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THE CAUSES AND EFFECTS OF THE AIG BAILOUT

HEARING

BEFORE THE

COMMITTEE ON OVERSIGHT

AND GOVERNMENT REFORM

HOUSE OF REPRESENTATIVES

ONE HUNDRED TENTH CONGRESS

SECOND SESSION

OCTOBER 7, 2008

Serial No. 110–208

Printed for the use of the Committee on Oversight and Government Reform

(

Available via the World Wide Web: http://www.gpoaccess.gov/congress/index.html

http://www.house.gov/reform

(II)

COMMITTEE ON OVERSIGHT AND GOVERNMENT REFORM

HENRY A. WAXMAN, California, Chairman

EDOLPHUS TOWNS, New York

PAUL E. KANJORSKI, Pennsylvania

CAROLYN B. MALONEY, New York

ELIJAH E. CUMMINGS, Maryland

DENNIS J. KUCINICH, Ohio

DANNY K. DAVIS, Illinois

JOHN F. TIERNEY, Massachusetts

WM. LACY CLAY, Missouri

DIANE E. WATSON, California

STEPHEN F. LYNCH, Massachusetts

BRIAN HIGGINS, New York

JOHN A. YARMUTH, Kentucky

BRUCE L. BRALEY, Iowa

ELEANOR HOLMES NORTON, District of

Columbia

BETTY MCCOLLUM, Minnesota

JIM COOPER, Tennessee

CHRIS VAN HOLLEN, Maryland

PAUL W. HODES, New Hampshire

CHRISTOPHER S. MURPHY, Connecticut

JOHN P. SARBANES, Maryland

PETER WELCH, Vermont

JACKIE SPEIER, California

TOM DAVIS, Virginia

DAN BURTON, Indiana

CHRISTOPHER SHAYS, Connecticut

JOHN M. MCHUGH, New York

JOHN L. MICA, Florida

MARK E. SOUDER, Indiana

TODD RUSSELL PLATTS, Pennsylvania

CHRIS CANNON, Utah

JOHN J. DUNCAN, JR., Tennessee

MICHAEL R. TURNER, Ohio

DARRELL E. ISSA, California

KENNY MARCHANT, Texas

LYNN A. WESTMORELAND, Georgia

PATRICK T. MCHENRY, North Carolina

VIRGINIA FOXX, North Carolina

BRIAN P. BILBRAY, California

BILL SALI, Idaho

JIM JORDAN, Ohio

PHIL BARNETT, Staff Director

EARLEY GREEN, Chief Clerk

LAWRENCE HALLORAN, Minority Staff Director

(III)

C O N T E N T S

Page

Hearing held on October 7, 2008 ............................................................................ 1

Statement of:

Dinallo, Eric R., superintendent, New York State Insurance Department;

and Lynn E. Turner, former Chief Accountant, Securities and Exchange

Commission ................................................................................................... 6

Dinallo, Eric R. .......................................................................................... 6

Turner, Lynn E. ......................................................................................... 17

Sullivan, Martin J., former chief executive officer, AIG; and Robert B.

Willumstad, former chief executive officer, AIG ........................................ 83

Sullivan, Martin J. .................................................................................... 83

Willumstad, Robert B. ............................................................................... 91

Letters, statements, etc., submitted for the record by:

Braley, Hon. Bruce L., a Representative in Congress from the State

of Iowa, article dated September 9, 2008 .................................................... 135

Dinallo, Eric R., superintendent, New York State Insurance Department,

prepared statement of ................................................................................... 9

McCollum, Hon. Betty, a Representative in Congress from the State

of Minnesota, article dated September 28, 2008 ........................................ 59

Sullivan, Martin J., former chief executive officer, AIG, prepared statement of ........................................................................................................... 86

Turner, Lynn E., former Chief Accountant, Securities and Exchange Commission, prepared statement of .................................................................... 20

Waxman, Hon. Henry A., a Representative in Congress from the State

of California:

Letter dated October 4, 2008 .................................................................... 101

Letter dated October 7, 2008 .................................................................... 148

Prepared statement of Mr. Greenberg ..................................................... 151

Willumstad, Robert B., former chief executive officer, AIG, prepared

statement of ................................................................................................... 93

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THE CAUSES AND EFFECTS OF THE AIG

BAILOUT

TUESDAY, OCTOBER 7, 2008

HOUSE OF REPRESENTATIVES, COMMITTEE ON OVERSIGHT AND GOVERNMENT REFORM, Washington, DC.

The committee met, pursuant to notice, at 10:04 a.m., in room

2154, Rayburn House Office Building, Hon. Henry A. Waxman

(chairman of the committee) presiding.

Present: Representatives Waxman, Maloney, Cummings,

Kucinich, Tierney, Watson, Higgins, Yarmuth, Braley, Norton,

McCollum, Van Hollen, Sarbanes, Welch, Speier, Davis of Virginia,

Shays, Mica, Souder, Turner and Bilbray.

Staff present: Kristin Amerling, general counsel; Russell Anello

and Stacia Cardille, counsels; Caren Auchman, press assistant;

Alvin Banks, staff assistant; Phil Barnett, staff director and chief

counsel; Jen Berenholz, deputy clerk; Zhongrui ‘‘JR’’ Deng, chief information officer; Ali Golden, investigator; Michael Gordon, senior

investigative counsel; Earley Green, chief clerk; Karen Lightfoot,

communications director and senior policy advisor; David Rapallo,

chief investigative counsel; Leneal Scott, information systems manager; Roger Sherman, deputy chief counsel; Mitch Smiley, special

assistant; Lawrence Halloran, minority staff director; Jennifer

Safavian, minority chief counsel for oversight and investigations; A.

Brooke Bennett, minority counsel; Brien Beattie, Molly Boyl, Alex

Cooper, Adam Fromm, and Todd Greenwood, minority professional

staff members; Larry Brady, John Cuaderes, and Nick Palarino,

minority senior investigators and policy advisors; Patrick Lyden,

minority parliamentarian and Member services coordinator; and

Brian McNicoll, minority communications director.

Chairman WAXMAN. The committee will please come to order.

Today we’re holding our second day of hearings on the financial crisis in Wall Street. Yesterday we examined the collapse of Lehman

Brothers. Our focus today is AIG.

There are obvious differences between Lehman and AIG. Lehman

is an investment bank. AIG is an insurance company. Lehman fell

because it placed highly leveraged bets in the subprime and real

estate markets. AIG’s problems originate in the complex derivatives called credit default swaps. But their stories are fundamentally the same.

In each case, the companies and their executives grew rich by

taking on excessive risk. In each case, the companies collapsed

when these risks turned bad. And in each case, their executives are

walking away with millions of dollars while taxpayers are stuck

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with billions of dollars in costs. The AIG CEOs are like the Lehman CEO in one other respect: In each case, they refused to accept

any blame for what happened to their companies.

In preparation for this hearing, the committee has received tens

of thousands of pages of documents from AIG. Our review of the

documents raises three fundamental sets of questions. Answering

these questions will be the focus of today’s hearing.

The first set of questions is whether AIG’s executive compensation practices were fair and appropriate. AIG has a Seniors Partners Plan that provides cash bonuses for its 70 executives. These

are the top 70 executives. This plan is supposed to be performance

based. In 2005, AIG’s CEO, Martin Sullivan received $2.7 million

under this plan. In 2006, his first full year as CEO, he received

$5.7 million under the plan. These payments are not in question.

Both years were good years for AIG, and as CEO, Mr. Sullivan naturally was well rewarded. 2007 is a completely different story. AIG lost over $5 billion in

the final quarter of 2007 due to the losses attributable to its Financial Products Division called AIG-FP. Under the terms of the Senior Partners Plan, Mr. Sullivan and the other top executives should

have had their bonuses slashed due to poor performance. But when

the compensation committee met on March 11, 2008, the award bonuses for 2007, Mr. Sullivan urged the committee to ignore the

losses from the Financial Products Division in calculating his

bonus and the bonuses of the other top executives. We obtained a

copy of the minutes from that meeting, and here’s what they say:

Mr. Sullivan next presented management’s recommendation with

respect to the earn-out for the Senior Partners Plan, suggesting

that the AIG-FP unrealized market valuation losses be excluded

from the calculation. The board approved this change in the Senior

Partners Plan, ignored the losses from the Financial Products Division, and gave Mr. Sullivan a cash bonus of over $5 million. Today

we’ll ask what could possibly justify this change in the compensation formula.

There are other compensation questions we will also ask. In

March, the board approved a new compensation contract for Mr.

Sullivan that gave him a golden parachute worth $15 million. We

will ask why that was in the interest of the shareholders. And we

will ask about the compensation of Joseph Cassano who was the

executive in charge of the Financial Products Division. Mr. Cassano

was well compensated by AIG. He received more than $280 million

over the last 8 years. After his division imploded, AIG terminated

him without cause in February and did not seek to recover any of

Mr. Cassano’s compensation. Instead, AIG allowed him to keep up

to $34 million in unvested bonuses and put him on a $1 milliona-month retainer. Last month the taxpayers bought out AIG in an

$85 billion bailout. This was a direct result of the mistakes made

by Mr. Cassano. Yet even today he remains on the company payroll, receiving $1 million a month.

The Federal bailout occurred on September 16. Less than 1 week

later AIG held a week-long retreat for company executives at the

exclusive St. Regis resort in Monarch Beach, California. And we

have a photograph on display of that resort. Rooms at this resort

can cost over $1,000 per night. Invoices provided to the committee

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show that AIG paid the resort over $440,000 including nearly

$200,000 for rooms, over $150,000 for meals, and $23,000 in spa

charges.

Well, average Americans are suffering economically. They’re losing their jobs, their homes and their health insurance. Yet less

than 1 week after the taxpayers rescued AIG, company executives

could be found wining and dining at one of the most exclusive resorts in the Nation. We’ll ask whether any of this makes any sense.

The second set of questions we’ll ask is whether Mr. Sullivan and

Robert Willumstad are right when they say they bear no responsibility for the collapse of AIG. Mr. Sullivan was CEO from March

2005 to June 2008. Mr. Willumstad was his successor. He joined

the AIG board in January 2006 and has served as chairman from

November 2006 until he was named CEO in June 2008. According

to their testimony, AIG failed because it was caught in a vicious

cycle and hit by a global financial tsunami. Mr. Willumstad says,

‘‘I don’t believe AIG could have done anything differently.’’

The information we received paints a different picture. We have

obtained a confidential letter from the Office of Thrift Supervision

to AIG’s general counsel. In this March 10, 2008 letter, the Office

of Thrift Supervision writes, ‘‘we are concerned that the corporate

oversight of AIG Financial Products lacks critical elements of independence, transparency and granularity.’’ Internal documents show

that AIG’s auditor, PricewaterhouseCoopers, reported similar problems. Minutes from a meeting of the board’s audit committee in

March 2008 revealed that PricewaterhouseCoopers told the committee that the root cause of AIG’s problems was that risk control

groups did not have appropriate access to the Financial Products

Division.

As part of our investigation, the committee requested information

from a former AIG auditor Joseph St. Denis. Mr. St. Denis was a

senior SEC enforcement official who was hired by AIG to address

its ongoing accounting problems. But when he expressed concerns

about how the Financial Products Division was valuing its liabilities, Mr. Cassano told him, ‘‘I have deliberately excluded you from

the valuation because I was concerned that you would pollute the

process.’’

Ultimately, Mr. St. Denis resigned in protest. As he explains, Mr.

Cassano took actions that I believe were intended to prevent me

from performing the job duties for which I was hired. Unlike Mr.

Cassano and Mr. Sullivan, Mr. St. Denis’s actions cost him his

bonus.

There are other questionable actions by Mr. Sullivan and Mr.

Willumstad. As losses were mounting and resources were getting

scarce, AIG depleted its capital by over $10 billion through stock

buybacks and rising dividend payments. This prompted shareholders to write the board, ‘‘the management and board inexcusably

and inexplicably raised the dividend while simultaneously issuing

expensive preferred stock at a discount.’’

And finally, we’ll ask whether AIG and in particular Mr. Sullivan

misled investors and the public about the financial conditions of

the company. On December 5, 2007, Mr. Sullivan told investors,

‘‘we are confident in our marks and the reasonableness of our valuation methods. We have a high degree of certainty in what we have

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booked to date.’’ What Mr. Sullivan didn’t tell investors was that,

on November 29th, 1 week earlier, PricewaterhouseCoopers had

raised their concerns about Mr. Sullivan, informing him that PWC

believed that AIG could have a material weakness relating to the

risk management of these areas.

There is one witness who should be here today but who will be

missing, Maurice ‘‘Hank’’ Greenberg, the long-time CEO of AIG.

Mr. Greenberg blames Mr. Sullivan and Mr. Willumstad for the

downfall of AIG. Many others think it is Mr. Greenberg who sowed

the seeds that led to AIG’s failure. Regrettably Mr. Greenberg has

told the committee that he is too ill to appear today to answer

questions.

There is a lot of ground for this committee to cover today. We

will probe AIG’s executive compensation arrangements, the leadership of its top officials and the veracity of their public statements.

Our goal is to examine the details of AIG’s fall so that we can learn

lessons about the reforms needed to restore stability to our financial markets.

Like all of our witnesses, Mr. Sullivan and Mr. Willumstad know

we will ask hard questions. I also want them and our other witnesses to know that we appreciate their cooperation and appearance before the committee today.

Before yielding to Mr. Shays, who will deliver the statement on

behalf of the Republicans, I do want to announce that the request

that we have received to look at Fannie Mae and Freddie Mac,

which is an investigation already underway, will be pursued in conjunction with the minority on the committee. And we will look at

holding a hearing on those two as well as the other hearings that

we have scheduled.

Mr. Shays, I want to recognize you at this time.

Mr. SHAYS. Thank you, Mr. Chairman.

Today we consider the case of the American International Group,

AIG, a global insurance conglomerate saved from insolvency by an

$85 billion loan from American taxpayers. As part of the deal, we,

the American taxpayers, own a controlling stake in the company.

In these bailouts, the U.S. Treasury is now in the business of picking winners and losers as the global economy struggles to purge

the toxins of speculative greed polluting capitalism’s bloodstream.

