama Administration still thinks of AIG as a real company that simply took excessive risks. No, to us what the fraud Bernard Madoff is to individual investors, AIG is to the global financial community.

As with the phony reinsurance contracts that AIG and other insurers wrote for decades, when AIG wrote hundreds of billions of dollars in CDS contracts, neither AIG nor the counterparties believed that the CDS would ever be paid. Indeed, one source with personal knowledge of the matter suggests that there may be emails and actual side letters between AIG and its counterparties that could prove conclusively that AIG never intended to pay out on any of its CDS contracts.

The significance of this for the US bailout of AIG is profound. If our surmise is correct, the position of Feb Chairman Ben Bernanke and Treasury Secretary Tim Geithner that the AIG credit default contracts are “valid legal contracts” is ridiculous and reveals a level of ignorance by the Fed and Treasury about the true goings on inside AIG and the reinsurance industry that is truly staggering.

Does Reinsurance + Side Letters = CDS?

One of the most widespread means of risk shifting is reinsurance, the act of paying an insurer to offset the risk on the books of a second insurer. This may sound pretty routine and plain vanilla, but what most people don’t know is that often times when insurers would write reinsurance contracts with one another, they would enter into “side letters” whereby the parties would agree that the reinsurance contract was essentially a canard, a form of window dressing to make a company, bank or another insurer look better on paper, but where the seller of protection had no intention of ever paying out on the contract.

Let’s say that an insurer needs to enhance its capital surplus by $100 million in order to meet regulatory capital requirements. They can enter into what appears to be a completely legitimate form of reinsurance contract, an agreement that appears to transfer the liability to the reinsurer. By doing so, the “ceding company” – an insurance company that transfers a risk to a reinsurance company – gets to drop that $100 million in liability and its regulatory surplus increases by $100 million.

The reinsurer assuming the risk does actually put up the $100 million in liability, but with the knowledge that they will never have to actually pay out on the contract. This is good for the reinsurer because they are paid a fee for this transaction, but it is bad for the ceding company, the insurer with the capital shortfall, because the transaction is actually a sham, a fraud meant to deceive regulators, counterparties and investors into thinking that the insurer has adequate capital. Typically the fee is 6% per year or what is called a “loan fee” in the insurance industry.

When it operates in this fashion, the whole reinsurance industry could be described as a “surplus rental” proposition, whereby an insurer literally loans another insurer capital in the form of risk cover, but with a secret understanding in the form of a side letter that the loan will be reversed without any recourse to the seller of protection. You give me $6 million in cash today, and I will give you a promise that we both know I will never honor.

Does this sound familiar? What our contacts in the insurance industry describe is almost a precise description of the CDS market, albeit one that evolved in the reinsurance industry literally decades ago and has been the cause of numerous insurance insolvencies and losses to insured parties. Or to put it another way, maybe the inspiration for the CDS market – at least within AIG and other insurers — evolved from the reinsurance market over the past two decades.

As best as we can tell, the questionable practice of using side letters to mask the economic and business reality of reinsurance transactions started in the mid-1980s and continued until the middle of the current decade. This timeline just happens to track the creation and evolution of the OTC derivatives markets. In particular, the move by AIG into the CDS market coincides with the increased awareness of and attention to the use of side letters by insurance regulators and members of the state and federal law enforcement community.

Keep in mind that what we are talking about here are not questionable risk management policies but acts of deliberate and criminal fraud, acts that often result in jail time for those involved. As one senior forensic accountant who has practiced in the insurance sector for three decades told The IRA:

“In every major criminal fraud case in which I have worked, at the center of the investigation were these side letters. It was always very strange to me that on-site investigators and law enforcement officials consistently found that these side letters were being used to mask the true financial condition of an insurer, and yet none of the state regulators, the National Association of Insurance Commissioners (NAIC), nor federal law enforcement authorities ever publicly mentioned the practice. They certainly did not act like the use of side letters was a commonplace thing, but it was widespread in the industry.”

It is important to understand that a side letter is a secret agreement, a document that is often hidden from internal and external auditors, regulators and even senior management of insurers and reinsurers. We doubt, for example, that Warren Buffet or Hank Greenberg knew the details of side letters, but they should have. Just as a rogue CDS trader at a large bank like Societe General (NYSE:SGE) might seek to hide losing trades, the underwriters of insurers would use sham transactions and side letters to enhance the revenue of the insurer, but without disclosing the true nature of the transaction.

There are two basic problems with side letters. First, they are a criminal act, a fraud that usually carries the full weight of an “A” felony in many jurisdictions. Second, once the side letter is discovered by a persistent auditor or regulator examining the buyer of protection, the transaction becomes worthless. You paid $6 million to AIG to shift risk via the reinsurance, but the side letter makes clear that the transaction is a fraud and you lose any benefit that the apparent risk shifting might have provided.

As the use of these secret side letters began to become more and more prevalent in the insurance industry, and these secret side deals were literally being stacked on top of one another at firms like AIG, the SEC began to investigate. And they began to find instances of fraud and to crack down on the practice. One of the first cases to come to the surface involved AIG helping Brightpoint (NASDAQ:CELL) commit accounting fraud, a case that eventually led the SEC to fine AIG $10 million in 2003.

Wayne M. Carlin, Regional Director of the SEC’s Northeast Regional Office, said of the settlements: “In this case, AIG worked hand in hand with CELL personnel to custom-design a purported insurance policy that allowed CELL to overstate its earnings by a staggering 61 percent. This transaction was simply a ’round-trip’ of cash from CELL to AIG and back to CELL. By disguising the money as ‘insurance,’ AIG enabled CELL to spread over several years a loss that should have been recognized immediately.”

Another case involved PNC Financial (NYSE:PNC), which used various contracts with AIG to hide certain assets from regulators, even though the transaction amounted to the “rental” of capital and not a true risk transfer.

As the SEC noted in a 2004 statement: “The Commission’s action arises out of the conduct of Defendant AIG, primarily through its wholly owned subsidiary AIG Financial Products Corp. (“AIG-FP”), (collectively referred to as “AIG”) in developing, marketing, and entering into transactions that purported to enable a public company to remove certain assets from its balance sheet.” Click here to see the SEC statement regarding the AIG transactions with PNC.

