Tavakoli: The Truth Behind the Losses and the AIG Bonuses

Janet Tavakoli just sent me an email on the AIG Bonus payouts:

[In the NYT article], Mr. Liddy said the company had entered into the bonus agreement in early 2008 before AIG got into severe financial straights and was forced to obtain a government bailout last fall. In the fourth quarter of 2008, AIG lost $61.7 billion, but it was in trouble long before that due to AIG Financial Products Group, even if AIG did not own up to it at the time.

The bulk of the bonus payments are to the troubled AIG Financial Products Group. Yet, this group had problems as far back as the second quarter of 2007, and AIG was in severe financial straights long before the first quarter of 2008.

In August of 2007, I challenged AIG’s accounting saying they had large unreported losses. I was challenging AIG’s earnings for the second quarter of 2007, and contrary to Liddy’s representations in the above article, AIG had grave concerns by the first quarter of 2008.

In her book, Dear Mr. Buffett , in Chapter 10 Tavakoli wrote:

AIG wrote credit default protection on a whopping $19.2 billion “safe” investment that had exposure to subprime loans...By August 2007, the prices of the collateral backing the super senior had tanked. Anyone who buys insurance knows that even if you are “safe,” if you are in a high risk category, your cost of insurance goes up. If AIG were to pay someone to take over its insurance-like obligation, AIG would have to pay more than it had received, and AIG should have shown this as a loss.

AIG’s stance seemed bizarre given that five insurance executives from AIG and Berkshire Hathaway’s Gen Re Corp (even Warren Buffett cannot control every action of every employee) were under investigation (and eventually found guilty) of conspiracy to inflate AIG’s reserves and mislead investors about AIG’s earnings.

I told Dave Reilly at the Wall Street Journal: “There’s no way these aren’t showing a loss.” That is simply a market reality. This is Wall Street speak for: In my humble opinion, you are a big fat liar. AIG responded: “We disagree.” That is Wall Street speak for: No, YOU are a big fat liar! [In her email to me Tavakoli notes this was August 2007]

Before Dave Reilly wrote his article, he talked to experts, including me, for background. Then he called AIG to ask them for their thinking. AIG stood firm. Then Reilly called me again. He didn't want the Wall Street Journal to look stupid, but told me “they pay me to go out on a limb.” He said he needed me to go on the record. It would make the article more forceful. I did not think that AIG would tell Reilly: You know, you have a point, maybe we should recheck our homework, but I did not anticipate arguing with AIG in the Wall Street Journal’s “Heard on the Street” column. I hesitated. AIG, a large global conglomerate, has the resources to crush me like a bug. On the other hand, I am not fat. I finally agreed to go on the record.

By June 2008, AIG recorded two back-to-back quarters of its largest losses ever. AIG took more than $20 billion in write-downs on its derivative positions through the first quarter of 2008; net losses for the fourth quarter of 2007 were $5.3 billion, and in the first quarter of 2008, AIG reported losses of $7.8 billion. In February 2008, its auditor said it found “material weakness” in AIG’s accounting.

UPDATE: Tavakoli has now posted to her web site details of the email she sent. There's plenty of other good stuff at her web site, also.