We need to understand what makes a private company like AIG

too big to fail and what drew such a large and venerable enterprise

to the brink of failure.

In the search for causes, all roads lead to the housing market,

dominated by the Federal National Mortgage Association, Fannie

Mae, and the Federal Home Loan Mortgage Corporation, Freddie

Mac. Without question, mortgage-backed assets sliced and diced

and scattered throughout the financial system lie at the epicenter

of the economic earthquake shaking world markets. Ripples from

defaults on subprime loans underwritten by Fannie and Freddie

grew to a tsunami that helped swamp Lehman Brothers and others, including AIG. And Fannie and Freddie were able to launch

more than $1 trillion, $1 trillion of bad paper into the private market because regulators and Congress let them do it.

This committee cannot conduct a credible examination of the current crisis without focussing on the market distorting power of the

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Federal mortgage giants and the firewall against reform, manned

by their enablers here in Congress.

No one is disputing the committee’s focus on executive pay. We

agree; company compensation is a telling indicator of a corporate

culture detached from larger market realities and the fundamental

fiduciary duty to be frugal stewards of other people’s money. And

that ‘‘me first’’ self-indulgence was just as rampant at Fannie Mae

as in its private sector partners and competitors.

From 1998 to 2003, Fannie Mae CEO Franklin Raines alone took

over $90 million in salary and bonuses. The Raines team was even

caught manipulating accounting practices to overstate profitability

so they could grab what their overseer called, ‘‘ill-gotten bonuses’’

in the hundreds of millions of dollars. The Fannie Mae board gave

recently ousted CEO Daniel Mudd a $2.6 million bonus in 2005 on

top of his $3.5 million salary based on a set of nonfinancial goals,

such as promoting respect, appropriate and productive relationship

with regulators. In the context of a $6 trillion mortgage securities portfolio, those

paydays may seem like small change, but it’s indicative of a prevalent and noxious rot that threatens the moral underpinnings of the

entire capitalist business model. So we need to keep the toxic

twins, Fannie and Freddie, at the center of this investigation, not

on the edge, not out in the future but right now.

Yesterday we sent a formal request to the chairman asking for

a specific commitment to make the Federal mortgage companies a

priority in this hearing, not after afterthought. We can’t wait until

Halloween to unmask these two failed monsters of mortgage finance.

As for AIG, I’m interested in learning more about the corporate

decisionmaking that took a solid insurance business into the far

less stable world of credit default swaps and other exotic derivatives. They thought they were selling insurance, when in fact they

were betting the company’s soul in a high stakes game of Russian

roulette. We need to ask what AIG knew about the risk behind

these novel products, when they knew the bet soured, and how

they informed investors, policyholders, regulators and the public

that the company was in peril. AIG, like Fannie Mae and Freddie

Mac, was considered too big to fail.

Going forward we need to grapple with the implications of the

concept, government will be there to break the fall of some large

businesses but not others. It’s been said, capitalism without failure

is like religion without sin. Any doctrine loses its moral authority

when bad conduct is rewarded and the consequences of poor choices

are foisted on someone else. Investigating the causes and effects of

this financial debacle should involve assigning capability, culpability, and restoring integrity and balance to the system of risks, rewards, and penalties our society uses to assign value to labor, capital, and commerce.

Thank you, Mr. Chairman.

Chairman WAXMAN. Thank you very much, Mr. Shays.

Chairman WAXMAN. For our first panel, we’ll hear from Lynn

Turner, who served as Chief Accountant of the Securities and Exchange Commission from 1998 to 2001. He has served on the

boards of public companies as a professor of accounting, as a partVerDate 11-MAY-2000 14:00 May 25, 2010 Jkt 000000 PO 00000 Frm 00009 Fmt 6633 Sfmt 6633 U:\DOCS\55767.TXT KATIE PsN: KATIE
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ner in an auditing firm and as the managing director of a research

firm. He is currently a senior advisor at Kroll, Inc.

Eric Dinallo currently serves as the superintendent of the New

York State Insurance Department. From 1999 to 2003, he served

as the chief of the Securities Bureau at the New York State Attorney General’s Office. Mr. Dinallo has also served as general counsel

at a large insurance broker and as managing director for regulatory affairs at Morgan Stanley.

We’re pleased to welcome both of you to our hearing this morning. It’s the practice of this committee that all witnesses that testify before us do so under oath. So I would like to ask if you would

stand and raise your right hands.

[Witnesses sworn.]

Chairman WAXMAN. The record will indicate that both of the witnesses answered in the affirmative.

You have given us prepared statements, some quite lengthy. And

I want you to know that all of those statements, both of those prepared statements will be in the record in its entirety. What we

would like to ask you to do is try to be mindful of 5 minutes that

we allocate to the oral presentation. We won’t cut you off if you exceed 5 minutes, but we will have a clock in front of you that will

be green for 4 minutes. For the last minute, it will turn yellow.

After 5 minutes, it will turn red. And then we would like you to

then wind down your presentation.

Mr. Dinallo, why don’t we start with you.

STATEMENTS OF ERIC R. DINALLO, SUPERINTENDENT, NEW

YORK STATE INSURANCE DEPARTMENT; AND LYNN E. TURNER, FORMER CHIEF ACCOUNTANT, SECURITIES AND EXCHANGE COMMISSION

STATEMENT OF ERIC R. DINALLO

Mr. DINALLO. Thank you, Chairman. Thank you, Chairman.

It’s an honor to be here. I’m here to try to explain, from our perspective, a little bit about what happened at AIG and what the

New York State Insurance Department’s role in that was.

The Insurance Department regulates certain insurance companies. I think that’s a very important distinction to make at the beginning. AIG was not strictly an insurance company, as was said

earlier. It was probably the largest financial services company in

the world. And in fact, I think its economic activity on the financial

services side exceeded its economic activity on the insurance side.

I agree that a large number of the problems there were due to

credit default swaps and collateralized debt obligations stemming

from subprime and the mortgage industry. But that activity was

largely, if not exclusively, done out of Financial Products Division,

which was sort of a subsidiary of the holding company.

The most immediate problem that got our attention was the

pending downgrade of the company. So one of the rating agencies

had threatened on I think it was September, I don’t know, 9th or

so to downgrade the company. That’s when I received a call from

the general counsel and the former CFO asking if we would be able

to help provide certain liquidity through the insurance subsidiaries,

which were very solvent and well capitalized. For the time before

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that, we had been monitoring the situation but it was a monitoring

of the situation based on the declining stock price of the company

and our wanting to confirm that the insurance subsidiaries were

solvent and policyholders were protected.

So it was in those conditions that we showed up at the company

on Friday, Saturday and Sunday, the long weekend, which went

into Monday and Tuesday at the Federal Reserve where different

private solutions were looked at. The history is well written now

in the press. But I can answer questions about that.

But the solvency problem was fine. The liquidity problem kept on

growing over the weekend. And the hole looked larger and larger.

And whatever we could have done through New York State, which

the Governor of New York, David Paterson, had authorized us to

try to help do, became not enough, and we ended up with a larger

and larger liquidity holder problem.

We were there to validate the concerns of the company, which

were true. We were also there I think to validate for the Federal

Reserve that there was real solvency and capital in the insurance

companies which was what the bedrock of the transaction was. In

other words, the $85 billion could not have been loaned if there was

not any hope of getting the money back, and to a large extent

whatever returns there are going to be is because of the robustness

of the insurance company.

To a large extent, I agree. I think that AIG got well away from

its core competency of insurance. It went into very complex instruments called credit default swaps, which I can explain some of the

basics as I’ve been asked. But overall, the State regulation of it, I

think, worked quite well. It is a lesson for us to talk about, I hope,

about what is the right way to regulate holding company undertakings.

There were 71 U.S. insurance companies. As I said, without

them, there would not have been a bailout. But to an almost exclusive extent, the problem was caused by activities conducted out of

Financial Products. Those activities were largely through the writing of credit default swaps. They are a legitimate need for hedging

of risk, which was the beginning of credit default swaps probably

in the 1980’s. It’s where you own a bond, let’s just say, you own

Ford bonds. And you want to hedge your risk that Ford is going

to default on those bonds, so you go to a third party and you ask

them to essentially insure you against that default. That’s the

swap. That’s the part of the swap. You’re swapping the risk of the

default with a third a party. That is called hedging also. And it is

often also called insurance in the sense you are buying insurance

against the default of the bond.

But I think that the committee should know that is now only

about 10 percent or so of credit default swaps that are outstanding

in the world. There are probably over $60 trillion of credit default

swaps. An overwhelmingly high percentage are what I termed a

couple months ago naked credit default swaps. What that means

is you enter into a contract with a party. Neither of you own any

exposure to Ford. You’re just taking a bet. You’re taking a gamble

on whether Ford is going to default or enter into bankruptcy or not.

It’s a form of shorting. It’s the way we short the credit-worthiness

of our industries. It is far larger than the equity shorting—and

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you’ve heard about naked shorting in the equities market and how

Chairman Cox asked to have that prohibited and did.

It’s interesting that on the bond side, on the credit-worthiness

side, we’ve permitted this to run completely unchecked to the point

that it is larger than the entire economic output of the world annually. That’s where we are on credit default swaps.

And the Governor has said that he’s willing to regulate the piece

that we can, which is the insurance piece, that original 10 percent

we can easily call an insurance product. We can regulate that because it is an insurance transaction as I described. You own the

bonds. You have exposure. You’re not going to the track and placing a bet, and that’s when you get your exposure. And we can do

that. And the Governor has announced that as of January 1st, if

there is not a more holistic solution through a central counterparty clearing or an exchange or some kind of clearing house that

the Governor and the insurance department is willing to do that

to help sort of clarify what Chairman Cox called the regulatory

black hole of credit default swaps.

I will note, just because I’m in front of Congress and maybe this

is helpful, that it required the Commodity Futures Modernization

Act of 2000 which I believe was a statute passed by Congress to

exempt credit default swaps, the naked kind that I described, from

being subject to the gaming laws of the various States and to what

are called the bucket shop laws. That is a very—it’s kind of funny,

but it is kind of funny. I could read to you that there’s a law that’s

directly on point that prohibits that kind of activity, entering into

this agreement without any exposure to the reference. And it required the CFMA to say that’s not gambling. And likewise, as

Chairman Cox pointed out, it also was required that it be not a security, otherwise it would have been regulated by the SEC.

So the CFMA both in one fell swoop said CDSs are not a security, and they’re also not subject to the gaming laws of the land.

And I think when you talk about moral hazard and the way they

got it right in the 1920’s, which is the law I’m referencing, 1907,

they probably understood some things then that we sort of forgot

along the way. And now we’re $63 trillion to the worse. Later on,

I can read you if you’d like, but it’s pretty well established, and I

think it’s something that we should at least examine along with

whether Glass-Steagall was such a mistake or not and other ways

that we sort of protect our depository institutions, like insurance

companies and commercial banks, from attendant activities at the

holding company level.

Thank you very much.

[The prepared statement of Mr. Dinallo follows:]

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Chairman WAXMAN. Thank you, Mr. Dinallo.

Mr. Turner.

STATEMENT OF LYNN E. TURNER

Mr. TURNER. Thank you, Chairman Waxman, committee members.

I think this is a very important hearing in light of the fact that

we’re watching millions of Americans lose their jobs. They’ve lost

their homes. Now, as we watch the stock market come down,

they’re also losing their savings. Much of this is destruction and

devastation I think that could have, and quite frankly should have,

been avoided.

Chairman WAXMAN. Could you pull the mic a little closer to you?

There is a button on the base.

Mr. TURNER. It is on. Is that better?

Put it in the words of philosopher George Santana, those who

cannot remember the past are condemned to repeat it. And certainly we fall in that category today.

AIG serves as a reminder, an unfortunate but excellent example

of what is wrong with our financial system today. While there are

many capital participants that have operated within sound business, ethical, and legal boundaries, there have been far too many

that have not. We began the decade with the mess around names

such as Enron and WorldCom, followed by the Wall Street analyst

scandal, then on to mutual fund late trading and market timing,

then the stock option backdating at such companies as United

Health, and now we find ourselves in the midst of the biggest and

by far and away the most destructive of all, the subprime fiasco.

This is a crisis that could have and, in my opinion, should have

been averted before it cost the American taxpayers what appears

to be in excess of a trillion dollars before we’re all said and done

with it. And certainly there’s plenty of blame to go around. All of

us I think probably share in that to some degree. But I hope the

focus of Congress and this committee would be, on a bipartisan

basis, holding hearings that, much like an investigation occurs

when a plane crash goes down, determines what went wrong and

then promptly turns around and fixes it so we don’t repeat history.

From my perspective, some of the causes of this economic crisis

include executives and mortgage brokers engaging in unsound if

not illegal business practices, compensation and incentives resulting in some business executives being paid both coming and going

as they walk away from the equivalent of quite frankly a train

wreck with huge severance packages that their corporate boards

actually agreed to; accounting standard setters who failed to provide the markets with the necessary transparency; woefully inadequate due diligence by investment banks underwriting the securities; cheap debt set up by our monetary policy people that created

low interest rates and led to tremendous leverage in debt in this

country; as Eric mentioned, a $62 trillion unregulated credit derivative market which had absolutely no transparency whatsoever;

the SEC being handcuffed by a lack of resources, lack of regulatory

authority and changes in policy that no doubt have hampered enforcement; the lack of a regulator that could regulate at the holding

company level for national and global insurance companies; and

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the failure of the Federal Reserve and banking regulators whose

exams failed to identify and rectify unsound lending practices at institutions such as IndyMac, WaMu, Countrywide, and Citigroup,

and often these practices led to what is our fundamental problem,

loans got made that people could not repay.

In addition, policymakers and regulators have allowed financial

institutions to merge and grow into colossal entities that have

shown they can have a devastating impact on our economy when

they get into trouble. Some are arguing that, as we’ve heard,

they’re now too large to fail. And with their failure now, though,

resulting in taxpayers paying hundreds of billions to rescue them,

it’s time to examine good public policy to ensure that regulation of

these entities provide much greater transparency, freedom from

some of the conflicts we’ve seen, accountability for their actions and

oversight.