The SEC statement reads in part: “In its Complaint, filed in the United States District Court for the District of Columbia, the Commission alleged that from at least March 2001 through January 2002, Defendant AIG, primarily through AIG-FP, developed a product called a Contributed Guaranteed Alternative Investment Trust Security (“C-GAITS”), marketed that product to several public companies, and ultimately entered into three C-GAITS transactions with one such company, The PNC Financial Services Group, Inc. (“PNC”). For a fee, AIG offered to establish a special purpose entity (“SPE”) to which the counter-party would transfer troubled or other potentially volatile assets. AIG represented that, under generally accepted accounting principles (“GAAP”), the SPE would not be consolidated on the counter-party’s financial statements. The counter-party thus would be able to avoid charges to its income statement resulting from declines in the value of the assets transferred to the SPE. The transaction that AIG developed and marketed, however, did not satisfy the requirements of GAAP for nonconsolidation of SPEs.”

In both cases, AIG was engaged in transactions that were meant not to reduce risk, but to hide the true nature of the risk in these companies from investors, regulators and the consumers who rely on these institutions for services. Keep in mind that while the SEC did act to address these issues, the parties involved received light punishments when you consider that these are all felonies that arguably would call for criminal prosecution for fraud, securities fraud, conspiracy and racketeering, among other things. Indeed, this is one of those rare cases where we believe AIG itself, as a corporate person, should be subject to criminal prosecution and liquidation.

Birds of a Feather: AIG & GenRe

Click here to see a June 6, 2005 press release from the SEC detailing criminal charges against John Houldsworth, a former senior executive of General Re Corporation (“GenRe”), a subsidiary of Berkshire Hathaway (NYSE:BRKA), for his role in aiding and abetting American International Group, Inc. in committing securities fraud.

The SEC noted: “In its complaint filed today in federal court in Manhattan, the Commission alleged that Houldsworth and others helped AIG structure two sham reinsurance transactions that had as their only purpose to allow AIG to add a total of $500 million in phony loss reserves to its balance sheet in the fourth quarter of 2000 and the first quarter of 2001. The transactions were initiated by AIG to quell criticism by analysts concerning a reduction in the company’s loss reserves in the third quarter of 2000.”

But the involvement of the BRKA unit GenRe in the AIG mess was not the first time that GenRe had been involved in the questionable use of reinsurance contracts and side letters.

Click here to see an example of a side letter that was made public in a civil litigation in Australia a decade ago. The faxed letter, which bears the ID number from the Australian Court, is from an insurance broker in London to Mr. Ajit Jain, a businessman who currently heads several reinsurance businesses for BRKA, regarding a reinsurance contract for FAI Insurance, an affiliate of HIH Insurance.

Notice that the letter states plainly the intent of the transaction is to bolster the apparent capital of FAI. Notice too that several times in the letter, the statement is made that “no claim will be made before the commutation date,” which may be interpreted as being a warranty by the insured that no claims shall be made under the reinsurance policy. By no coincidence, HIH and FAI collapsed in a $5.3 billion dollar fiasco that ranks as Australia’s biggest ever corporate failure.

Click here to read a March 9, 2009 article from The Age, one of Australia’s leading business publications, regarding the collapse of HIH and FAI.

In 2003, an insurer named Reciprocal of America (“ROA”) was seized by regulators and law enforcement officials. An investigation ensued for 3 years. According to civil lawsuits filed in the matter, GenRe provided finite insurance to ROA in order to make the troubled insurer look more solvent than it was in reality. Several regulators and law enforcement officials involved in that case tell The IRA that the ROA failure forced insurers like AIG and Gen Re to start looking for new ways to “cook the books” because the long-time practice of side letters was starting to come under real scrutiny.

“These reinsurance deals made ROA look better than it really was,” one investigator with direct knowledge of the ROA matter tells The IRA. “They went into the ROA home office in VA with the state insurance regulators and law enforcement, and directed the employees away from the computers and records. During that three-year investigation, GenRe learned that local regulators and forensic examiners had put everything together and that we now understood the way the game was played. I believe the players in the industry realized that that they had to change the way in which they cooked the books. A sleight- of-hand trick that had worked for 25 years under the radar of regulators and investors was now revealed.”

Several senior officials of ROA eventually were prosecuted, convicted of criminal fraud and imprisoned, but DOJ officials under the Bush Administration reportedly blocked prosecution of the actual managers and underwriters of ROA who were involved in these sham transactions, this even though state officials and federal prosecutors in VA were anxious to proceed with additional prosecutions.

AIG: From Reinsurance to CDS

While some reinsurers are large, well-capitalized entities that generally avoid these pitfalls, AIG was already a troubled company when it began to write more and more of these risk-shifting transactions more than a decade ago. It is easy to promise the moon when people think that they can deliver, but because AIG and their clients saw how easy it was to fool regulators and investors, the practice grew and most regulators did absolutely nothing to curtail the practice.

It was easy for AIG to become addicted to the use of side letters. The firm, which had already encountered serious financial problems in 2000-2001, reportedly saw the side letters as a way to mint free money and thereby help the insurer to look stronger than it really was. AIG not only helped banks and other companies distort and obfuscate their financial condition, but AIG was supplementing its income by writing more and more of these reinsurance deals and mitigating their perceived exposure via side letters.

A key figure in AIG’s reinsurance schemes, according to several observers, was Joseph Cassano, head of AIG-FP. Whereas the traditional use of side letters was in reinsurance transactions between insurers, in the case of both CELL and PNC neither was an insurer! And in both cases, AIG used sham deals to make two non-insurers, including a regulated bank holding company, look better by manipulating their financial statements. Falsifying the financial statements of a bank or bank holding company is an felony.

AIG-FP was simply doing for non-insurers what was common practice inside the secretive precincts of the insurance world. The SEC did investigate and they did finally obtain a deferred prosecution agreement with AIG, which was buried in the settlement with then-New York AG Elliott Spitzer.

The key thing to understand is that if you look at many of these reinsurance contracts between ROA and Gen Re, they look perfect. They appear to transfer risk and seem to be completely in order. But, if you don’t get to see the secret agreement, the side letter that basically says that the reinsurance contract is a form of window dressing, then you cannot understand the full implications of the transaction, the reinsurance agreement. Not, several experts speculate, can you understand why AIG decided to migrate away from reinsurance and side letters and into CDS as a mechanism for falsifying the balance sheets and earnings of non-insurers.

