Grassley seeks transparency from AIG regarding use of Fed loan dollars

WASHINGTON – Senator Chuck Grassley has asked American International Group, Inc., AIG, to disclose its expenditures so far of the $123 billion lent by the Federal Reserve Bank in order to prevent the company from filing for bankruptcy.

Grassley based his inquiry on an October 30 New York Times story which is included here with his letter of inquiry.

Mr. Edward M. Liddy
Chairman and Chief Executive Officer
American International Group, Inc.
70 Pine Street
New York, NY 10270

Dear Mr. Liddy:

Today, a story in The New York Times reported that the American International Group,
Inc. (AIG) has already used $90 billion of the $123 billion lent to it by the Federal Reserve only
one month ago. The article also notes that AIG has refused to provide the public with a detailed
and transparent accounting of what that money has been used for, offering only that “some is
being used to shore up its securities-lending program, some to make good on its guaranteed
investment contracts, some to pay for day-to-day operations and […] tens of billions of dollars to
post collateral with other financial institutions.” AIG’s use of the Federal Reserve loans is of
great interest to the American people because they are footing the bill. Moreover, some experts
believe that AIG will need additional funding over and above the $123 billion the Federal
Reserve has already lent it.

As Ranking Member of the Senate Finance Committee, I request that you provide a
briefing to my Committee staff regarding this issue. In addition, please provide responses to the
following questions:

1) Please provide a full and detailed accounting of AIG’s $90 billion (or more) in expenditures
to date.

2) When does AIG anticipate using all of the $123 billion emergency loan it received?

3) How much more money does AIG believe it will need to borrow in the future?
4) When can American taxpayers expect AIG to repay the loan it received?

In cooperating with the Committee’s review, no documents, records, data, or other
information related to these matters, either directly or indirectly, shall be destroyed, modified,
removed, or otherwise made inaccessible to the Committee.

Sincerely,

Charles E. Grassley
United States Senator
Ranking Member of the Committee on Finance

A Question for A.I.G.: Where Did the Cash Go?

By MARY WILLIAMS WALSH

The American International Group is rapidly running through $123 billion in
emergency lending provided by the Federal Reserve, raising questions about
how a company claiming to be solvent in September could have developed
such a big hole by October. Some analysts say at least part of the shortfall
must have been there all along, hidden by irregular accounting.

“You don’t just suddenly lose $120 billion overnight,” said Donn Vickrey of
Gradient Analytics, an independent securities research firm in Scottsdale,
Ariz.

Mr. Vickrey says he believes A.I.G. must have already accumulated tens of
billions of dollars worth of losses by mid-September, when it came close to
collapse and received an $85 billion emergency line of credit by the Fed. That
loan was later supplemented by a $38 billion lending facility.

But losses on that scale do not show up in the company’s financial filings.
Instead, A.I.G. replenished its capital by issuing $20 billion in stock and debt
in May and reassured investors that it had an ample cushion. It also said that
it was making its accounting more precise.

Mr. Vickrey and other analysts are examining the company’s disclosures for
clues that the cushion was threadbare and that company officials knew they
had major losses months before the bailout.

Tantalizing support for this argument comes from what appears to have been
a behind-the-scenes clash at the company over how to value some of its
derivatives contracts. An accountant brought in by the company because of an
earlier scandal was pushed to the sidelines on this issue, and the company’s
outside auditor, PricewaterhouseCoopers, warned of a material weakness
months before the government bailout.

The internal auditor resigned and is now in seclusion, according to a former
colleague. His account, from a prepared text, was read by Representative
Henry A. Waxman, Democrat of California and chairman of the House
Committee on Oversight and Government Reform, in a hearing this month.

These accounting questions are of interest not only because taxpayers are
footing the bill at A.I.G. but also because the post-mortems may point to a
fundamental flaw in the Fed bailout: the money is buoying an insurer — and
its trading partners — whose cash needs could easily exceed the existing
government backstop if the housing sector continues to deteriorate.

Edward M. Liddy, the insurance executive brought in by the government to
restructure A.I.G., has already said that although he does not want to seek
more money from the Fed, he may have to do so.

Continuing Risk

Fear that the losses are bigger and that more surprises are in store is one of
the factors beneath the turmoil in the credit markets, market participants say.

“When investors don’t have full and honest information, they tend to sell
everything, both the good and bad assets,” said Janet Tavakoli, president of
Tavakoli Structured Finance, a consulting firm in Chicago. “It’s really bad for
the markets. Things don’t heal until you take care of that.”

A.I.G. has declined to provide a detailed account of how it has used the Fed’s
money. The company said it could not provide more information ahead of its
quarterly report, expected next week, the first under new management. The
Fed releases a weekly figure, most recently showing that $90 billion of the
$123 billion available has been drawn down.

A.I.G. has outlined only broad categories: some is being used to shore up its
securities-lending program, some to make good on its guaranteed investment
contracts, some to pay for day-to-day operations and — of perhaps greatest
interest to watchdogs — tens of billions of dollars to post collateral with other
financial institutions, as required by A.I.G.’s many derivatives contracts.

No information has been supplied yet about who these counterparties are,
how much collateral they have received or what additional tripwires may
require even more collateral if the housing market continues to slide.

Ms. Tavakoli said she thought that instead of pouring in more and more
money, the Fed should bring A.I.G. together with all its derivatives
counterparties and put a moratorium on the collateral calls. “We did that with
ACA,” she said, referring to ACA Capital Holdings, a bond insurance company
that filed for bankruptcy in 2007.

Of the two big Fed loans, the smaller one, the $38 billion supplementary
lending facility, was extended solely to prevent further losses in the securitieslending
business. So far, $18 billion has been drawn down for that purpose.