Investor confidence is paramount to the success of any capital

market. And transparency is what creates that confidence. Indeed,

it is the lifeblood of any capital market system. When people believe they can no longer trust those for whom they invest their

money, they withdraw it quickly and find safer havens for it, as

we’re seeing today. And when they demand their money back from

a financial institution for fear of losing it, it can cause a serious

liquidity crisis and failure, as we’ve seen at Bear Stearns, Lehman,

and others. And as the money dries up and demand for the investment of the stock in these institutions falls, so does their stock

price, making capital difficult if not impossible to raise. It’s a vicious cycle. But it is one that has occurred many times in the past.

More specifically, with respect to AIG, there has been, in my

opinion, poor management and governance that has led to a poor

tone at the top and lack of risk management controls. I heard the

chairman talk about Mr. St. Denis and his concerns. Mr. St. Denis

worked for me at the SEC. He worked for me when I was a partner

in the accounting firm. And his credibility is beyond reproach, and

I’d seriously consider the comments that he has provided you.

The company has engaged in questionable business practices, including assisting others engage in illegal activities. This along with

a constant slew of errors being reported in its financial statements

have led to various investigations by legal authorities and sanctions. It’s not a company that has a good track record. And in addition, opaque disclosure has been less than forthcoming. In the summer of 2007 an AIG executive said that the company would not

incur a dollar of loss, would not incur a dollar of loss on its derivatives. Yet by December of last year, counterparties to the credit insurance required posting a collateral of over $5 billion, a number

that had grown to $14 billion as of June 2008. And in a stunning

revelation, the company disclosed on October 3rd that it borrowed

$61 billion of the $85 billion made available to it by the Federal

Reserve. The rapid changing disclosures on this, from zero to $61

billion in less than 12 months, is phenomenal, and investors certainly have to raise the question of, did we get the straight scoop

back a year ago?

At the same time, AIG, in a move that appears to deflect criticism, blamed its problems on accounting rules which required it to

disclose losses to its investors. This is like blaming the thermomVerDate 11-MAY-2000 14:00 May 25, 2010 Jkt 000000 PO 00000 Frm 00022 Fmt 6633 Sfmt 6633 U:\DOCS\55767.TXT KATIE PsN: KATIE
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eter folks for a fever. As we saw with the savings and loan crisis

and as the GAO, Congress’s own watchdog has reported at the

time, the ability of financial institutions to reporting—to avoid reporting to clients in the value of assets contributes to unsound

business practices and large losses for the government who has to

step in with a bailout. Again, we should not forget the past and repeat these costly mistakes. Thank you, Mr. Chairman.

[The prepared statement of Mr. Turner follows:]

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Chairman WAXMAN. Thank you very much, Mr. Turner. We’ll

now recognize Members for 5 minutes each to ask the two of you

questions.

And I want to recognize Mrs. Maloney first.

Mrs. MALONEY. Thank you, Mr. Chairman.

And I’d like to welcome our panelists and thank them for their

public service, particularly Mr. Dinallo from New York State.

Thank you and the Governor for your creative response to the AIG

crisis.

Last night and this morning I have been criticized for some pundits of my line of questioning on deregulation. Some of them called

it partisan. I just want to begin by saying that our financial crisis

is not a partisan issue. I truly do believe that every Republican,

Democrat, Independent, conservative, liberal are dedicated to working toward a solution, and I believe the Members of Congress want

to find a solution.

I am going to ask questions on deregulation and the relationship

to the problems we confront. But I want to preface it by saying I

am not being partisan. I am not criticizing anyone or any act or

any particular thing. I am just trying to understand more about it.

And so with that being said, I’d like to ask Mr. Dinallo a few

questions about the lack of regulation around credit default swaps

of which seem to be at the center of AIG’s downfall. Credit default

swaps are basically insurance contracts to protect against defaults

on bonds and loans. It’s an enormous market.

Since 2000, it has exploded from $900 billion to $58 trillion.

That’s roughly twice the size of the entire U.S. stock market. It is

also bigger, I understand, than the annual output of the entire

world economy for 1 year. And yet, incredibly, the market for credit

default swaps is entirely unregulated. Although they operate like

insurance contracts, parties selling these guarantees are not required to have capital reserves to protect the other party. And I

would first like to ask, because they are so huge, $58 trillion, if

there is no value behind them, as some economists allege, could

they bring down our entire economy?

Mr. DINALLO. Well, I guess we’re going to find out. I hope not.

But I will say that the distinction between credit default swaps and

insurance policies is when you write an insurance policy, you’re required to have a certain amount of solvency and capital behind

that commitment. For a large, large, large percentage of credit default swaps, you’re required to have absolutely no collateral or capital behind them. I—I do agree that it is interesting to note that,

as Lynn said, it is not, you know, insider trading or late trading

or the analyst cases or lax regulation or firm regulation or hard enforcement or soft enforcement that brought down the global economy.

I think it’s politically neutral to observe; it’s what we chose not

to regulate. And I don’t think that’s actually very partisan at all.

I think we as a country in 2000 made certain choices, along

Gramm-Leach-Bliley and the CFMA, to permit this kind of activity

as being a way to, ironically, to hedge risk. This is the ironic part.

CDSs were to meant to hedge risk. But they multiplied risk incredibly in part because now only about 10 percent of what you describe is actually an insurance policy kind of transaction. The rest

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is really just a bet about the future of a company’s credit-worthiness.

Mrs. MALONEY. So are those products just gambling, as you mentioned?

Mr. DINALLO. Well, the Governor called them gambling.

Mrs. MALONEY. We had the bucket shop laws, and we banned it

in New York State. And then the commodities law usurped our position, and you think that should change?

Mr. DINALLO. We did ban it. In 1909, after the crash of 1907, we

banned this kind of activity that used to be done in bucket shops

where they would just take bets on the market, bucket the trades.

And yes, that is what we did. And it required this—and no lawyer,

no good lawyer could convince a client that a naked credit default

swap was not also possibly prosecutable as gaming, so the CFMA,

appropriately, because we do need some kind of futures market—

there is a role here—but it completely exempted them. And the results are, in part, what you see today, which is not necessarily all

about credit default swaps, as Lynn said, but also just the opacity.

One of the important points, I think, is when we were working

through the bond insurers and back at MBIA and all the work we

did on those, as you know, and at AIG, no one, including ISDA,

could tell you how much credit default swaps were written on those

entities as reference points. So if AIG had failed, no one knew how

much CDS was written on AIG.

Mrs. MALONEY. My time has expired.

Chairman WAXMAN. Yes. Thank you.

Thank you, Mrs. Maloney.

Mr. Mica.

Mr. MICA. Thank you.

First of all, let me say that I’m pleased that we may be looking

at Fannie Mae and some of its responsibility in fomenting the financial crisis and the mess that we see right now.

I’m disappointed, though, that we didn’t start with some of the

culprits, and we should actually have reviewed some of what took

place with the Federal backed agency that helped, again, get us

started down this wrong path. Yesterday and today we’re sort of

splashing around in the wading pool, and we really need to be looking at the cesspool. We’re talking today about AIG, a private firm,

now with government backing, but it was a private firm; and yesterday about Lehman Brothers, a private investment firm and

their compensation, their running away with millions of dollars of

investor dollars. And we’re ignoring the core perpetrator of all this,

Fannie Mae, whose executives ran away with tens of millions of

dollars in public-backed bonuses, public-backed activities.

Is it correct that AIG and Lehman are private investor firms as

opposed to Fannie Mae?

Mr. DINALLO. Yes.

Mr. MICA. Just for the record, they both nodded their heads affirmatively.

Mr. Turner, I read your written testimony. I agreed with most

of it. You didn’t mention Fannie Mae or Freddie Mac. Were their

practices in any way contributory to the financial mess we’re in?

Mr. TURNER. I have actually done work on behalf of OFHEO at

both Fannie and Freddie.

39

Mr. MICA. Ok, then I don’t want to hear your opinion——

Mr. TURNER. But let me just say that I see great similarities between both of those institutions and AIG. And I applaud you, very

highly, for taking a look at those two because I don’t see a whole

lot of distinction.

Mr. MICA. Well, I want to do more than applaud because if this

committee isn’t going to investigate, I intend to ask the now—the

special counsel statute has expired, but it’s my understanding that

the Attorney General can help us drain the swamp and go after

those who created the cesspool. And I’m going to ask my fellow Republicans and Democrats to consider asking the Attorney General

to go after those folks who robbed the American taxpayer and start

with Fannie Mae, which is a federally backed institution, which

you both nodded to, which started, in my opinion, this whole mess.

There were contributing factors. Glass-Steagall, didn’t that contribute? Just answer yes if you agree.

Mr. Turner, did you think Glass-Steagall, the repeal——

Mr. TURNER. I think the repeal of Glass-Steagall was a contributing factor here.

Mr. MICA. OK, Mr. Commissioner?

Mr. DINALLO. I agree.

Mr. MICA. One of the interesting things, too, New York did—in

most cases, the States were pretty good regulators of insurance, is

that correct?

Mr. DINALLO. Thank you. Yes. I think the record would support

that.

Mr. MICA. And default swap is really out of your purview. But

even regulation of what Fannie Mae and what they were doing and

some of the activities that took place at government-sponsored financial enterprises: 2002, Mr. Shays and I introduced a law that

would have brought this activity under the SEC. That would have

helped regulate it. 2004, it was introduced and passed, actually, I

think in 2005 by the House and blocked in the Senate, is that

right?

Mr. TURNER. It was actually—Congressman Frank, much to his

credit, did introduce legislation that got passed in the House over

here, and I applaud——

Mr. MICA. But it was blocked in the Senate.

Mr. TURNER. But it was not passed in the Senate, and that was

greatly unfortunate.

Mr. MICA. Yes, I voted against it—Glass-Steagall, Mr. Waxman

and I voted against—not to repeal that. We voted opposite for the

regulation in 2005.

But the responsibility lies with Congress, not with a State of

New York Department of Insurance or some other State to regulate

and go after some of these speculative investment activities at that

level. Is that not right?

Mr. DINALLO. The responsibility of the State regulators, which I

think they executed on extremely well here——

Mr. MICA. Yes, but you couldn’t control the situation, is that correct?

Mr. DINALLO. To protect policyholders and protect the solvency

of the insurance company.

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Mr. MICA. It’s the responsibility of the Congress of the United

States, and also it’s the responsibility of the Congress to start first

with its—and clean up its own dirty cesspool, which is Fannie Mae.

And we still don’t have a commitment or a date to do that. And

I know exactly why.

Chairman WAXMAN. The gentleman’s time has expired.

Mr. Cummings.

Mr. CUMMINGS. Thank you very much, Mr. Chairman.

And to the witnesses, I want to thank you all for being here.

And my constituents are concerned about where the $700 billion

is going. They want to know, because they get up every morning.

They work hard. They give up their tax dollars, and they’re trying

to figure out where did the money go? Where is it going?

Mr. Turner and Mr. Dinallo, after the bailout of AIG last month,

the U.S. Government effectively bought an 80 percent share in the

company. That should have caused a fundamental change, you

would think, in how the company was spending funds on compensation, bonuses and benefits. But it doesn’t look like that’s what

happened. The committee learned that shortly after the bailout

went through, executives from AIG’s major U.S. life insurance subsidiary, AIG American General, held a week-long conference at an

exclusive resort in California.

The resort is called the St. Regis Monarch Beach. Let me put up

some pictures of the hotel up on the screen. It’s very impressive.

This is an exclusive resort. The rooms start, gentlemen, at $425 a

night. Some are more than $1,200 a night. By the way, that’s more

than some of my constituents pay on a mortgage payment every

month on the homes that they’re now losing, by the way.

We contacted the resort where AIG held this week-long event.

And we requested copies of AIG’s bills. We learned that AIG spent

nearly half a million dollars in a single week at this hotel. Now

this is right after the bailout.

Mr. Turner, have you heard of anything more outrageous, a week after taxpayers commit $85 billion to rescue AIG, the company’s

leading insurance executives spend hundreds of thousands of dollars at one of the most exclusive resorts in the Nation? Mr. Turner.

Mr. TURNER. I’ve been a business executive myself, and I tell you

what, when our company—you know, when things got tough, you

cut back on expenses. You just go out and eliminate those type of

things. I’m sure they had the issue, they were probably already

committed to it and were going to have to spend it one way or another. But nonetheless, I remember, we—as business executive VP

and CFO of a company, we would actually go out and cancel those

conferences because we just didn’t want to send a message to the

employees that we are spending on this type of thing and we need

to cut back expenses.

Mr. CUMMINGS. And if a company is drowning, then you’re going

to go and spend that kind of money? It’s crazy. And I agree with

you.

Let me describe for some of you the charges that the shareholders who are now U.S. taxpayers had to pay. Check this out. AIG

spent $200,000 for hotel rooms. And almost $150,000 for catered

banquets. AIG spent—listen to this one—$23,000 at the hotel spa

and another $1,400 at the salon. They were getting their maniVerDate 11-MAY-2000 14:00 May 25, 2010 Jkt 000000 PO 00000 Frm 00044 Fmt 6633 Sfmt 6633 U:\DOCS\55767.TXT KATIE PsN: KATIE
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cures, their facials, their pedicures and their massages while the

American people were footing the bill. And they spent another

$10,000 for, I don’t know what this is, leisure dining.

Ms. SPEIER. That’s bars.

Mr. CUMMINGS. Oh, thank you very much.

Mr. Dinallo, let me ask you, not as the insurance commissioner

but as a taxpayer, does this look right to you?

Mr. DINALLO. I think there are some regrettable headlines in

that. But I will say one thing, having been at large global companies and knowing what condition AIG was in when the injection occurred, the absolute worst thing that could have happened to AIG

after the Government extended $85 billion would have been for

them to basically go into a run-off situation, for employees to leave,

for traders and major underwriters to flee the company. So if there

was a thinking that they needed to bring everybody together in

order to keep the productivity of the insurance companies in tact

and protect policyholders by keeping them from going into a runoff status, I do agree there is some profligate spending there, but

the concept of bringing all the major employees together to mix—

let me just—to ensure that the $85 billion could be as greatly as

possible paid back would have been not a crazy corporate decision.

Mr. CUMMINGS. Well, I would tend to disagree with you. When

it comes to pedicures facials manicures, the American people are

paying for that.