Several observers believe that at some point in the 2002-2004 period, Cassano and his colleagues at AIG began to realize that state insurance regulators and the FBI where on to the reinsurance/side letter scam. A number of experts had been speaking and writing about the issue within the accounting and fraud communities, and this attention apparently made AIG move most of its shell game into the world of CDS. By no coincidence, at around this time side letters began to disappear in the insurance industry, suggesting to many observers that the industry finally realized that the jig was up.

It appears to us that, seeing the heightened attention from regulators and federal law enforcement agencies such as the FBI on side letters, AIG began to move its shell game to the CDS markets, where it could continue to falsify the balance sheets and income statements of non-insurers all over the world, including banks and other financial institutions.

AIG’s Cassano even managed to hide the activity in a bank subsidiary of AIG based in London and under the nominal supervision of the Office of Thrift Supervision in the US, this it is suggested to hide this ongoing activity from US insurance regulators. Even though AIG had been investigated and sanctioned by the SEC, Cassano and his colleagues at AIG apparently were recalcitrant and continued to build the CDS pyramid inside AIG, a financial pyramid that is now collapsing. The rest, as they say is history.

Now you know why the Fed and EU officials are so terrified about an AIG liquidation, because it will result in heavy losses to or even the insolvency of banks and other corporations around the globe. Notice that while German Chancellor Angela Merkel has been posturing and throwing barbs at President Obama, French President Nicolas Sarkozy has been conciliatory toward the US.

But for the bailout of AIG, you see, President Sarkozy would have been forced to bailout SGE for a second time in two years. So long as the Fed and Treasury can subsidize AIG’s mounting operating losses, the EU will be spared a financial bloodbath. But this situation is unlikely to remain stable for long with members of the Congress demanding an investigation of the past bailout, a process that can only result in bankruptcy for AIG.

Are the CDS Contracts of AIG Really Valid?

The key point is that neither the public, the Fed nor the Treasury seem to understand is that the CDS contracts written by AIG with these various non-insurers around the world were shams – with no correlation between “fees” paid and the risk assumed. These were not valid contracts as Fed Chairman Ben Bernanke, Treasury Secretary Geithner and Economic policy guru Larry Summers claim, but rather acts of criminal fraud meant to manipulate the capital positions and earnings of financial companies around the world.

Indeed, our sources as well as press reports suggest that the CDS contracts written by AIG may have included side letters, often in the form of emails rather than formal letters, that essentially violated the ISDA agreements and show that the true, economic reality of these contracts was fraud plain and simple. Unfortunately, by not moving to seize AIG immediately last year when the scandal broke, the Fed and Treasury may have given the AIG managers time to destroy much of the evidence of criminal wrongdoing.

Only when we understand how AIG came to be involved in CDS and the fact that this seemingly illegal activity was simply an extension of the reinsurance/side letter shell game scam that AIG, Gen Re and others conducted for many years before will we understand what needs to be done with AIG, namely liquidation. Seen in this context, the payments made to AIG by the Fed and Treasury, which were then passed-through to dealers such as Goldman Sachs (NYSE:GS), can only be viewed as an illegal taking that must be reversed once the US Trustee for the Federal Bankruptcy Court for the Southern District of New York is in control of AIG’s operations.

(Editor’s note: Officials of BRKA and GenRe did not respond to telephonic and email requests by The IRA seeking comment on this article. An official of AIG did respond but was not willing to comment on-the-record for this report. We shall be happy to publish any written comments that BRKA, AIG or GenRe have on this article.

Questions? Comments? info@institutionalriskanalytics.com

Category: Markets

Please use the comments to demonstrate your own ignorance, unfamiliarity with empirical data and lack of respect for scientific knowledge. Be sure to create straw men and argue against things I have neither said nor implied. If you could repeat previously discredited memes or steer the conversation into irrelevant, off topic discussions, it would be appreciated. Lastly, kindly forgo all civility in your discourse . . . you are, after all, anonymous.

55 Responses to “AIG: Before CDS, There Was Reinsurance”

  1. howard0339 says:

    I was once an insurance agent back in my ill spent youth, and I asked somebody at a sales meeting how in the hell all the policies we sold could possibly be paid (our office covered about six miles of office buildings along a main thoroughfare in the San Gabriel Valley that in the event of a serious earthquake would be at least 75% destroyed). It was then that I first heard of “re-insurance” as we all were told that all policies were immediately sold or transferred to a larger “re-insurance” company. I questioned how they could pay if every insurance broker in LA was writing policies all over town. We were told that we’d have to study insurance actuarials, risk assessments over time, and that it was the “genius” of insurance that spread risk over huge numbers of similar risks around the world. In other words, after thinking about it recently, insurance was a shell game. An unending series of “passing along” risk that nobody could possibly pay off if real disaster struck. I think this has been the business since the end of WWII and we’ve all been involved in it.

    I think the root of our current problem is the fact that we are all engaged in preying upon one another economically, and to do this successfully we must lie and cheat. I have no idea how many things I’ve sold that I inflated the quality of, how many times I’ve lied to the IRS or countless other government agencies, lied to a girl friend (or spouse), lied to get loans, and so on and so forth.

    I think we are paying for our own dishonesty. Think about it.

  2. danm says:

    In 1992, when I started in the business, I did discounted cash flow models and could never arrive at the market prices unless I used perma-bull assumptions (15-25% growth forever).

    My boss was impatient and quickly told me to stop trying to reinvent the wheel. He did not care about the intrinsic values, he just cared about which stock would outperform the other, relative performance that is.

    For the last few decades, everything has been run using relative performance. It’s no wonder asset prices don’t reflect their true productive values.

  3. Pat Shuff says:

    howard0339 Says: I think we are paying for our own dishonesty. Think about it.


    Wood burns because it has the proper stuff in it; and a man becomes famous because he has the proper stuff in him.

