AIG Had Early Warning from Government Regulators on Risk, Says House Chairman

By and | October 7, 2008

U.S. regulators sent a letter to American International Group Inc. in March warning of its lack of transparency and ability to oversee its financial products, a top Democratic lawmaker said Tuesday.

Rep. Henry Waxman, who chairs the House Oversight and Government Committee, revealed the letter from the Office of Thrift Supervision (OTS) and a warning by AIG’s accountants about material weaknesses at a hearing into the insurer’s near-collapse and federal bailout last month.

“We are concerned that the corporate oversight of AIG Financial Products … lacks critical elements of independence, transparency, and granularity,” read Waxman, of California, from the March 10 OTS letter.

U.S. lawmakers are holding a series of hearings to probe the causes of the financial crisis and to propose changes to the regulatory system.

AIG’s woes led the Federal Reserve Bank of New York on Sept. 16 to lend up to $85 billion to the cash-strapped insurer over two years in exchange for a 79.9 percent equity stake.

Lawmakers, mostly Democrats, expressed outrage at perks AIG executives enjoyed less than a week after the bailout, including a spa retreat where AIG racked bills for $200,000 for hotel rooms and $23,000 for spa services.

“They were getting facials, manicures, and massages, while the American people were footing the bill,” said Rep. Elijah Cummings, a Maryland Democrat on the oversight panel.

Republicans, as they did on Monday at a hearing with of Lehman Brothers chief executive Richard Fuld, tried to focus the attention to housing finance companies Fannie Mae and Freddie Mac, that were seized by the government in September.

Some Republicans are calling for a special counsel or the Justice Department to examine the companies’ role in the financial chaos. Waxman said his committee will hold a hearing on Fannie and Freddie’s role.

INTERNAL DOCUMENTS

The congressional panel had combed thousands of pages of internal documents produced by AIG and former executives.

Minutes from a compensation committee meeting in March say then CEO Martin Sullivan urged exclusion of the money-losing AIG financial products unit when calculating executives’ bonuses.

The committee approved the change, according to Waxman.

The congressional found also that an AIG auditor was excluded from a review process because then financial products division executive Joseph Cassano worried he would “pollute” it. Auditor Joseph St. Denis, who later resigned in protest and lost his own bonus, expressed concerns about AIG’s valuation of its financial products liabilities.

Lynn Turner, a former Securities and Exchange Commission chief accountant, told lawmakers that the company failed to be open about problems it was facing even when it had hints it was in trouble.

“If you go back at the filings, at the third quarter filing … you don’t see any notion for the fact that this company doesn’t have the necessary model to value this stuff. … no indication that you don’t have controls,” said Turner.

The letter from OTS, a division of the Treasury Department, and addressed to AIG’s board, said “a material weakness exists within corporate management’s oversight of (the company’s financial products unit) super senior Credit Default Swap (CDS) valuation process and financial reporting.”

“You’ve got this thing that may all of a sudden blow up… that is the disclosure that just I cannot find in these filings,” Turner said.

DINALLO CALLS FOR BANKING, DERIVATIVE REFORM

A big part of AIG’s losses stem from its exposure to the market for credit-default swaps, used to protect against the risk that a borrower will default on its debt.

Eric Dinallo, head of New York State’s insurance regulator which oversees AIG, said lawmakers should revisit regulating the swaps.

Dinallo also said lawmakers should seriously consider revising the Gramm-Leach-Bliley law, which broke down barriers between investment and commercial banks, letting them to combine in new ways under one umbrella.

Some blame the landmark 1999 law for contributing to the financial mess.

“I would take a serious look at Gramm-Leach-Bliley… and whether the supermarket of financial services is worth it when things kind of smell in aisle six,” Dinallo said.

In prepared testimony, former AIG Chief Executives Hank Greenberg and Robert Willumstad blamed short sellers, fair value accounting standards and credit agencies’ for the company’s problems.

Greenberg left in 2005 following an accounting scandal for which he has denied any wrongdoing. He was AIG’s largest individual shareholder before the federal bailout.

Willumstad was CEO from June 15 until mid-September, when the government put together the rescue package. Sullivan, who was CEO before Willumstad for three years, also blamed accounting standards for AIG’s troubles in his testimony.

(Reporting by Rachelle Younglai, Kim Dixon, Diane Bartz; Editing by Lisa Von Ahn and Tim Dobbyn)

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