Mr. DINALLO. I agree.

Mr. CUMMINGS. And they’re very upset.

Mr. DINALLO. I said there are regrettable and wrong headlines

in that. But the idea of making sure that you can get the game

plan back on track so you can pay off the loan is not an irrational

one.

Mr. CUMMINGS. That is an expensive way to get the game plan

back on track.

Mr. DINALLO. I agree.

Chairman WAXMAN. The gentleman’s time has expired.

Mr. Bilbray.

Mr. BILBRAY. Thank you, Mr. Chairman.

And, Mr. Chairman, let me say personally, thank you very much

for agreeing to do a hearing on Freddie and Fannie. I appreciate

you doing that. I hope we can get that date.

Mr. Turner, I appreciate your frankness of saying, even though

I’m not talking about it, we need to go back and look, concentrate

on Freddie and Fannie.

I appreciate, Mr. Chairman, your ability to respond to that reality.

And in fact, Mr. Chairman I would almost say that we may be

sitting in a situation that now that Freddie and Fannie has become

public agencies, that we may want to talk to the Attorney General

about the possibility of a special prosecutor to go in and take a look

at that as one of the public agencies. And I think that’s important

to show the American people we really are serious at getting to correcting some of these problems and really doing it based on an indepth study of the problem.

Let me sort of backtrack. This issue of the credit swaps, it seems

like there are two—there’s a balancing line here, where it is an inVerDate 11-MAY-2000 14:00 May 25, 2010 Jkt 000000 PO 00000 Frm 00045 Fmt 6633 Sfmt 6633 U:\DOCS\55767.TXT KATIE PsN: KATIE
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surance hedge and then they move into a gambling. Now, the preemption that the feds put in to say it is not gambling totally,

wouldn’t you agree that maybe we ought to go back and revisit that

and try to develop a bright line between what is gambling and the

States can intervene on as opposed to what is insurance and States

can’t intervene?

Mr. DINALLO. Yes. What I would have done is I would have said

that each one of those activities had to get some kind of an exemption activity by activity. So there is a good argument that sort of,

in crop insurance, you need futures to protect yourself against crop

failure, etc. There are lots of hedging activities that are kind of on

the border. You don’t maybe absolutely own the security or the

bond, but you do have exposure. But we basically through the

law—I could read to you—we completely exempted all of it. And I

think it needs to be seriously revisited.

Mr. BILBRAY. Mr. Chairman, this is the type of line that I wish,

instead of just us meeting, and maybe we ought to ask the Speaker

to reconvene the Financial Services Committee, to meet now, not

out a month from now, to talk about the specific proposals that the

House could come back into session and address.

Gentlemen, if you were in Congress, you were a Member of Congress and maybe in the Financial Services Committee, what

changes and what proposals would you propose to the Speaker of

the House of Representatives, to the President and the leader of

the Senate at this time and place?

Mr. DINALLO. I would first revisit the CFMA on its credit default

swap decisions that it’s a completely unregulated and open field

and that it’s neither a security nor subject to the gaming laws and

get back to the hedging instrument, which is I think core for our

society and appropriate. I would take a serious look at GrammLeach-Bliley and decide whether the supermarket of financial services is worth it when sometimes things really smell on aisle six and

infect the rest of what we view as kind of sacred stuff, which is depository money; whether it’s insurance policy proceeds or banking,

commercial banking deposits, there needs to be a greater clarity

about how the holding company activities, which here did not bring

down the insurance companies but did ding them from a franchise

value greatly, can harm those two depository type institution activities, and whether it’s always good to just let them willy-nilly be

together under a holding company type umbrella.

Mr. TURNER. Congressman Bilbray, you actually raised a very

good question. My first comment would be that certainly, I think,

the American public were concerned about how quick we ran into

the $700 billion bailout, but I do applaud you for doing the bailout.

I think without a doubt it needed to be done. It could have been

done in perhaps a different fashion.

But I think the public is looking for Congress to do what this

committee—and I agree with you, what the Financial Services and

the Senate Banking Committee should be doing, and that is immediately holding a series of hearings, just like the Pecora hearings

were held in the 30’s. We need a set of hearings that first identify

some of the issues where each of the problems should be. It should

be all inclusive. It should be the whole swamp. As people mentioned, let’s drain it all out, and then turn around and, once we

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know where each of the issues are, bring in very knowledgeable

people, like a Chairman Volker and like a Chairman Leavitt and

the type, to turn around and get the best of their thinking.

And then with that, then let’s go take a real good shot at putting

in the things that need to be fixed. And there’s a gob of things.

There’s questions about who should be doing the examination of

these. There’s questions about failures at the Fed and failures at

the SEC. Do we need to restructure those examination functions,

which I think we probably do? Do we have adequate resources? Do

we need to repeal the Gramm-Leach-Bliley in light of what’s happened with the growth of these institutions and they’re too big to

fail?

Certainly there’s things that need to be done in terms of transparency because both in the credit derivatives market as well as

some of the other subprime stuff, there’s been a tremendous, tremendous lack of transparency, which has directly contributed to

the lack of confidence. And I serve on two—the boards of two investment funds. And right now, people can’t tell which companies

they can trust and which ones they can’t because of that lack of

transparency. Until we get that problem solved, we are going to

continue to see days like we saw yesterday in the stock market.

Mr. BILBRAY. Mr. Chairman, thank you.

I just got back from my district. And the outrage is not that we

threw money at the problem but that we threw money at the problem and look like we’ve walked away for a month. And if it such

a crisis to throw that much money out there, my constituents are

saying there should be a crisis that you get in and not walk away

from answers or demanding answers to solve the problem.

Thank you very much for the opportunity to question the panel.

Chairman WAXMAN. Thank you very much Mr. Bilbray.

Of course, that’s the purpose of this hearing.

Mr. Kucinich.

Mr. KUCINICH. Thank you very much, Mr. Chairman.

To Mr. Dinallo, Treasury Secretary Paulson is the former CEO

of Goldman Sachs. Mr. Paulson, of course, was involved in helping

to save AIG. And Goldman Sachs is AIG’s largest trading partner.

News reports say that Goldman Sachs had at least $20 billion at

stake in AIG.

Now you, sir, were involved in negotiations to rescue AIG. Was

the CEO of Goldman Sachs Lloyd Blankfein and other Goldman

Sachs executives present at meetings to save AIG?

Mr. DINALLO. Yes.

Mr. KUCINICH. Could you speak into the mic.

Mr. DINALLO. Yes. Yes.

Mr. KUCINICH. Was Secretary Paulson at any of those meetings?

Mr. DINALLO. None that I was present at.

Mr. KUCINICH. Do you have any knowledge that Secretary

Paulson was present at any meetings relating to saving AIG?

Mr. DINALLO. I’m not trying to avoid the answer. I just had no

personal knowledge of that.

Mr. KUCINICH. Do you have knowledge that he was the former

CEO of Goldman Sachs?

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Mr. DINALLO. Oh, absolutely. Oh, I can talk to you—I am happy

to talk to you about this. You’re asking me yes-or-no questions, and

I’m finding it hard to——

Mr. KUCINICH. Before the bailout, did Secretary Paulson or other

Federal officials raise concerns about the impact that the AIG collapse would have on Goldman Sachs?

Mr. DINALLO. Yes, but not only Goldman Sachs. In fact, if I may,

I’ll just tell you that I—I admire Tim Geithner, the president of the

Federal Reserve. He has taught me various techniques in working

through some of these problems. One of them is he believes——

Mr. KUCINICH. I’m not really asking you about Mr. Geithner, so

I want to know——

Mr. DINALLO. Well, I just want to finish—please, sir.

Mr. KUCINICH. But you are on my time and I want you to answer

my questions. Now my question is, the head of global

commerce——

Mr. DINALLO. Yes.

Mr. KUCINICH. For Lehman sent an e-mail on July 13, 2008, to

Lehman’s CEO which said, ‘‘it is very clear GS,’’ speaking of Goldman Sachs, ‘‘is driving the bus with the hedge fund cabal and

greatly influencing downside momentum,’’ meaning that Goldman

Sachs was working to intentionally drive down the price of Lehman’s stock. This was in mid July; 2 months later, Lehman went

down with tremendous impact on the market and impact all over

the world. But AIG was saved.

Now, what I’m trying to find out, you know, if Lehman’s death

was natural causes or murder. Now we’re told that Secretary

Paulson, as a former CEO of Goldman Sachs, has brought in another former Goldman Sachs employee to manage the $700 billion

bailout fund.

Now, Mr. Dinallo, you are the superintendent of New York insurance.

Mr. DINALLO. Yes.

Mr. KUCINICH. You are a regulator. As a regulator, do you have

any concerns that Mr. Paulson, as the former head of Goldman

Sachs, was and continues to be in a position of conflict of interest

with respect to being able to make decisions that would enhance

the position of Goldman Sachs or be able to make decisions that

would adversely affect those who might be in competition with

Goldman Sachs? As a regulator, do you have any of those concerns?

Mr. DINALLO. From what I witnessed in the 4 days and 5 days

that I was exposed to what I was exposed to based on my personal

knowledge, I don’t have concerns. I can’t personally attest to Secretary Paulson’s management of whatever conflicts of interest.

Mr. KUCINICH. So your answer is you don’t know?

Mr. DINALLO. My answer is I don’t feel I have the basis to answer the question asked. I could give you reasons that I think AIG

was treated differently than Lehman. I could do that——

Mr. KUCINICH. Thank you, Mr. Chairman.

Chairman WAXMAN. The gentleman yields back his time.

The Chair now recognizes Mr. Souder.

Mr. SOUDER. Thank you, Mr. Chairman.

This unbridled greed, this callous abuse of trust of hardworking

Americans’ savings is just so disgusting it’s hard to put into words.

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And the anger level in America is coming, as it often has, directly

at Wall Street but at everybody. They’re worried they’re going to

lose everything they’ve worked to save because some people were

living so high on the hog, so disrespectful of what was going on.

The issue of that hotel wasn’t the amount of money. It is the insensitivity of how people behaved with our dollars. And it’s just massive discouragement to all of us that—I wanted to ask a few questions about the State insurance fund first in New York.

Is there sufficient guidelines to wall off the divisions from dipping in when they’re dealing with these credit futures and money

market things and so on to the insurance reserves? How is that

walled off?

Mr. DINALLO. Yeah. That’s what I—I think the system worked

well because there’s a fairly strong regulatory moat around each of

the insurance operating companies versus the holding companies.

So I think that there is—there was kind of an instinct at AIG that

maybe there was more capital for liquidity purposes than was really available. And that’s how they got it arguably into their liquidity

crunch. So policyholders are extremely well protected from the

holding companies reaching into the operating companies for capital and liquidity needs——

Mr. SOUDER [continuing]. Disclosure to stockholders at AIG that

in fact those assets are walled off and cannot be used, and is part

of the problem here that they discovered, the insurance assets were

protected, markets started to adjust and caved AIG?

Mr. DINALLO. That’s a very sophisticated statement. And I think

there is some truth to the—I don’t know, because I’m not in their

minds. But certainly there is—there is a—I think a good realization among policyholders across this country that their—the operating companies are relatively walled off from that kind of activity.

Mr. SOUDER. In your State insurance fund, we have—I met with

one company that’s in danger of going under, an insurance company, because they had too much Fannie Mae stock. Do you have

an inventory as a State insurance regulator of how exposed your

insurance companies are in Fannie Mae? Because right now preferred stock’s probably worth zero. Common stock certainly is.

Mr. DINALLO. We do constant examinations of the company. We

have—one of the reasons I think insurance companies have done

well is there are fairly strict rules and accounting standards which

Lynn and I could try about what insurance companies can buy and

hold in their asset liability match. I will just tell you right now, the

worst exposure an insurance company can have right now is some,

but the percentages that we’ve looked at are very low, some exposure to what had been AAA rated, CDOs, the famous AAA rated

mortgage-backed CDOs, but actually the default levels of those are

still relatively small, so if you hold them to term, you may be OK

for an asset liability match.

Mr. SOUDER. This insurance company I believe had 25 percent liability in Fannie Mae. Do you have a guideline in New York on

Fannie Mae?

Mr. DINALLO. As I sit here today, I can’t answer that. I do know

that we have a bureau that sort of specializes in rehabilitation of

distressed insurance companies.

46

Mr. SOUDER. If I was trying to go through the different guarantee funds and so on, if insurance companies would start to need to

be rescued, do you have a fee much like do we for FDIC——

Mr. DINALLO. Yes.

Mr. SOUDER. And others like the insurance companies would kick

in?

Mr. DINALLO. You are being very helpful. Thank you. Yes, we

have what’s called a guarantee fund.

Mr. SOUDER. Do you have right now—because I would assume

everybody should be going, because one of the debates here is, can

the States do this as opposed to Federal?

Mr. DINALLO. Yes.

Mr. SOUDER. It sounded like you were looking at but do not have

a clear analysis of the Fannie Mae exposure but others exposures

that you have so that you could have an idea of your kind of your

plan at the State level if the economy continues to tank, if more

of these risky purchases that didn’t seem so risky, because even

Fannie Mae just this summer was insured by the Department of

the Treasury, investors were told, hey, this is great. And then all

of a sudden, it collapses. How are you dealing at the State level?

Mr. DINALLO. We have very frequent reporting through our capital markets bureau. We regulate over a thousand companies. So

I can’t, on any one company, I cannot sit here and tell you what

the numbers are. We do have in place a system where, if there was

a distress, we would bring the company into what’s called rehabilitation, which is a form of bankruptcy proceeding to protect the policyholders so the capital is there to pay off the loans. If there is

a shortfall, there are, as you pointed out, both life and property

guarantee funds behind those.

What bothers me about the whole AIG episode the most from

what I do for a living is I think it’s—it’s a broad misunderstanding

bordering on the inappropriate that people would use it as an argument that there needs to be Federal regulation of insurance. I actually have been open to discussion of Federal regulation of insurance. I’ve testified several times in front of Chairman Kanjorski’s

committee, and I think I am one of the more open to those ideas.

But AIG is Exhibit A for how well the States did, not how poorly

they did. And that has to be said clearly because it’s bad for policy

holders if they think that actually their regulators did not execute

well on that part of the industry.