    Johann Wolfgang von Goethe

    My how 19th century times have changed. Britney, Paris, Michael, OJ to serial defaulting swindler Trump.
    Seems fame and celebrity are market driven phenomenom. Dope, child pornography and lottery tickets are all
    produced by the consumer as is celebrity. The problem(s) may lie a little deeper, written in synapse software.
    Have thought about. Denial, anger, bargaining, depression, acceptance. The arrival at destination was before
    the mirror. Seems alot of anger and denial out there, should it save any time.

    The article was amazing, very clear and concise. You’re in good hands with All State.

  4. Chris Whalen says:

    Danm makes a very important observation. Another way to put it is that we selected the valuations that we think we — not the investment — deserve. Probably a book in here somewhere.

  5. dead hobo says:

    Thanks for this. I bookmarked your website so I can read this later in more detail. In fact, I think I’ll copy it to a pdf file and put it on my desktop for later referral. It will essentially vanish here in a couple of days.

    You brought up a lot of ideas I as never thought of and did so with a lot of detail. My first impression based on a quick read is that the world of finance and insurance is crowded with crooks and scam artists, auditors are incompetent and probably crooked, and everything involving big money is just one form of organized crime or another.

  6. Aeroscout840 says:

    Long time lurker, compelled to post and all I can is: thank god for a blog like this. With the markets set to “rally” today we are again reminded that much of our known world is built on pillars of sand.

  7. bonghiteric says:

    I’d be hesitant to indict the entire insurance industry, their auditors and their regulators. I work in reinsurance and have been through several tri-annual NY State regulators audits. They are extraordinarily thorough. Side letters occur at the highest level of executive management (that’s what sent Ferguson the former CEO, of GenRe to jail). I don’t know and I’m not privy to the level of testing that auditors do to know whether that is required disclosure. I would presume that it isn’t. I’m no apologist for my industry but I’m on the finance side (its the business side cutting those deals) and a visit from the Del or NY auditors is no picnic.

  8. dead hobo says:

    Let’s also expand the concept of sham businesses to the Auditing profession. GAAS are designed to both maintain a high level of performance AND provide cover for the inevitable slackerism people frequently display. While the auditor must plan and document an audit, GAAS aggressively promotes the idea that there is only a reasonable assurance of no material misstatement in the financial statements.

    Fraud must be considered using a skeptical mind in the planning phase and this consideration must be a part of the documentation. THIS is where excellence or mediocrity can enter the picture. Both are defensible if done correctly. The auditor will claim that not all frauds are detectable if covered up well. This leave it up to the damaged party to define the concept of “covered up well”.

    The auditor will claim, with industry support, the audit is not intended to be a fraud investigation. It’s only meant to provide reasonable assurance that the financial statements are free of material misstatement.

    Therefore, if the auditor can claim that fraud was considered, and this consideration was documented, and internal controls that might apply were reviewed, and management was asked about if there’s any fraud around here, and management asserts in a representation letter that fraud is their responsibility and not the auditor’s, then the auditor gets paid and the investors gets ‘assured’.

  9. atulvora says:

    Did BRKA accomodate the request for reinsurance contract for FAI Insurance, any idea? Chris it appears you got something very big here. Good Luck

  10. new swing highs this morning. 84 is the target on the spy’s. 10 for xlf.

    my prudence yesterday was just that – could have gone either way. i will most likely wait until the xlf gets around 10 to start putting on short positions.

  11. Stuart says:

    Outstanding. In all probability then, the vast majority of AIG CDS contracts are Null and Void. The implications are nothing short of horrific. Checkmate.

  12. Transor Z says:

    Chris, truly dramatic stuff. Congratulations on breaking this after all the hard work (and tense legal consults, no doubt ;) ) that went into it.

    Reading this article reminds me of the disaster movie device where you see a distant, muted flash after the asteroid hits . . . and then there’s a pause before . . . .

  13. the man from nantucket says:

    Pat Schuff:

    you are correct. it’s sad, but the famous are rarely significant and the significant are rarely famous.

    rally mode still the order of the day, seems like relief that general econ data aren’t continuing to deteriorate at previous pace is the driver. could take another couple of months before general market realizes that doesn’t indicate robust recovery around the corner.

  14. hey there says:

    No offense, but i think you are barking up the wrong tree with the side letter and fraud arguments at AIG, at least as it relates to CDS. as someone who was in the industry, on the business side, competing against AIG, my experience was that the CDS business was out in the open with it’s goals and intentions: by providing credit protection against AAA assets, AIG and others earned a fee against a risk they thought was highly unlikely to ever produce a claim and helped create arbitrage for their counterparties. This wasn’t a hidden agenda – all of the investment banks had large teams of sales people helping to facilitate it across the market. The rating agencies and regulators were briefed on it regularly and actively encouraged it. I suspect the boards of AIG and most other companies involved scrutinized the business, questioned the motives and recieved satisfactory (at the time) answers. it would be next to impossible to prove fraud for something so widely disclosed, discussed and distributed across constituencies.

    The failure of AIG’s CDS business is, in my view, attributable to something more fundamental and less nefarious than fraud: people in didn’t really understand risk very well. this was not limited to the CDS or CDO markets – vast numbers of banks, borrowers and lenders failed to truly understand the risks of the business they were in and failed to properly price such risk. Using far too limited historical data set and the stamp of approval of the rating agencies, vast numbers of participants in the CDS, securitization, private equity, banking and mortgage lending markets piled deeper and deeper into the mispriced business of risk, creating a stampede that fed upon itself. this is the classic definition of a bubble. the tighter credit spreads got, the harder people in the credit business had to compete to make money and the further out on the risk spectrum they had to go. AIG was the biggest participant in the market becuase they had the biggest balance sheet and because they lacked the proper understanding of the “AAA” risk they were taking and because… the market let them take that risk without demanding more protection in return (because they were AAA rated – however, other smaller AAA monoline companies were not granted such breadth – counterparties had a much more limited appetite for their names).

    it is easy to call it all a fraud in retrospect, but all of these people and companies operated in a world where this business was normal, profitable, publicly disclosed and widely approved and applauded. Dissenters were considered behind the times and old fashioned who were unable to compete and stay current.
    i prefer to call it a big mistake – lots of people, across our society and the globe – who were not nearly as smart we thought we were, yet still convinced, with the help of tremendous outside enabling, that we were building a bright new future for the financial world. the reckoning is not in the criminal courts – it’s in the realization that the industry was based on false premises, foolish optimism and poor judgement.