For securities lending, an institution with a long time horizon makes extra
money by lending out securities to shorter-term borrowers. The borrowers are
often hedge funds setting up short trades, betting a stock’s price will fall. They
typically give A.I.G. cash or cashlike instruments in return. Then, while A.I.G.
waits for the borrowers to bring back the securities, it invests the money.

In the last few months, borrowers came back for their money, and A.I.G. did
not have enough to repay them because of market losses on its investments.
Through the secondary lending facility, the insurer is now sending those
investments to the Fed, and getting cash in turn to repay customers.

A spokesman for the insurer, Nicholas J. Ashooh, said A.I.G. did not anticipate
having to use the entire $38 billion facility. At midyear, A.I.G. had a shortfall
of $15.6 billion in that program, which it says has grown to $18 billion.

Another spokesman, Joe Norton, said the company was getting out of this
business. Of the government’s original $85 billion line of credit, the company
has drawn down about $72 billion. It must pay 8.5 percent interest on those
funds.

An estimated $13 billion of the money was needed to make good on
investment accounts that A.I.G. typically offered to municipalities, called
guaranteed investment contracts, or G.I.C.’s.

When a local government issues a construction bond, for example, it places
the proceeds in a guaranteed investment contract, from which it can draw the
funds to pay contractors.

After the insurer’s credit rating was downgraded in September, its G.I.C.
customers had the right to pull out their proceeds immediately. Regulators say
that A.I.G. had to come up with $13 billion, more than half of its total G.I.C.
business. Rather than liquidate some investments at losses, it used that much
of the Fed loan.

For $59 billion of the $72 billion A.I.G. has used, the company has provided
no breakdown. A block of it has been used for day-to-day operations, a broad
category that raises eyebrows since the company has been tarnished by reports
of expensive trips and bonuses for executives.

The biggest portion of the Fed loan is apparently being used as collateral for
A.I.G.’s derivatives contracts, including credit-default swaps.

The swap contracts are of great interest because they are at the heart of the
insurer’s near collapse and even A.I.G. does not know how much could be
needed to support them. They are essentially a type of insurance that protects
investors against default of fixed-income securities. A.I.G. wrote this
insurance on hundreds of billions of dollars’ worth of debt, much of it linked
to mortgages.

Through last year, senior executives said that there was nothing to fear, that
its swaps were rock solid. The portfolio “is well structured” and is subjected to
“monitoring, modeling and analysis,” Martin J. Sullivan, A.I.G.’s chief
executive at the time, told securities analysts in the summer of 2007.

Gathering Storm

By fall, as the mortgage crisis began roiling financial institutions, internal and
external auditors were questioning how A.I.G. was measuring its swaps. They
suggested the portfolio was incurring losses. It was as if the company had
insured beachfront property in a hurricane zone without charging high enough
premiums.

But A.I.G. executives, especially those in the swaps business, argued that any
decline was theoretical because the hurricane had not hit. The underlying
mortgage-related securities were still paying, they said, and there was no
reason to think they would stop doing so.

A.I.G. had come under fire for accounting irregularities some years back and
had brought in a former accounting expert from the Securities and Exchange
Commission. He began to focus on the company’s accounting for its creditdefault
swaps and collided with Joseph Cassano, the head of the company’s
financial products division, according to a letter read by Mr. Waxman at the
recent Congressional hearing.

When the expert tried to revise A.I.G.’s method for measuring its swaps, he
said that Mr. Cassano told him, “I have deliberately excluded you from the
valuation because I was concerned that you would pollute the process.”

Mr. Cassano did not attend the hearing and was unavailable for comment. The
company’s independent auditor, PricewaterhouseCoopers, was the next to
raise an alarm. It briefed Mr. Sullivan late in November, warning that it had
found a “material weakness” because the unit that valued the swaps lacked
sufficient oversight.

About a week after the auditor’s briefing, Mr. Sullivan and other executives
said nothing about the warning in a presentation to securities analysts,
according to a transcript. They said that while disruptions in the markets were
making it difficult to value its swaps, the company had made a “best estimate”
and concluded that its swaps had lost about $1.6 billion in value by the end of
November.

Still, PricewaterhouseCoopers appears to have pressed for more. In February,
A.I.G. said in a regulatory filing that it needed to “clarify and expand” its
disclosures about its credit-default swaps. They had declined not by $1.6
billion, as previously reported, but by $5.9 billion at the end of November,
A.I.G. said. PricewaterhouseCoopers subsequently signed off on the
company’s accounting while making reference to the material weakness.

Investors shuddered over the revision, driving A.I.G.’s stock down 12 percent.
Mr. Vickrey, whose firm grades companies on the credibility of their reported
earnings, gave the company an F. Mr. Sullivan, his credibility waning, was
forced out months later.

The Losses Grow

Through spring and summer, the company said it was still gathering
information about the swaps and tucked references of widening losses into the
footnotes of its financial statements: $11.4 billion at the end of 2007, $20.6
billion at the end of March, $26 billion at the end of June. The company
stressed that the losses were theoretical: no cash had actually gone out the
door.

“If these aren’t cash losses, why are you having to put up collateral to the
counterparties?” Mr. Vickrey asked in a recent interview. The fact that the
insurer had to post collateral suggests that the counterparties thought A.I.G.’s
swaps losses were greater than disclosed, he said. By midyear, the insurer had
been forced to post collateral of $16.5 billion on the swaps.

Though the company has not disclosed how much collateral it has posted since
then, its $447 billion portfolio of credit-default swaps could require far more if
the economy continues to weaken. More federal assistance would then
essentially flow through A.I.G. to counterparties.

“We may be better off in the long run letting the losses be realized and letting
the people who took the risk bear the loss,” said Bill Bergman, senior equity
analyst at the market research company Morningstar.

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