Chairman WAXMAN. Thank you, Mr. Souder.

Mr. Tierney.

Mr. TIERNEY. Thank you, Mr. Chairman.

Let me followup on that, Mr. Dinallo. And Mr. Souder makes the

point. You noted in your written statement that AIG is a holding

company and owns a variety of insurance and other businesses.

And Massachusetts’ insurance commission was quick to share with

me the fact that the problems at AIG are really those that deal not

with its insurance subsidiaries but with its operations and holding

company, those in the Financial Products Division, securities lending division and that area there. The State-regulated insurance

subsidiaries remain solvent and able to that pay their claims, correct?

Mr. DINALLO. Yes, sir.

47

Mr. TIERNEY. And in fact, it’s that solvency and ability to pay

their claims that really gives them the basis for the Federal loan

and the comfort that it will be paid back.

Mr. DINALLO. Absolutely.

Mr. TIERNEY. Now your office regulates insurance subsidiaries,

not the corporate parent. The only agency with authority to regulate the corporate parent is, in fact, the Federal Office of Thrift Supervision.

Mr. DINALLO. Yes. That was a choice by the company back I

think a few years ago. They could have chosen us.

Mr. TIERNEY. Yes, they could have chosen a regulatory agency

that would have been more difficult to deal with. And then they

probably would have supervised them better.

Mr. DINALLO. I didn’t say that.

Mr. TIERNEY. They chose the Federal Office of Thrift Supervision, which is not known for its expertise in this area, and we

should get that on the table.

But the committee has obtained a letter that the Office of Thrift

Supervision sent to the AIG board on March 10, 2008. According

to the letter, the agency criticized AIG’s management and AIG’s

oversight of its subsidiaries, including in particular the Financial

Products Division. I’d like to read from you a part of the letter and

get your reactions.

The letter says, we are concerned that risk metrics and financial

reporting provided to corporate management by AIGFP and other

key subsidiaries may lack the independence, transparency and

granularity needed to provide effective risk management oversight.

It also says, a material weakness exists within corporate management’s oversight of AIGFP’s super senior Credit Default Swaps,

CDS, valuation process and financial reporting.

Last, it says that AIGFP was allowed to limit access of key risk

control groups while material questions relating to the valuation of

the super senior CDS portfolio were mounting.

So it wouldn’t let in the people that would deal with this, and

it kept that secret. Now, obviously, it says the oversight in key divisions has failed and that AIG apparently didn’t have a full understanding of the risks taken by the financial products division. As

an insurance regulator, I imagine you spend a lot of time assessing

how well companies manage their risk, so we ask you, do the problems identified by the Office of Thrift Supervision sound serious to

you?

Mr. DINALLO. If I authored such a letter as a regulator, I would

view those as very serious allegations, yes.

Mr. TIERNEY. The letter also says that the AIG’s outside auditor,

PricewaterhouseCoopers, had reported the same criticisms to AIG’s

risk management and the lack of transparency issues. Things were

so bad that the agency decided to downgrade AIG’s risk management rating, its earnings rating and its composite rating.

Mr. Dinallo, can you tell us what that means in layman’s terms?

Mr. DINALLO. It means that they were—I guess if they—I don’t

know where they downgraded it from and to, but it would indicate

that they had some kind of enterprise risk management matrix and

they brought them down at least a notch on how they were managing those core risks, which would, again, be something for concern.

48

Mr. TIERNEY. Mr. Turner, you indicated at the beginning of your

testimony, I think we ought to be looking at what went wrong here;

and I agree. What’s your reaction to the agency’s conclusions about

inadequate controls at AIG and what does it tell us about the corporate governance there?

Mr. TURNER. Given the fact that AIG had been going through numerous restatements, literally since the beginning of the decade

have said they’ve had errors in their financials, to get a letter like

that out of an agency saying you had those type of risk management problems I think is extremely serious. I would agree with Mr.

Dinallo on that. And I would say that you’ve got a serious problem

from the top down, tone at the top. People just aren’t giving it

enough attention and aren’t serious enough about making sure

these things are dealt with. And in an organization this big that

can bring an organization down, and obviously there is a contributing factor here. So I think it’s very, very serious.

Mr. TIERNEY. So when our two next witnesses take the stand and

tell us it’s all about mark to marketing and circumstances beyond

their control, in fact, management very much was a part of this

problem in your understanding, is that correct?

Mr. TURNER. I would totally agree with that.

Mr. TIERNEY. Thank you very much.

I yield back, Mr. Chairman.

Chairman WAXMAN. Thank you very much, Mr. Tierney.

Mr. Turner.

Mr. TURNER OF OHIO. Thank you, Mr. Chairman.

Thank you both. I greatly appreciate your explanations, your descriptions. This is very helpful, not only just for the American people but for all of us in Congress as we’re taking a look at what do

we do next and how do we approach what other hearings are necessary.

In looking at your written testimonies, Mr. Dinallo, you say that

using its noninsurance operations AIG, just like many other financial services institutions, invested heavily in subprime mortgages.

And then, Mr. Turner, you say—and I love this paragraph in

your written testimony. You’re talking about mark to market, and

that comes into play because of the issue of subprime mortgages

and the securitization of the mortgage-backed securities that were

having to be mark to market. You say, I note the banks are requesting a moratorium on their fair value report card, but they are

also requesting $700 billion of American’s money to bail them out

for the bad loans they’ve made, and they want both.

Then you go on to say, it is a red herring, that obviously if it was

just mark to market they wouldn’t need both the shift on mark to

market and the cash.

And then you conclude here, ultimately, it’s no different than

someone who spends more than their paychecks each month, indicating that the banks spent more on assets bought or created than

they are subsequently getting paid back.

And that brings us back to the subprime mortgages. So I think

it is so important that we have additional hearings on Fannie and

Freddie and the subprime mortgage area. And I’ve got a question

about that for you, and I want to tell you what the experience is

in my community.

49

Yesterday, when we had our hearing on Lehman Brothers, we

had a panel that spoke beforehand. And they say that this all

comes from a period of easy credit, housing prices escalating and

then declining, securitization of mortgages, people using their

houses as ATMs; and, of course, excessive CEO compensation was

cited. In my community, subprime mortgage lending, predatory

lending has had a decimating impact on neighborhoods and families. We are at the forefront of the foreclosure crisis.

In 2001, our community held a hearing on predatory lending. A

city commissioner, Dean Lovelace, pushed for this. There was legislation passed to try to deal with it that was ultimately knocked

down.

But the community experience is about 5,000 foreclosures a year,

Ohio about 80,000 a year. Every 3 years, that’s the size of an entire

congressional district that we see being foreclosed.

But the experience we found in those hearings and what is happening in Ohio is that, many times, these are loans where the loan

origination amount exceeded the value of the property. It’s not

mortgage values declining, although they are now, which is

compounding the problem, but that there was systematic efforts to

give people loans that were in excess of the value of their homes.

Many times capitalizing the fees, many times giving them terms

that either had escalating rates or payments that got them into difficulty, and then also economic conditions causing them not being

able to keep up with payments. Then having a house that has a

greater mortgage than the value would result in abandonment and

foreclosure.

Many of the things that we hear about in this, what we should

do and what has happened, fall in the category of bad business

judgments or areas of regulation. But to me loaning people a loan

greater than the value and then securitizing that and not disclosing that there’s a gap between the loan value and the value of the

ongoing asset should be, if it’s not, a crime; and I believe it is. And

I think, ultimately, when we start looking at all these things, we’re

going to find that there were real crimes committed here that real

people stole and that had a big impact on our economy.

What are your guys’ thoughts on the subprime mortgage crisis

that has brought this about? What are some of the things that we

should be looking at, or practices like this, that might lead us to

how we stop these practices? Because in the bailout Congress did

not stop the practices that got us here.

Mr. DINALLO. I would amend one of my earlier answers. I was

asked what are the things that I would have the Financial Services

Committee look at working with you, and I said CDSs, and I said

Gramm-Leach-Bliley. The third would be that there is only so

much good risk in any community. And we have permitted,

through securitization underwriters, to basically do a set of loans

to their community and then re-up the tank for doing more loans

an endless amount of times.

So the first set of loans that were CDO’d, the first set of mortgages performed very well; and that banker probably said, you

know, there’s at least twice as many loans that I would have made,

because I got great people in my community. I wanted them to own

homes, so I had to make some tough decisions. And a banker on

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Wall Street securitized it, and the second set did really well. And

those were made with proper underwriting, due diligence decisions.

After the sixth or seventh or eighth iteration, for however we got

there, I think that there is a basic, fundamental issue with people

not owning the underwriting risks of their decisions. They have to

have exposure to their underwriting risks. And if you put into place

a system where they no longer have to worry about whether they

get paid back on their loans because they’ve handed it off to Wall

Street who’s handed it over to investors seven, eight times, we will

repeat this again.

Mr. TURNER OF OHIO. Mr. Turner.

Mr. TURNER. I would agree with Eric on this one, that this intermediation that the banking regulators allowed to happen to whoever was lending the money no longer had any skin in the game

and you got paid handsomely for doing those type of deals is a

major contributing factor here. And I think you got to go back and

look at the regulation of the mortgage brokers. Certainly the appraisal process is going to be part of that.

But I think people have to go back and say, as a matter of public

policy, we all love securitization because it gave everyone a chance

to get into a home; and no one was complaining about it when we

gave everyone the chance to get into a home. But when we loaned

up 100 percent on those values, and there were a lot of those

homes, I think there’s something like 55 million of these of which

10 or 12 to 13 million are now in foreclosure, clearly something

wasn’t working out about them; and someone needs to go back to

the banking regulators. And they’ve done some work on this, but

people need to make sure that they’ve done enough work to make

sure those type of loans can’t be made.

And then the bigger question of the role of securitizations, which,

quite frankly, Fannie and Freddie play a big role in here, we have

to reexamine that policy and say, if there’s securitizations, do we

have enough safeguards? The underwriting that occurred on them

was undue diligence by the investment bankers, was atrocious; and

that played a role as well.

Mr. TURNER OF OHIO. Thank you.

Mr. Chairman, I just want to make an additional point that most

of the loans that went into default in my community were actually

refinances where the family had the American dream but that

someone went back and sold them then a product that they could

not maintain. Thank you, Mr. Chairman.

Chairman WAXMAN. Thank you very much, Mr. Turner.

Mr. Higgins.

Mr. HIGGINS. Thank you, Mr. Chairman.

Gentlemen, I would like to talk to you about internal audits of

independent AIG auditors advising the CEO of AIG of a precarious

situation that wasn’t reported to investors in a conference call. In

fact, the internal audits’ warnings were ignored and an optimistic

picture was painted relative to AIG’s financial situation, which I

think goes to the heart of credibility and trust. Or, in this case,

lack of credibility and lack of transparency.

For example, there was an all-day conference on December 5,

2007. During this investor conference, Mr. Sullivan painted an optimistic picture of the firm’s management and fiscal health. He said

51

that we are confident in our marks and the reasonableness of our

valuation methods. We have a high degree of certainty in what we

have booked to date.

However, according to internal minutes from the audit committee

meeting on January 15, 2008, AIG’s independent auditor,

PricewaterhouseCoopers, raised serious concerns before this investor meeting took place. At this meeting, auditors warned Mr. Sullivan personally back in November in preparation for the investor

conference. Here is what the minutes said:

Mr. Ryan, a PricewaterhouseCoopers’ auditor, reported, in light

of AIG’s plan to hold an investor conference on December 5th,

PricewaterhouseCoopers had raised their concerns with Mr. Sullivan and with Mr. Bensinger, the Chief Fiscal Officer, on November

29th informing them that PricewaterhouseCoopers believed that

AIG could have a material weakness relating to risk management

in these areas. Mr. Ryan expressed concern that the access that the

enterprise risk management and the AIG senior finance officials

have into certain business units, such as AIG Financial Products

Group, may require strengthening. At no point during the December 5, 2007, investor conference did Mr. Sullivan mention these

warnings from the auditors. He never disclosed them.

Mr. Turner, you used to be a senior official at the Securities and

Exchange Commission. What do you think about Mr. Sullivan’s

failure to disclose the auditor’s warnings to investors?

Mr. TURNER. If you go back and look through the filings and go

back and look through the third quarter filing for the period ending

September 30th—and, Congressman, you raise an excellent question—you don’t see any notion of the fact that this company probably doesn’t have the necessary models to be valuing this stuff. So

if you look at September 30th filings, there’s no indication we don’t

have the ability to value these things in the way we do or no indication that you don’t have controls. You’re still saying things are

fine.

You go then to the communication from PricewaterhouseCoopers

and then to an investors day meeting on December 5th where we’re

saying things are OK; we don’t have a problem. If you’re an executive and you’ve known by that point in time that you’ve got these

disclosures out at September 30th saying in essence we don’t have

this problem—and while this is going on keep in mind you also, as

I understand it, have counter parties to these derivatives starting

to argue. And I think in fact there’s some disclosure by October

31st people were questioning their valuations. So it’s not only that

you got a September 30th cue out there, you’ve now got questions

from outside parties, not only the auditors but very well—you

know, Goldman Sachs might have been one of them raising the

questions.

Back to the questions that Mr. Kucinich was raising, if you’ve got

an outfit that is probably no one better in the world at valuing this

stuff like Goldman Sachs about these values and your auditors are

now raising your value, I think it’s unconscionable you go out to

the investors on an investor day and pretend like you’ve got yourself under control and you know what all the numbers are and

there’s no problem. And subsequent events turn around and I think

pan that out when you say you’ve got $5 billion in collateral at the

52

end of December and then up to $14 and now we’ve borrowed $61,

it raises a serious question about was anyone on top of this.

Mr. HIGGINS. I yield back, Mr. Chairman.

Chairman WAXMAN. Thank you, Mr. Higgins.

Mr. Yarmuth.

Mr. YARMUTH. Thank you, Mr. Chairman.

In the chairman’s opening statement he said we were going to

ask questions about the compensation packages of the CEOs at

AIG, and so I’m going to ask that now.