  15. Chris Whalen says:

    Agree on the lack of understanding on CDS. I have long argued that price does not equal value, or to say another way, volatility and P(D) are not the same thing. But bottom line for me is that when you execute a risk shifting transaction that misrepresents a financial statement, that is fraud.

  16. Wes Schott says:

    Amazing story. Once again American business practices born of unethical financial chicanery.

    I remember thinking when the AIG-GenRe dust up occurred that Buffett remained oddly unscathed. And this Jain fellow was specifically noted in the recent BRKA annual report as a wonderful leader of that business unit. I guess if you provide political contributions and/or are an American business icon you are protected. Not quite the case for Greenberg.

  17. Wes Schott says:

    AIG problems not his fault, says Greenberg
    Thu Apr 2, 2009 8:51am EDT


  18. Great work Chris. It seems the more you dig in the shit pile, the stinkier it becomes.

    Now, let’s get back to our regularly-scheduled programming that has us reinflating the housing bubble, the car bubble, the banking bubble, and of course, the insurance bubble, inter alia. All this truth-telling is not conducive to propping up false market outcomes.


    bubble–a market condition that obtains when market performance is founded upon fraud and illusion, usually originating with the central bank, but spreading and infecting all markets in time.

  19. Transor Z says:

    Important to bear in mind that insurance companies have different accounting and insolvency rules. The interdependence of life/casualty insurers through the reinsurance web has been known for decades.

    The ominous possibility is that AIG’s corrupt practices involved using creative accounting to get around insurance regulation capital reserve requirements for its allegedly segregated insurance unit. Recent rumblings from Bob Lenzner and others are hinting in that direction. Barry posted on it the other day.

    “Delay” has been the government agency non-strategy in handling insurance insolvencies for quite some time.

  20. hey there says:

    risk shifting in and of itself doesn’t come close to meeting the definition of fraud. it is possible that misrepresenting a financial statement would – but i don’t think that will be provable in this case, at least not on AIG’s part. AIG was asked to take on risk for a (low) premium for the benefit of someone else looking to shift risk. since they were insuring what they perceived to be low risk, AAA rated assets, why would they think they were misrepresenting their own balance sheet?
    perhaps the banks and others who purchased the CDS and insurance to manipulate their regulatory capital and earnings could be held accountable for fraud if they knew the AIG insurance was worthless – but why would they think that if AIG was rated AAA?
    my point is that all of this CDO and CDS stuff was done in plain sight – they called it regulatory arbitrage and dozens of people with oversight responsibilities approved (and encouraged) it all. the definition of fraud requires the INTENT to decieve, but how can you prove that when all parties were saying loud and clear exactly what they were doing. their is just a ton of information available, dozens of research reports and analysis and model results, internal and external, to provide cover to the people responsible for this business. No one would ever prevail in court with allegations of fraud, unfortunately.

    on the other hand, the much bigger issue: an entire industry, that employed thousands of people and affected millions more, was built on junk analysis, stupidity and a grand, but false, sense of value and self-worth. many of the beliefs that people in and out of the industry held over the past decade were just plain wrong. facing up to this and dealing with the consequences will be painful – and the financial industry still hasn’t come close to addressing it.

    The following essential elements must be present before an actual finding of fraud will occur:
    Misrepresentation of a material fact consisting of a false representation, concealment or non-disclosure;

    Knowledge of the falsity (scienter);
    Intent to deceive and induce reliance;
    Justifiable and actual reliance on the misrepresentation; and
    Resulting damages.

  21. hey there says:

    put another way – i think calling AIG criminal or corrupt is another way that we are engaging in self deception. if we can point the finger at them, convince ourselves that just a few people were bad actors, than we don’t have to deal with the much bigger issue – that the entire industry was based on false assumptions, ineffective models and a belief that we know things that we really don’t.

  22. Transor Z says:

    @ hey there:

    “Fraud” has a much different definition — and much lower threshold to satisfy — in the bankruptcy/insolvency context. The Trustee looks at things like whether the “badges of fraud” were present in transactions and whether the company in question was insolvent at the time of or became insolvent because certain transaction(s).

    One point of clarification re your very thoughtful commentary: AIG is/was corrupt as a factual matter, not a speculative one. Thus the Greenberg debacle. As the IRA article points out, a corrupt corporate leadership group was still in place when AIG entered the CDS market whole-hog. Not a smoking gun, but certainly reason to start applying the sniff test to their activities.

  23. danm says:

    I would presume that it isn’t. I’m no apologist for my industry but I’m on the finance side (its the business side cutting those deals) and a visit from the Del or NY auditors is no picnic.
    It’s not about picnics and laziness. It’s about our system being built on pillars of sand.

    Ever hear of Sisyphis? Working hard for nothing?

  24. hey there says:

    regarding “badges of fraud” in a bankruptcy case – unfortunately, AIG is not in bankruptcy!

    even if we agree that AIG management was corrupt – what is the relevance? Dozens of companies and thousands of people participated in the CDS and CDO markets and did similar transactions. Hundreds of thousands of people believed that credit could be analyzed, modeled and priced even at the peak of a now, readily apparent bubble. thousands of homeowners convinced themselves that 2006 and 2007 were great years to buy homes. they were all wrong!

    to me, pointing fingers at AIG because they were “corrupt” is just a way of trying to say “it’s their fault, not mine.” i think the problem ran, and continues to run, much deeper.

  25. bman says:

    howard0339 Says: ” I think the root of our current problem is the fact that we are all engaged in preying upon one another economically, and to do this successfully we must lie and cheat.” Speak for yourself white man.
    Some people actually create value in this world without them there would be nothing to insure, nothing to sell or trade Unfortunately those people are often the least respected and lowest paid. On the other hand those who derive value from others efforts truly have no clue what a given thing is worth they just know what they can get from it. If you get too many people like that in one place the result is the effect that we’ve seen over the last 2 decades, engineers fired during boom times, research and science and education budgets cut, manufacturing outsourced, off shored, downsized. While banks and investment agencies got bigger greedier and blinded by their own trading.

  26. Mannwich says:

    @danm & hey there: I agree. I think the problem runs much deeper. Bottom line is this (and other questionable methods) were easy ways to book “profits” and pocket big bonuses. I think it’s largely due to a lack of imagination. It was too easy, so why not do it? Sure, there had to have been some fraud in there but I think it’s much deeper than that. The problem (and “enemy”) is us.

  27. Mannwich says:

    Amen bman. Amen indeed.

  28. a quick note, as an aside:

    telling, should be, that “Fraud Magazine” has a circulation #’d w/ 5 digits, and the WSJ has a circulation #’d, still, w/ 7 digits..

    if we’re fixin’ to get better, those, respective, #’s need to converge, dare I say, transpose..

    also, Chris, the IRA needs a few T-Shirts, Summer beckons..

  29. Transor Z says:

    Insurance companies and banks don’t go through normal Ch. 11. Different insolvency process.

    Re AIG insolvency, what I may not have been clear about in my 10:13 post when I wrote:
    “Delay” has been the government agency non-strategy in handling insurance insolvencies for quite some time

    is that AIG is clearly insolvent now but the government is not acknowledging that reality. Sorry, but anyone who thinks AIG is a going concern in any real sense isn’t keeping up with the news. One big reason that Treasury won’t say “insolvent” and “AIG” in the same sentence is because it’s a huge insurance company — nothing to do with CDSs. Government agencies tend to put off insurance insolvencies as long as possible. They don’t want to spook existing policy holders and push an already precarious capital reserve situation over the edge.

    “Zombie Insurance Company” is more like it.

    The other point is that there is always a look-back period when resolving insolvencies, especially with regard to fraudulent (i.e., insolvency-fraudulent) transactions, in which case the look-back is usually a period of years depending on state law and applicable federal law. So the fact that AIG is not in receivership/insolvency protection at this moment doesn’t mean that its creditors aren’t already on the phone with outside counsel specializing in insolvencies.

  30. hey there says:

    @transor z:
    sorry – i was trying to be funny. i meant that i believe that AIG should be in receivership so that the normal rules of handling insolvent companies would apply – which would have made the whole AIG bonus issue irrelevant. AIG is insolvent because they, and many others, mispriced risk on a widespread basis. the government, past and present, has chosen not to go this route and that is their contribution to the denial that is so widespread.

  31. Transor Z says:

    @ hey there:

    I agree that criminal fraud is going to be very, very hard to prove without more. As you said, CDSs are so widespread and accepted that, in an of themselves, it’s hard to imagine anyone finding them per se fraudulent. Seems to me that what would have to turn up would be witnesses or documents/emails establishing that AIG made a sham of due diligence. But again, assuming the files all show AAA ratings for the underlying securities from S&P or Moody’s, we keep going around in circles. Off balance-sheet activities were also commonplace, making due diligence into financial condition murkier still.

    I think that IRA is on to something important pointing out the similarities between the reinsurance “racket” and the CDS “racket.” Easy money and gaming the regulatory scheme to free up liquidity to feed the bubbles. What those of us on the sidelines have to wonder, based on AIG’s sketchy track record, is whether AIG properly segregated life/casualty reserves or whether it deliberately misstated things on the insurance side. If it was robbing Peter to pay Paul, Ponzi-style, then I guess we’ll all find out soon enough.

  32. gringcorp says:

    They used to call them side letters. Now they call them side phone calls. Short of bugging all your reinsurance brokers, who are a fairly filthy bunch, there’s not much you can do to stop sham reinsurance.

  33. Chris Whalen says:

    Just posted this in the Cafe. Lucy is an old friend from my Mexico days. We’ve both been on the receiving end of a lot of threats and worse because of our writings.


  34. standingup says:

    @hey there:

    Doesn’t the fact that AIGFP did not hedge, did not even ask Gary Gorton to measure risk of writedowns or collateral calls in his models seem very odd? Is that a simple misunderstanding of risk? Or could they have addressed the risk through a side letter or similar agreement that all but eliminated the risk?

    The idea that a company of AIG’s size and experience in dealing with risk simply failed to understand what they were undertaking with CDS’s is a little difficult to swallow. On the other hand, they have a documented history of using side letters and other fraudulent schemes to help themselves and other companies hide their true financial condition.

    Is it really too far out of the realm of possibilities to consider that AIG’s infamous “product innovation” could also be applied to their use of side letters or their equivalents with the sale of credit default swaps?

  35. hey there says:


    i’m a firm believer that incompetence explains a lot more than conspiracy theories…

    monolines wrote the same risk but were not required to post collateral. As a multiline, AIG did get asked to post collateral – because of the risk that their other lines of business presented to their CDS business. Nobody thought the “insuring” of AAA and super senior assets would require collateral posting, that’s why it wasn’t modeled. by the way, apparently lehman failed to model their collateral posting requirements very well, either.

    it’s possible they had some hidden scheme, via side letters, to void risk they had actually written if claims came due (even though they ultimately ended up posting collateral and commuting on much of this exposure, thus ignoring the “out” they had)…

    it is probable that this wasn’t the case and that the simpler, occam’s razor explanation was that they weren’t as smart as they thought they were and neither were their regulators, rating agencies, counterparties, risk managers, etc.

  36. hey there,

    tamp this:

    into yon’ pipe, and see how it pulls..

    if AIG/AIGFP were as incompetent as you claim, they wouldn’t be able to make it to work, let alone, on their own recognizance..

  37. Transor Z says:

    @ MEH:

    Julia Child was OSS in Asia also. I predict a spike in aluminum foil futures after Chris’s posting of Part II.

    I had McCann last year, worked out great. ;)

  38. Transor,

    if you need another C, Iannetta, from Colo. looks to have a Major League season..

    and, now you know why Ol’ Julia was able to dress her own fowl..

  39. AccreditedEYE says:

    Chris, I am a recent fan of yours. By chance I heard you on a Bloomberg interview months ago and was so impressed that I put your site on top of my favorites. Honest bankers (and capitalism for that matter)have no greater proponent than you! Keep up the great work!!

  40. Transor Z says:

    She also rescued a young downed pilot named George H.W. Bush and swam with him back to a sub (true story!). Also, not a lot of people know that Brando modelled Kurtz after her in Apocalypse Now. Her husband was Grand Master Templar (no relation to Grand Master Flash) and Freemason before his death. She also invented the microwave oven which, in addition to burning popcorn, also steals people’s thoughts and sends them back to Langley.