You said in your written testimony that one of the problems here

is that we had CEOs walking away from a train wreck, essentially,

with huge severance packages. And we’ve seen or heard many

times now that in the fourth quarter of 2007 fiscal year, 2008 fiscal

year, the loss posted by AIG was $5.3 billion and shortly thereafter

that the compensation committee of AIG met and extended the contract of CEO Martin Sullivan, including a $15 billion severance

package. And I guess my question that most every American would

have is, is there any way that the compensation committee or corporation could justify that type of activity as being responsible, in

the best interest of the stockholders if there was such a dramatic

turnaround and loss in the corporation and then granting a very

generous package in light of that?

Mr. TURNER. I’m a believer that if a company has performed well

the executives should be compensated well for that. So I have no

problem with people if they’ve done very well and created a lot of

value—like I said, I am on the board of two of these investment

funds. If they created a lot of value for our shareholder, I certainly

am one that would support them on getting tremendous compensation.

On the other hand, when you don’t perform, having been an executive, I don’t believe you deserve a bonus. If you’ve had a lousy

year, you just shouldn’t get a bonus. And then to walk away and

get paid millions for walking away and doing nothing further to

create value for us as shareholders I think is just wrong.

In this case, the question probably goes back to did the board

agree to that agreement when they first put Mr. Sullivan in place.

That was probably not a high mark for this board.

Twice I flew to New York and met with their then chairman of

the board Frank Zarb and seriously questioned how they had gone

through the process. They didn’t go through an outside search for

a new chairman. They just very quickly selected and put in place

with very little due diligence the next chairman.

And, quite frankly, then when you put in place a severance

agreement with the guy and agree to it at that point in time, even

if things turn out bad later on, you’re committed to it and you need

to honor a contract. But for the board to have put something like

that in place just shows very, very poor governance, very poor.

Mr. YARMUTH. And it was compounded subsequently because the

next quarter the loss was almost $8 billion. So that’s $13 billion in

two quarters. And at that point they terminated Mr. Sullivan but

allowed him to retire so that he could receive that bonus. If they

had terminated him for cause, then he wouldn’t have received it,

as I understand it. Is that something that you would consider to

be in the interest of the stockholders or in his interest?

53

Mr. TURNER. Again, whenever you’re paying someone for walking

away from the company where they’re not creating any further

value and haven’t been creating value, that’s certainly not in the

best interest of shareholders.

Mr. YARMUTH. Thank you for that.

I have a question going back to these credit default swaps that

I would like to get some clarification on. We threw out the number

or you threw out the number $62 trillion that’s out there. Is that

$62 trillion a potential loss, is it absolute obligation, is somebody

going to have to pay $62 trillion at some point to somebody or is

that just a potential loss and to whom is that owed? I mean, in

general, to whom is it owed?

Mr. TURNER. The $62 trillion, which, by the way, I believe has come down to the mid 50’s at this point in time. It’s only $55 trillion or $57 trillion, you know. But you raise an interesting question, because I don’t think anyone really knows what the real exposure is. That’s the nominal value or the amount of debt that these

things have been written on, although the actual amount of debt

is actually substantially less than this.

As Mr. Dinallo mentioned, some of this is nothing more than wagers of bets against one another in trading, and that’s a fairly significant portion of that. But no one knows because there’s no disclosure. There’s no central market.

And this isn’t the first time this thing almost came apart. The

Fed in 2005 had to bring about 17 of these institutions together because they had gotten so far late in just doing their paperwork no

one knew who owed one at that point in time. Which goes back to

your question then, does anyone really know what’s going on here?

And the answer is probably no. No one can tell you what’s going

on, there’s no regulation, there’s no FASB, and no one can answer

the questions with a high degree ofcertainty because there’s no

place that gathers that data.

Mr. DINALLO. This is just a very overly simplistic statement

which will not hold in practice, but there’s an argument that the

total notional value of CDSs should not exceed the total face value

of corporate bonds out there. Because if you bought insurance for

all corporate bonds that anybody owned it would be—and I’m going

to make up a figure. I’ve heard something like $15 trillion, $17 trillion—$6 trillion, I’m being told $6 trillion.

Well, I’m an optimist. So if you think of it that way, that’s why

we say 10 percent. Do you remember I said 10 percent? So if it’s

10 percent of 62—so, yes, $6 billion is the right number. Ninety

percent of it is written on just going to the track and putting a bet

on whether Ford is going to fail or not. It does not represent a

securitized bond exposure to the companies.

Mr. YARMUTH. If I can ask just one question in followup. So this

is one corporation, in this case AIG, betting against another corporation on value that doesn’t exist? I mean, they’re wagering

money, wagering presumably shareholders’ money, and in this case

it may turn out to be taxpayers’ money, on basically you and I betting on a football game.

Mr. DINALLO. Yeah. Just technically I’m going to correct you to

the extent it kind of went the other way. People, they sold protection as a triple A or double A rated vehicle, they sold their protecVerDate 11-MAY-2000 14:00 May 25, 2010 Jkt 000000 PO 00000 Frm 00057 Fmt 6633 Sfmt 6633 U:\DOCS\55767.TXT KATIE PsN: KATIE
54

tion to those who wanted to take a bet on whether Ford was going

to say—I’m just making that up. I’m picking on Ford. It’s unfair—

Ford was going to default or not. And when they got downgraded—

I think this is an important fact that didn’t really come out. When

they got downgraded, the reason they had the liquidity crisis that

we’ve all discussed is when they got downgraded they had to put

collateral beyond those obligations. When they were a certain high

rating they didn’t have to post any collateral.

So getting back to the Congresswoman’s point, I would say all

the more frightening about all this is there’s no ‘‘there’’ there.

There’s no collateral behind any of these four A, double A and triple A rated companies. And that’s a big number that there may not

be backing for. Not the case for insurance.

Chairman WAXMAN. Thank you, Mr. Yarmuth.

Mr. Braley.

Mr. BRALEY. Thank you, Mr. Chairman.

Mr. Dinallo, I want to start with you.

Twenty-five years ago, I was a research assistant to Professor

Alan Whitus, who was updating the Keeton and Whitus basic text

on insurance law; and I think both Professor Whitus and Professor

Keeton would be rolling over in their graves seeing what has happened to the industry that they were so passionate about. I think

you would agree with me that industry has changed radically in

the 25 years that I’ve been talking about.

Mr. DINALLO. Yes. In particular going from mutual companies to

publicly traded companies.

Mr. BRALEY. And a lot of those demutualizations resulted in a

significant financial loss to policy owners who owned the shares of

those mutual companies—who owned the mutual companies and

during the conversion in many cases were screwed out of their financial share of those companies.

Mr. DINALLO. I might not use the same verb, but I will agree.

Mr. BRALEY. I think you get my point.

Mr. DINALLO. Well, I think it’s important for everyone to know

there’s a very strong tension between policyholders’ interest and

shareholders’ interest in a publicly traded company. The board and

management has a fiduciary interest to shareholders under our

law, fiduciary interest to shareholders, but, at the same time,

whenever they release capital to satisfy that to get a bigger return

on equity, they are necessarily taking incremental protection

against policyholders.

Mr. BRALEY. And you also have a fiduciary obligation to policyholders under their contractual obligation with the policyholder.

Mr. DINALLO. Yes. Sadly, there is some debate, actually, because

they’ve been so trained under our law and after Enron, etc., to

worry about fiduciary duty to shareholders that there is a good argument that, although it’s in their blood to worry about policyholders, the legal requirements are a little bit gray, actually.

Mr. BRALEY. Well, one of the things we know, in your opening

statement you said AIG was not strictly an insurance company.

And that’s one of the big problems. Because insurance companies

are fond of talking to consumers about gaps in coverage and how

they should eliminate those gaps. But based on both of your testimonies we’ve got a massive $63 trillion gap in coverage where

55

we’ve got a product that according to most commonsense interpretations would be considered insurance. We’re not regulating in the

State insurance commissioners’ offices. We’ve taken action in Congress before I got here to declare that it’s not subject to gaming

regulations, which again under the Constitution are historically

made by States rather than by the Federal Government, and you’ve

eliminated any oversight from the Securities and Exchange Commission, which has the only Federal capability to exercise jurisdiction over these companies. So how did we get here?

Mr. DINALLO. I wish I could have said it so clearly. I don’t know

how we got here. We thought it was important to permit leverage,

we thought it was important to permit risk mitigation, and we

thought that mega holding companies were accretive to shareholder

value and to be competitive.

And I will say that we are—that one of the big issues is after

Basel II and what’s called Solvency II we are in danger of going

the European route, which is a lot more holding company control

over the operating company, which is code for much more ability

to move around policyholder money—that’s what we are talking

about—around for holding capital liquidity purposes. If AIG had

been under a Solvency II regime, I would think we would be in

much worse straits than we are today.

Mr. BRALEY. But one of the concerns I have is this blurring distinction between financial services providers—real estate, insurance, banking, other financial institutions—and how you hold accountability when these holding companies are involved in all these

different financial services. Because clearly the system we have in

place now is not working.

Is it time for Congress to revisit the fundamental premise of the

McCarran-Ferguson Act and talk about a Federal intervention that

takes into account the need to have some oversight of insurance

companies that choose to engage in risky financial propositions like

the ones we’ve been talking about today with no ability to have accountability to their shareholders?

Mr. DINALLO. Earlier, I said we should—I think I would recommend a revisitation of Gramm-Leach-Bliley and the concept of

supermarkets when you’re dealing with policyholder money and depository commercial—money. I’m not sure—I will just remain agnostic—whether the solution is a Federal oversight or continue

with the States or some hybrid.

Because I think that it is important to have States in the solvency business. They’ve done extremely well on that. They’ve done

not so well, clunky on other things like product registration and licensing of the agencies. We’re pretty clunky on that. But the one

thing we got right and the reason that we’re even here today to the

extent there’s optimism here is because there was solvency done by

State regulators.

Mr. BRALEY. And just to followup on Mr. Souder’s comment

about the guarantee funds, you would agree that most State insurance laws provide a cap on those guarantee funds typically in the

amount of $500,000 or surely $1 million or less. And when you’re

talking about an exposure of $63 trillion that would have no impact

to protect taxpayers.

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Mr. DINALLO. Actually, New York is one of the richest guarantee

funds; and I think the numbers you just described are New York

numbers. Most States—and this is not to be pejorative to other

States—but most States are substantially lower. Some people think

that lower is better because it stops the moral hazard of writing

bad policies because there’s always the guarantee fund behind it.

But, yes, it would have been a real stress on the system, undoubtedly.

Chairman WAXMAN. Thank you, Mr. Braley.

Mr. Davis.

Mr. DAVIS OF VIRGINIA. Thank you.

Do you think anybody ought to go to jail over this? Do you want

to take a stab at that? Do you think anybody should go to jail over

this?

Mr. DINALLO. To whom is your question directed?

Mr. DAVIS OF VIRGINIA. Both of you. I’m not asking you to name

anybody or build a case. But I’m just saying, looking at the end results, how the companies operated, at this point, were they all

within the law or did somebody break some rules along the way because nobody caught it?

Mr. DINALLO. I don’t have sufficient evidence to have an opinion

about it.

The only thing I would say is I think that as a regulatory society,

so to speak, we all did kind of chase after mortgage default numbers. In other words, some of what was described earlier about the

escalating losses at AIG were certainly a default rate loss. In other

words, we’ve all seen how the rating agencies have hugely changed

the ratings based on how quickly the default numbers are coming

in for mortgages.

And I’m not taking a position whether it’s criminal or even civil,

but it is the case that a lot of us, including the best rating agencies, some of the best securitization people in the world and some

regulators, got wrong what was going to be the default rates, which

it turned out our global economy was hinged on.

Mr. DAVIS OF VIRGINIA. Well, if it wasn’t criminal, was it at least

negligent in some areas?

Mr. DINALLO. I won’t even opine on that. But I would say that—

I did say that the letter, if true, that I heard is something that you

would be concerned about.

Mr. DAVIS OF VIRGINIA. Mr. Turner, do you have any thoughts

on that?

Mr. TURNER. Yes Congressman. I don’t think you send people to

jail for making bad business decisions. That happens day in and

day out, and people shouldn’t be prosecuted for that.

On the other hand, if someone knew there were problems in the

company and failed to comply with the security laws and disclosed

those to investors who bought them and are now seeing their retirement savings go away and disappear, then, yes, I would turn

around and say a little time behind the bars would probably be

good.

Mr. DAVIS OF VIRGINIA. Well, let me ask this. How about the people writing the mortgages? You talked about the first tier and the

second tier and how it got lax. I mean, at the end, they weren’t

even asking tough questions.

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Mr. DINALLO. I think the term is a NINJNA, no income, no job

and no assets, or something like that. It’s unbelievable. We were

harvesting mortgages at a rate that I think is completely unacceptable as a society; and we were in various ways encouraging people

to engage in underwriting decisions that I find shocking, frankly.

Mr. DAVIS OF VIRGINIA. In fact, didn’t AIG—they got caught up

in this. Their competitors were doing it. They started a new line

that they had no expertise in, used an insurance model, and it just

blew up on them. Is that basically what happened?

Mr. DINALLO. I think to a large extent people did not—this is

what I was trying to say before. We relied on historical default

rates in housing that maybe for the first two iterations of loans

was wholly appropriate. By the seventh or eighth, we had basically

injected—we correlated the system because we weren’t securitizing

natural loans, we were securitizing created loans.

Mr. DAVIS OF VIRGINIA. Now, your argument, as I understand it,

is that the Commodities Futures Modernization Act, in retrospect,

went too far. It was a mistake.

Mr. DINALLO. I think that’s a fair implication of what I said, yes.

Mr. DAVIS OF VIRGINIA. And that was signed just on the eve of

the 2000 election. I think it passed Congress. Fortunately, I did not

support it. But as I was looking at that, just going through the

votes and everything, it was signed right on the eve of the 2000

election. Obviously, some modernization was needed, because there

was a huge congressional and, at that point, administration consensus. But you think it just went too far. You wouldn’t have argued

it shouldn’t have been changed. You just think in retrospect it went

too far.

Mr. DINALLO. No, it was just absolute. It says this act shall

supercede and preempt the application of any State or local law

that prohibits or regulates gaming or the operation of bucket shops

other than anti-fraud provisions.

Mr. DAVIS OF VIRGINIA. I agree.