    (Just talking my book here)

  41. Zigurrat says:

    Wow….where to start.

    1. AIG was a net BUYER of reinsurance. Brightpoint was way out of line and they didn’t do very much of this. The main purpose of accounting is to match revenue and expenses by assigning them to the proper time periods. Insurance inherently moves cash flows between time periods — you pay a premium for years and collect when something you have a loss that requires an unusual payment. This is smoothing of earnings, no? But does it do a better or worse job of matching revenues and expenses. It is standard, customary, and legal.

    2. Risk transfer is total legal and the main purpose of insurance and reinsurance. You want to transfer the risk of your home burning down to someone else for a fee, right? I don’t know what you mean by risk shifting. Misrepresentation of risk is done by everyone everyday (don’t worry, I’ll be careful), and only certain misrepresentations are illegal.

    3. Finite reinsurance is legal and a good idea in a lot of cases. Finite reinsurance with inadequate risk transfer, inadequate documentation, or with side letters has been considered a problem and largely cleared up and eliminated by 2005.

    4. The issues from a decade or more that you are bringing up are old news. In general, there weren’t a lot of rules regarding finite reinsurance prior to 1993 and limited ones for the next decade.

    5. The HIH and other problems have been kicking around forever. They are settled (for the most part) and have been extensively disclosed in BRK’s 10k for years.

    6. AIG had a reputation for playing hardball on claims. People that did reinsurance deals with them tended to lose money. If one gets into the details of the BRK/AIG dustup, it is ironic that the single most common topic of conversation regarding the deal with AIG involved making sure they didn’t cheat on the deal. In a rather bizarre turn of events, BRK executives are serving time because they openly discussed the probability that AIG would book the deal improperly. However, this is the first time that I recall that anyone has gone to jail because a counter party booked a deal wrong. If firms become responsible for the accounting of all their counter parties, we might as well go back to barter.

    7. If AIG had side letters on the CDS’s, why didn’t they use them?????

    8. AIG clearly didn’t know what it was doing in financial products.

    9. AIG signed agreements requiring them to post a lot of collateral. The money that went to the settlements on the CDS’s on multi sector CDO’s was cash out the door. AIG didn’t have any bargaining power since they didn’t have the cash. It’s one thing for AIG to be playing hardball with the rank and file of corporations. It’s another for them to be dealing with Goldman, etc. Clearly they were simply out of their league.

    10. What are the details of the side emails? I would be surprised if there were any on the multi sector CDO’s. They have other agreements that were very unusual, but so far, out of the money.

    I don’t have any specific knowledge on any of this, just what I read in SEC filings and company pitch pages.

  42. s0mebody says:

    Great report Chris. I actually pay attention when you get on the financial networks. Keep up the good work.

  43. Benedict@Large says:

    Back in the high inflation days of the late 70′s, the financial division of my employer (a MAJOR insurer) was writing all these agreements to pay rather generous interest on monies they were handling. I thought at the time that in the short term, these rates might be OK, but these were long term contracts, and I couldn’t help but think these would eventually come back to bite us. I left the company and never heard any more of them, but the hurt I imagined might result would certainly have started in the mid-80s, the same time that you’ve mentioned as a starting point in this article.

    Perhaps this starting point of the mid-80s was almost inevitable? My company certainly could not have been the only one offering deals like this, and reserves certainly had to be taking a big hit. Perhaps the industry as a whole had been caught with its pants down in the unwind of the high interest and inflation 70s, and turned to these pratices in the 80s to hide the pain from shareholders?

  44. grr says:

    I have a couple questions regarding this, as I am naturally skeptical that an overt fraud of this size could have occurred.

    First, your allegation is that the fraud consisted of informal agreements between people in AIG-FP and in various trading desks of financial institutions around the world. These desks are very porous in terms of personnel movement and general chatter. The contracts they sign are often enforced not by the traders who made them (who might be gone) but by their successors or in many cases by lawyers and back office staff who would not honor an illegal agreement. The original traders would not have control over this.

    Second, what types of insurance are you talking about here? Often in securitization a super senior tranche is insured and then the package (tranche + insurance) is sold to a third party. Are you saying that the third parties were involved in this fraud as well?

    Third, if the CDSs were not considered valid by AIG-FP or their counterparty, why would the counterparty have enforced collateral posting requirements on an AIG downgrade? This was the event that drove AIG to insolvency.

    And fourth, if counterparties had not considered these real contracts, why would they have paid to hedge their counterparty exposure to AIG?

    I have no problem with the idea that the AIG CDSs might be considered fraudulent under a broader definition. I think that it would have been clear from the beginning that these contracts would pay out only under circumstances that were very likely to find AIG otherwise in deep water. Of all people, credit traders would have understood this. So in that sense the contracts were fraudulent. I don’t know if that makes them illegal or not, however.

  45. Anonymous Jones says:

    I am troubled by a few of the comments above.

    1. “Much of our known world is built on pillars of sand” — What troubles me about this is the implication that our *economy* is built upon pillars of sand. I think that is a poor conclusion from the post above. Economics is the study of the allocation of scarce resources. There is a real economy here and in the rest of the world. What has happened in the financial world the last few decades, especially as so well described and analyzed by Mr. Whalen, is that a huge transfer of wealth has occurred through sham transactions. There is, in some general sense, a finite amount of wealth in the world, as judged by the amount of goods and services we can amass in total. What these sham transactions did was to shift the wealth from participants in other sectors of the economy to participants in the financial sector. This transfer of wealth has been exposed as especially egregious now that we see how many financiers (and their families) became extremely wealthy and then basically left the “taxpayers” with the bill. This was an enormous transfer of wealth, and I am completely on board with Whalen’s description of it as often being obtained through fraudulent means. In one sense, the finance sector found a way to bury the risk, take huge profits from savers (and those who “saved” through pensions) by hiding that risk and convincing the general public that the risk did not exist, and then kept the gains once the risk blossomed into losses for the savers. I understand that the economy is not exactly a zero sum game, but it is close enough that we should really be focused on who are the winners and who are the losers in any particular scheme rather than whether this was all built upon pillars of sand.

    2. “Incompetence explains a lot more than conspiracy theories.” I have expounded upon this elsewhere, but there is a third explanation that I think explains a lot more than both incompetence and conspiracies. No doubt there is enormous incompetence in all sectors (I see it every day), and no doubt many people collude in conspiratorial ways to defraud others, but what happens in a huge system like the financial sector (which includes hundreds of thousands of participants) is more subtle. I’ll pull a little Upton Sinclair on you, “It is difficult to get a man to understand something when his job depends on not understanding it.” The explanation is, of course, not incompetence or conspiracy, but willful ignorance. Each individual participant in the financial sector had little reason to ever question any assumptions as long as the system continued to make him rich. There is no need to have an overt conspiracy or to be incompetent. Millions upon millions of transactions slowly move the system to where those in control of the transaction extract maximum benefit; no conspiracy necessary. You can see this everywhere in the system, down to subprime mortgage originators. The money was great. Why question the system that is making you rich? The market rewarded those who pushed the envelope as far as possible, so the envelope kept getting pushed. That’s the market. Unfortunately, those ultimately bearing the risk (savers, taxpayers, however you want to label them) did not have as strong a personal incentive on an individual basis to keep watch over the system, and thus, those in charge of the financial sector ran roughshod over the entire enterprise, extracting profits far in excess of any value generated by their actions. I guess that’s why economics text discuss the concept of market failure (sarcasm…). So in addition to looking at who wins and who loses (as I noted in #1), we should always be looking at the incentives in any system. When there are enormous incentives for each individual participant to cheat, the efficiency of any market breaks down. That’s one reason we enforce contracts through public courts. It’s also the reason we should regulate a system like Mr. Whalen has described above.

  46. FromLori says:



  47. FromLori says:

    p.s. Barry remember this?

    FromLori Says:
    March 24th, 2009 at 1:48 pm
    Unless someone forces them to tell us what our losses would be as citizens you might want to rethink the nationialization. I believe from what I have been able to uncover they are too big to save. Since they no longer pose a risk of systemic failure we should bail out now and let them fail!

    How much does anyone really know? here..


    No longer a systemic risk here…


    It was a giant fraudulant ponzi scheme to begin with let them take their licks they will bankrupt us otherwise!

    Fraud here..


    Public Risk here..



  48. JackSparrow says:

    I worked in international reinsurance for a long time and have seen sideletters, backdating of contracts etc etc. on a number of occasions.

    As a matter of fact finite or financial reinsurance should not be considered illegal or fraudulent in the first place as long as these contracts are fully disclosed to regulators/auditors and are accounted for properly. I have personally tailored legitimate solutions for large international companies which were fully approved by regulators and vetted and accounted for per auditors instructions.

    As in many other areas of business there are always black sheep who cheat and commit fraud such as in the HIH Insurance case referred to in the article. Fortunately the investigation was thorough and some the culprits were imprisoned for their deceit.

    I hope to see similar actions by US courts.

  49. Chris Whalen says:

    To the post on CP hedging, I think some of the AIG CPs DID believe they were hedging, especially a lot of the “non-dealer” banks in the EU and Asia who face serious loss due to AIG. But the key question, to me, is whether it was reasonable for these CPs to do business with AIG in the first place. Many of the market participants I have interviewed on this issue concede that AIG was the dumbest guy in the room and that the dealers, who stood between the CPs on these trades and COLLECTED A COMMISSION ON EACH TRADE, knew that AIG was doomed. The dealers then ran to Uncle to get bailed out of their rancid CP risk exposure facing AIG at taxpayer expense.

    It is interesting to note that Hank Greenberg testified before Congress yesterday that the failure of AIG would not have been a huge, systemic event. — Chris

  50. Transor Z says:

    Hank Greenberg testified before Congress yesterday that the failure of AIG would not have been a huge, systemic event.

    Well, that was just an oblivious statement from Greenberg, wasn’t it? Both on the insurance side and the FP side. But, assuming he really believes that, perhaps it illustrates THE core problem: that no one in positions of power — companies, Congress, government agencies, auditors — took TBTF/systemic risk seriously over the past decade.

  51. fistynuts says:

    Buying buildings insurance with a ‘side letter’ saying I won’t claim and still paying the premium would be pretty stupid, especially if I can get the same insurance elsewhere for the same price without the waiver.

    AIG facilitated accounting manipulation with the ‘side letters’ given as examples, many banks facilitated Enrons transactions, but this facilitation was not fraudulent, and didn’t bankrupt the banks.

    In the fraud/incompetance debate, the risk was taken, if those in charge knew how big a bet it was, then they were fraudulent(although perhaps not in the legal sense unless they can be proven to have been deliberately misleading), if they didn’t, then they were incompetent.

    Damning in either case.

    This article however is poor, arguing for a pre determined conclusion, and showing a clear lack of understanding of the CDS market.

  52. Grumpy old coot says:

    Chris, way to libel an entire industry. Your explanation of how reinsurance works is naive and simplistic at best, and really plain wrong. Then you go on to say that most reinsurance transactions are shams and illegal, citing a couple of old, well known instances of a couple of bad actors and then implying everyone in the industry does the same thing. Shame on you.

    Like everywhere else in life, the majority of people are well meaning and ethical. And then there are the people who aren’t. It’s the way of the world unfortunately. I have worked in the reinsurance industry for over 30 years, and I am very proud of what I and my colleagues do for a living. Reinsurance performs an important function in the financing of risk – in it’s many variations, including finite risk. I also happen to know personnally the author of the FAI fax to Ajit Jain – he’s a bad actor, and would probably act in an unethical manner no matter what industry he worked in.

    I think the point of your article might have had a little more validity if you actually used facts instead of inuendos and smears. Nice try. You didn’t do it.

  53. davidgmills says:

    What if all the AIG CDSs had side letters and were never intended to be paid in the event of default?

    Imagine how much money might have been passed through AIG to banks who never would have even had the expectation of being paid for their loss?

  54. [...] if you haven’t read Chris Whalen’s stunning and exhaustive piece on AIG, reinsurance and CDS swaps, and side-letter fraud from earlier this month, you’re [...]