What about the reauthorization act this year, did you follow that,

that was reauthorized this year? Do you know how they reauthorized it? They attached it to a farm bill, an agriculture bill, which

was vetoed by the President and overridden in Congress. That’s

how a lot of these things get done. So that’s how a lot of this business gets done.

What about Gramm-Leach-Bliley in retrospect? Again, that was

done over 8 years ago. In retrospect, obviously, a need to modernize

Glass-Steagall. Would you agree with that?

Mr. DINALLO. Yes. Some in need, yes. But I’ve learned a lot

through this process.

Mr. DAVIS OF VIRGINIA. Well, let me finally ask, should the SEC

or should Congress have stepped in much earlier to suspend the

mark-to-market accounting rules as a way to head off some of the

problems we’re experiencing today?

Mr. DINALLO. I think Mr. Turner would be better qualified to answer that. I’ll just say that insurance companies do it a different

way; insurance regulators do it a different way. It’s much more

conservative and, fortunately, beneficial, I think, to what we’re

talking about.

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Mr. DAVIS OF VIRGINIA. Mr. Turner, do you have any thoughts

on that?

Mr. TURNER. I don’t think Congress should step into that. As I

mentioned in my testimony, the GAO found—actually supported

going to mark to market and believes that when you suspend it—

when you allow a bank to turn around and have losses, OK, and

not tell us as investors about it, I got to tell you we ain’t got any

confidence in the system or trust. And if Congress goes in and says,

we’re going to let you hide those things from us, I got to tell you,

you’re going to see a devastation in spark. We will not be investing

in financial institutions if you do that.

Mr. DAVIS OF VIRGINIA. OK. Thank you.

Chairman WAXMAN. Thank you, Mr. Davis.

Ms. McCollum.

Mr. DAVIS OF VIRGINIA. Mr. Chairman, can I ask unanimous consent that Members be allowed to submit statements for the record

today?

Chairman WAXMAN. Without objection, that will be the order.

Ms. MCCOLLUM. Thank you, Mr. Chairman.

Mr. Turner and Mr. Dinallo, AIG didn’t suddenly collapse and

need to be bailed out on September 18th. AIG’s financial situation

had been growing increasingly dire with each passing quarter, but

AIG’s executives kept telling shareholders that their finances were

in great shape.

And in fact, Mr. Chair, I would like to submit a New York Times

article dated September 28th which numerates time and time

again how these people have said AIG was in great shape.

[The information referred to follows:]

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60

61

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63

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67

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Ms. MCCOLLUM. In December 2007, for example, Mr. Sullivan

told AIG investors, ‘‘we believe we have a remarkable business

platform with great prospects that represent tremendous value.’’

Two months later, AIG posted $5.3 billion losses for the quarter.

February 2008, Mr. Sullivan said, based on our most current

analysis, we believe any credit impairment loss realized over time

by AIGFP would not be material to AIG’s consolidated financial

condition. Then AIG posted $7.8 billion in losses for that quarter.

On May 28th, Mr. Sullivan told investors, the underlying fundamentals of our core business remains solid. The next month the

board voted to replace Mr. Sullivan.

Mr. Turner, I have a couple of questions. What do you think of

Mr. Sullivan’s statements? Do you think they accurately reflected

AIG’s conditions? And, Mr. Dinallo, I would like to know if have

you a view on that as well.

Mr. Turner, in your written statement you said—and I’m going

to quote you—trust and confidence in markets and in any company

begins and ends with transparency, transparency that ensures investors can fully understand the assets and rewards of investing in

a company. You should be able to trust what the CEO is saying.

So if you gentlemen could please elaborate.

Mr. TURNER. As you go through these filings and you look at the

disclosures that start to occur and the timeframe in which they are,

the one thing I take away from this is I don’t think the company

ever was honest with the investors about the magnitude of the potential impact of these things. And I think that’s what is grossly

missing here. And then, as things start to go bad, they go bad very

quickly; and we’re finding out about everything not prospectively

here’s what could happen.

Keep in mind, the SEC rules are very clear. They require you to

tell the investor right through the eyes of management what’s happening with the company. And I don’t think we ever get that out

of here. I don’t think the rules were followed.

I just think it’s astounding that all of a sudden you’re borrowing

$61 billion and yet you’ve never told the investors up to that point

in time, hey, we’ve got these credit derivatives out there that could

cause us such a problem that we could come short.

And granted the market goes down, OK, and certainly people

were not wishing for the market to go down the way it was, but,

nonetheless, when you’ve got that type of exposure and that type

of potential, you owe it to me as an investor to tell me that’s the

type of risk I’m taking on when I’m investing in you. You’ve got

this thing that may all of a sudden blow up and cause you to need

tens of billions and you can’t get to it because all the cash is in

regulated subsidiaries that Mr. Dinallo is appropriately trying to

protect. And that’s the disclosure, the gist I cannot find in these

filings.

The SEC and the DOJ I hope will go through, get the e-mails,

get the data and then everyone is entitled to their day in court and

due process. But, right now, there is a question there that I can’t

answer for myself as to why we didn’t get that.

Ms. MCCOLLUM. Mr. Dinallo.

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Mr. DINALLO. Obviously, I have to be sort of—I’m not informed

enough at the holding company level on some of the disclosures to

have a position about this.

I think I did say earlier that I witnessed sort of a very shocking

realization as to the liquidity needs of the company on that weekend. I was surprised that some of the risk was being rolled up at

that—sort of contemporaneously at that time.

I will say, just one observation that we just touched on, which

is one of the lessons learned. There are these things called lines of

credit that every company has, and they assume they’re there in

these liquidity crunches. But what is kind of interesting I think

that the committee should know about, and the Financial Services

Committee should probably be told about, is if you touch them you

get a three-notch downgrade from the rating agencies. And so

they’re kind of fictitious in some ways.

I don’t mean this badly, but people have them and they convince

us that they have this line of credit that will help them through

these tough times. But God forbid you need to hit the $15 billion

line of credit these companies have. The consequences are such

that you might as well not have them because you might as well

have gone through the downgrade because you’re going to go

through it for touching the line of credit. We’re all learning together to some extent. And I think that’s one of the lessons that

I would kind of inject in this.

Ms. MCCOLLUM. Thank you, Mr. Chair; and thank you for the

hearing because I think this is clearly showing people were gambling—they weren’t investing—with the dollars that these investors

had.

Chairman WAXMAN. Thank you, Ms. McCollum.

Mr. Van Hollen.

Mr. VAN HOLLEN. Thank you, Mr. Chairman.

Thank you both for your testimony today.

Mr. Turner, I just want to followup on my colleague Mr.

Yarmuth’s questions. He asked you about some of the golden parachutes that were available for Mr. Sullivan and others at AIG.

I want to talk about the regular compensation and bonus plan.

And as you state in your statement you talked about the dangers

that bonus plans that are, ‘‘designed to pay executives hundreds of

times what their average employees made as they engaged in business that would eventually cripple the business that they ran.’’ And

you hear a lot of talk from some of the CEOs about how they have

these pay-for-performance plans, that in the good times they benefit but when times are bad they take a hit. And I think the more

we look at these different companies like AIG you find that they

rigged the rules so in good times they do well and in bad times

they do well.

I would like to get your opinion of the actions of AIG’s former

CEO Martin Sullivan at a meeting of the company’s compensation

committee on March 11, 2008. The committee has obtained documents of that meeting.

AIG has two bonus programs. The first is called the Partners

Plan, and that covers the top 700 executives. The second is called

the Senior Partners Plan, and that applies only to the top 70 executives. Mr. Sullivan benefits from both plans.

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Now, according to the plans—and, again, if you listen to what

they’re saying, rewards were supposed to be based on the company’s performance. But I want to show you or at least mention to

you—I don’t if we have it on the screen, but we have the internal

minutes of the meeting that was held by AIG’s compensation committee on March 11, 2008; and, as you can see, what those committee meetings show is that Martin Sullivan, who was CEO at the

time, personally urged the committee to waive, to waive the bonus

rules right after the company posted a record loss.

And as you can see that what the minutes say is Mr. Sullivan

next presented management’s recommendation with respect to the

earnout for the senior partners for the 2005 through 2007 performance period suggesting that the AIGFP—that’s the financial products division—that their unrealized market valuation losses be excluded from the calculation. Essentially what he’s saying there is

the rules, if we applied them, wouldn’t let me get my bonus, so let’s

change the rules, isn’t that right?

Mr. TURNER. That’s the way I would read that.

Mr. VAN HOLLEN. And this comes on the heels of the February 8th—28 AIG posting of losses of $5.3 billion for the quarter, which

came primarily from the financial products division, isn’t that

right?

Mr. TURNER. Yes.

Mr. VAN HOLLEN. And the record also makes clear that in fact

the board, not surprisingly, agreed with their CEO; and he got his

$5.4 million bonus, despite the fact that AIG ran up $5.3 billion in

losses in the quarter before.

I just have to ask you, you know, because people understand

when people get rewarded for doing well. But everybody else out

there operating in the economy, when they don’t perform, they get

their pay cut. They get fired. These guys, there is absolutely no accountability. So I would like you to comment on the kind of

changes that need to be made in your view to make sure this kind

of thing does not happen going forward.

And then, Mr. Dinallo, I would like any comment you’ve got.

Mr. TURNER. As someone who has followed governance and read

many of these type of plans—quite frankly, when I was running

the research at Glass, Lewis, this is not an isolated occurrence.

We’ve seen this time and time again in corporate America where

you set up a pay for performance plan but then, when you didn’t

hit the performance triggers, you changed the triggers, you didn’t

change the compensation. And there’s just something fundamentally wrong with that.

And that’s one of the reasons this institution, quite appropriately

so, I believe, last year voted and approved the ‘‘say on pay proposal’’ that is a middle of the ground proposal and a very, very

good proposal. It’s unfortunate. I know it was in one of the drafts

of the bailout legislation and didn’t stay in it. That is very unfortunate.

But I think certainly we need to have in this country—give the

shareholders the vote and opportunity to pay on—or vote on situations like this with full disclosure so you’re aware this type of stuff

is going on; and I think only by doing that are we going to get this

reigned in. I think anything short of that is going to leave these

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plans in place, leave this type of behavior in place, and people are

going to continue to be outraged about it, and you’re not going to

get the changes that you need.

So when we have say on pay as investors, when we invest in the

U.K., when we invest in Netherlands, when we invest in Australia,

but we don’t even have that right as investors here in the United

States, there’s just something fundamentally wrong with it. So we

need this institution, the House, and we need the Senate, by golly,

to follow your good leadership on that and pass the say on pay proposal now, not a year from now, but now.

Mr. VAN HOLLEN. Thank you. Thank you, Mr. Turner.

Mr. DINALLO. I would only add that a lot of Wall Street and traders—and I think AIGFP is analogous to this—are paid on a revenue basis, as opposed to an end-of-year profit basis, and there is

something to that. And you can create a lot of revenues without actually booking a profit sometimes. And so that’s something that

people have written about recently, about sort of changing that approach to compensation for certain financial services activities.

Mr. VAN HOLLEN. Thank you. Thank you both.

Chairman WAXMAN. Thank you, Mr. Van Hollen.

Mr. Sarbanes.

Mr. SARBANES. Thank you, Mr. Chairman.

I’m trying to understand this in the context or in terms of how

we got all these toxic assets infecting the markets out there which

at the end of the day just gets back to this insatiable appetite to

generate new loans. And when there weren’t enough loans out

there in the conventional market we then had these people that

were reaching into the unconventional market, into a very risky

market, and that created this toxin that went up the chain.

So my interest in what AIG was doing is to the extent that it

was seen as providing the hedge/insurance backstop to these Wall

Street firms that were increasingly getting into the business of

trading in very unstable or risky security products, with the effect,

I take it—and I would like your view on this—with the effect that

it increased their risky behavior, and that gets pushed down the

chain. So they begin to encourage more and more risk on the front

end. And once you’ve relaxed the underwriting standards on the

front end of this thing, it becomes very difficult to continue to manage the risk up the line, because the original thing that you’ve created in and of itself is unstable.

So talk to me about that. Talk to me how what the product that

AIG was offering basically led to riskier behavior on the part of

these Wall Street firms which in turn led them to encourage risky

behavior all the way down the chain. Mr. Dinallo.

Mr. DINALLO. Well, I think, Congressman, you sort of said it in

there. They were arguably at the end of a chain of exceedingly ridiculous optimism about the value of these mortgages. So people

harvested the mortgages. They securitized them. The rating agencies rated those at the highest levels; and, through CDO squared,

triple A traders at various trading houses held them. And then

wanting to prudently, arguably, have a default protection on those

bought a credit default swap from certain guarantors, AIG being

one of them.

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So I would say that at some level what AIG did was it gave—

kind of it was the last line of defense with its high rating—I think

it was double A at this time—saying, well, the rating agencies

rated it triple A, so we’ll even guarantee it against default.

And one of your points I thought you were sort of making was

maybe if anyone in that line of activity had acted with—this will

be a little bit impolite—but acted with common sense instead of

models they might have said this doesn’t feel right and I’m not

going to put my reputation, assets, shareholder value, rating at

risk for this.

Mr. SARBANES. Well, you had two things happening. You had a

bunch of people along the way who could keep off-loading the risk

to somebody further up the chain. So then they have no incentive

themselves to stop or curb their behavior, particularly if they’re

making money off the deal.

Then you start getting to the end of the chain, right, the people

that are actually holding these securities at the end of the line.

And the way they, ‘‘offload the risk is to go insure against it.’’ So

they turn to an AIG as a way of doing that.

And I guess in the initial iteration of that maybe it made sense.

But then you have AIG basically opening a casino in London, right,

to start this other activity. So at what point should the investors

that were purchasing this as an insurance policy, should they have

known that AIG, their, ‘‘insurer was getting into this other risky

enterprise?’’ Did they know that? Did they realize that they had

opened the casino in London and something else was going on that

was putting their policies, ‘‘at risk?’’

Mr. DINALLO. I just want to clarify. I think we’re mixing the

term insurance policy somewhat loosely. When you ask that, you

mean the people who had actual property—the common man and

woman who had life insurance policies and property polices with

AIG? Is that what you meant?

Mr. SARBANES. No, no. I’m talking about the insurance product

that was the CDS, because it began that way, right?

Mr. DINALLO. But my understanding, Congressman, is it was always out of financial products.

Mr. SARBANES. Right. But I’m saying is it began as a legitimate,

‘‘hedge against the downside risk of this particular security that

you hold.’’ But the reason it got up to $55 trillion or $62 trillion

or whatever it was is because it became a betting house. And what

I’m trying to figure out is, at the point that happened, no longer

should I as an investor who is hedging against the security that I

actually own have taken any comfort from the fact that AIG——

Mr. DINALLO. I think I can answer that, yes. I think that at AIG

most of the activity in the CDS was off of covered, nonnaked activity. These people really owned the CDOs. These were traders that

owned CDOs, and they wanted default protection on the CDOs. But

it is actually a profound observation that the Governor has made

that for the 10 percent of people who thought that they actually

had capital and some kind of insurance protection behind those

covered CDSs, it turns out that possibly the continued unregulated

activity that is naked could seriously impact their ability to receive

payment. I think that’s what one of the Congress people was—I

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think that’s what Congresswoman Maloney was very concerned

about before.

Chairman WAXMAN. Thank you, Mr. Sarbanes.

Mr. Welch.

Mr. WELCH. Thank you very much.

I really appreciate your testimony. Very informative, very helpful.

A couple of things. One, Mr. Turner, I think you said that the

SEC Office of Risk Management was reduced to a staff, did you

say, of one?

Mr. TURNER. Yeah. When that gentleman would go home at

night, he could turn the lights out. In February of this year, that

we had gotten down to just one person at the SEC responsible for

identifying the risk at all the institutions.

Mr. WELCH. So that included the $62 trillion credit default swap.

Mr. TURNER. That’s correct.

Mr. WELCH. And how did he do?

Mr. TURNER. Well, I suppose he got the lights turned out but

didn’t get the problems taken care of.

Mr. WELCH. It reminds me we had a hearing earlier on in this

committee about these tainted toys kids were buying, or they were

getting toys that had lead paint. And it turned out that the Consumer Product Safety Commission apparently had one person—I

hope it wasn’t the same person—inspecting all the Chinese imports.

Mr. TURNER. In all fairness to the SEC, the staff over there that

I’ve dealt with over the years have been excellent. But when you

only have one person there’s no way on God’s green Earth anyone,

Chairman Cox or anyone else, could have even imagined that this

person could do the job. When you cut it down to one, you know

what you’re doing. You know that you’re basically saying we’re not

going to do the job.

Mr. WELCH. Was there a systematic depopulating of the regulatory force so that it was impossible actually for regulation to

occur? If you have one person in that office—and then I understand

that 146 people were cut from the enforcement division at the SEC.

Is that what you also testified to?

Mr. TURNER. Yes. I think there has been a systematic gutting or

whatever you want to call it of the agency and its capability

through cutting back of staff. We talked about risk management,

we talked about enforcement, but as well just in some basic fundamental policies. The enforcement staff are now asked to jump

through many more hoops before they can proceed with investigations, a change that’s been written a lot about in the media, and

it’s not a healthy change for the agency.

Mr. WELCH. You in your testimony—and I think it was really

supported by Mr. Dinallo—identified a number of things that have

contributed—and there is plenty of blame to go around—the executive compensation, people coming and going, making money, the accounting standards being lax, cheap debt, this whole unregulated

casino-like $62 trillion credit default swap, handcuffing of the SEC,

lack of regulation at the holding company level, failure of the Federal Reserve to tighten up on credit and mergers that were too

large.

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But I want to get back—and that was quite a laundry list. In all

the things that we could act on, but on this specific question of

having public servants in the job so they can do the job on behalf

of the American public, would it be your recommendation that

we’ve got to boost the personnel levels at these organizations to

protect the consumer?

Mr. TURNER. Unequivocally yes. I believe in the Appropriations

Committee over in the Senate Banking they’ve given them about

a $30 million increase. And I suspect that falls short. It probably

is going to need to be—if you really want the SEC to do a job and

you’re serious about it, given the cutbacks that have occurred in

the last 3 years or so, you’re probably going to need an increase at

the SEC realistically more in the range of $50 million to $75 million.

Mr. WELCH. And that’s paid for by that SEC transaction fee?

Mr. TURNER. Yeah. And, in fact, the SEC collects more in transaction fees, substantially more in transaction fees from businesses

than they actually pay out for their costs and their staff.

Mr. WELCH. Let me ask you this. Some of us have suggested that

there be an SEC fee or transaction fee that would go into an escrow

account to offset any cost to the taxpayer of this bailout. Is that

something that you have an opinion on?

Mr. TURNER. I’ve always believed that the SEC from a funding

perspective should be treated solely as an independent agency and

that the SEC be given the ability to collect its fees and whatever

it collect it spends on that and that those fees don’t go elsewhere.

They just basically go to fund the SEC so that they don’t—you

know, they get what they need but not more than what they need.

Mr. WELCH. Mr. Dinallo, how about you, both on this question

of personnel to get the job done and establishing basically an escrow fund to help offset the cost of the bailout?

Mr. DINALLO. Obviously, I’m a big fan of hiring regulators. I

think the department is—I think we’re well—you know, we have

a lot of—there’s hundreds of people who do what they do at the

New York State Insurance Department. It takes a lot of people to

regulate closely. I think it is definitely the case that you can design

a system. I certainly feel independent in our work, but we are net,

we are net, you know——

Mr. WELCH. Thank you.

One last question for both of you.

Mr. DINALLO. So I think you can do it without costing the taxpayer any money.

Mr. WELCH. There are a number of companies that are going to

participate in this bailout program, and my question to you is this:

Do you believe it would be right and appropriate for the taxpayers

to have the right to claw back some of these outrageous executive

salaries and golden parachutes from companies that have voluntarily opted to participate in this bailout?

Mr. TURNER. The provisions that are in the legislation, you

know, does under what I would consider to be limited situations

allow claw back. But people need to understand it’s limited. It’s not

everyone. I thought it should have been everyone, quite frankly.

Mr. WELCH. That’s what I’m asking. We have another crack at

this. This was a gun-at-our-head piece of legislation we had to

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pass, we were told, in order to avert a catastrophe. But we have

an opportunity to improve it, and we are going to have to. So would

you support a stronger claw-back provision?

Mr. TURNER. Yes. And I communicated with Members of Congress already that I think the claw-back provision, the severance

provision—there were three provisions there on compensation, and

they all could have been much stronger than what was done the

first go-around.

Mr. WELCH. Mr. Dinallo, how about you?

Mr. DINALLO. I don’t think I have enough of a basis to give an

opinion. I think Congress did a pretty good job the first time

around. But I would have to see some kind of proposal to know for

all such instances.

Mr. WELCH. OK. Thank you.

Thank you, Mr. Chairman.

Chairman WAXMAN. Thank you, Mr. Welch.

Ms. Speier.

Ms. SPEIER. Thank you, Mr. Chairman.

Mr. Dinallo, I am one of those that believes that the regulation

of insurance companies should be at the State level. And if there

ever was a great example of why it works it is AIG, because the

insurance part of AIG is solid.

Now, having said that, you as a regulator have the authority to

conserve, to take institutions into conservatorship. And once you do

that my understanding is, certainly is in California law, that all

bets are off. The contract is off. You are there to make sure that

the corpus is protected for the policyholders, is that correct?

Mr. DINALLO. Yes.

Ms. SPEIER. In this situation we now own AIG. The taxpayers of

this country for all intents and purposes own AIG. It’s in conservatorship. Mr. Cassano, who was the golden boy of the casino

in London, had his compensation very attractively devised so that

over the course of 8 years he actually earned more money than the

CEO, some $280 million, because he was getting $0.30 back for

every—on every dollar he was receiving $0.30 back in terms of the

products that were being sold. So he also was eligible for bonuses.

He was eligible for $34 million of what were unvested bonuses.

But in February of this year he took that company, that division,

down by $5.3 billion. And yet he was fired the next day, and the

following week the committee has a copy of a letter, that’s a contract, I presume, here, that confirms this agreement in which he

was given the $34 million, and, oh, by the way, he is now on contract as a consultant to the tune of $1 million a year, and we, the

taxpayers, are picking up that tab.

So here’s someone who brought the company down, the taxpayers

now own this company, it should be in conservatorship, and this

man is still getting $1 million a year. Now, in conservatorship as

an insurance company, you would be able to void those contracts,

wouldn’t you?

Mr. DINALLO. Yes.

Chairman WAXMAN. Let me intervene just to say it’s $1 million

a month.

Ms. SPEIER. Excuse me. $1 million a month.

Mr. DINALLO. If those contracts were——

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Ms. SPEIER. Thank you, Mr. Chairman, for that clarification.

Mr. DINALLO. If those contracts were with an operating company

that we brought into rehabilitation, which you would call conservatorship, we do have incredibly potent powers over policies and

contracts. The company, we basically step in and become the management at our, you know, salary.

Ms. SPEIER. So that fancy conference in California could have

been stopped under those circumstances?

Mr. DINALLO. Yes. Although I presume—yes. Although again

we’re talking about a holding company activity.

Ms. SPEIER. So Mr. Turner, knowing what we know, knowing

that Mr. Cassano now is getting a million dollars a month paid for

by the taxpayers even though he’s no longer working there and he

did get his bonus even though he didn’t earn it, do you think we

should claw back?

Mr. TURNER. Well, there is always the legal question of legally

what you can or cannot do. Unfortunately, one of our problems is

we’ve paid out or investors are quite frankly going to pay out now,

as you mention taxpayers time and time again, it’s not just this situation, it’s this situation as you aptly describe, others at their institutions, Merrill Lynch, Countrywide and the likes. If there’s a

way you could find legally to go enact legislation that would allow

clawbacks of those sums where there was absolutely no pay and no

performance, if not destruction, I would be a big fan of it. And the

real question is legally whether or not you could do that. I would

certainly say though we’ve learned a lesson and let’s not repeat it

again and let’s go fix this going forward as well. If you can do

something in the past, I’m sure—I’ve heard from a number of my

fellow neighbors that they’d love to see you go get what you

couldn’t back from the past as well.

Ms. SPEIER. One last question to Mr. Dinallo. You determined to

take $20 billion from the insurance company and give it to the

holding company.

Mr. DINALLO. Yes.

Ms. SPEIER. Explain to us why you did that. Did you think that

was going to be enough to hold them over?

Mr. DINALLO. Yes. So we didn’t actually do it. But we did at a

certain point offer to do it as part of a holistic solution. We did believe at the time that the liquidity problem of the downgrade that

I talked about before was on the order of $15 billion, a need for liquidity. So there was a plan to take what was excess surplus—this

is an important point. There’s the asset liability match, promises

versus assets held. There’s a statutory surplus above that. And

then there’s excess surplus even above that which companies often

have the right to decide how to use. And we thought that prudently

we could loan that essentially through the property and casualty

companies to fix the liquidity problem on the basis that the life insurance companies were going to be sold, which is part of the AIG

plan, or some companies to repay that loan. So at the time the Governor thought given AIG’s presence in the community, the number

of jobs at stake, etc., that was a—and given it was not in any way

going to put policyholder protection at risk, it was a reasonable use

of excess surplus.

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Ultimately we didn’t need to do to it. But that was the beginning

of that weekend where I was called in and the Governor sent me

in to understand how we could be pragmatic on a liquidity basis,

yes.

Ms. SPEIER. Thank you.

Chairman WAXMAN. Thank you very much, Ms. Speier. Ms. Watson.

Ms. WATSON. Mr. Chairman, I want to thank you for this opportunity to have the public listen in as we try to unscramble eggs.

And Mr. Dinallo, Mr. Turner, thank you very much. I don’t know

if your responses are really doing that, but at least I hope at the

end of the series of hearings, we as the policymakers will have a

little more clarity as to where we need to go forward and what we

need to do.

Mr. Turner, in your written testimony you told the committee

about AIG’s disclosure on May 2005 that it had inadequate internal

controls. You also said the errors overstated AIG’s income by approximately $3.9 billion. And Mr. Turner, AIG has had a history

of internal control problems. Would you say that’s true?

Mr. TURNER. Yes.

Ms. WATSON. OK. As part of the committee’s investigation, we reviewed internal minutes from AIG’s audit committee meetings,

which are not public, and these minutes show that the company’s

independent auditor, PricewaterhouseCoopers warned the company

as recently as this year that there were significant problems and

that these problems were growing worse. Now here are some of the

examples, and they might be up on the screen.

As of February 7th, the meeting of the audit committee, PWC

warned that the role and reporting of risk management needs a

higher profile in AIG. And at a February 26th meeting, PWC indicated that the process at AIG seemed to break down, in that—and

it was kind of unlikely that other companies, where there was good

dialog at appropriate levels of management on the approach, alternatives considered and key decisions—at AIG only AIG-FP was involved in the December valuation process.

At the next meeting on March 11th PWC reported that there is

a common control issue and root cause for these problems and that

AIG does not have appropriate process or access or clarity around

the roles and responsibilities of critical control functions.

Mr. Turner, as a former SEC accountant, do you consider these

deficiencies serious? Can you elaborate?

Mr. TURNER. Yeah. Again going back into 2007, there’s obviously

some questions about whether the company at a time it had disclosed—and in all fairness to the company they had disclosed that

they had a half trillion in nominal value of these derivatives. They

didn’t tell people just the magnitude of what that could turn into,

but they had told the public they had a half trillion. But in light

of that and the fact there was some very, very serious concerns

about the models and where they could do the valuation right,

which would raise the question of could you actually disclose something with integrity, I think the things that PWC is telling the

company here are extremely serious. If I was—I must say though

if I was sitting on the audit committee—and I’ve chaired a couple

of audit committees—one of my concerns would be obviously the

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company has been doing credit derivatives for quite some period of

time. And now all of a sudden we’re just seeing it from the auditors

for the very first time as we get down to a very critical stage and

things are in essence imploding on us. I would have the question

for AIG management, one, why hadn’t you solved the problem before now? Why didn’t you have the systems in place to make sure

you could get your hands around these and get the right disclosures? But I’d also have a question for PWC, who had been for a

number of years auditing the internal controls, why are you just

now coming and telling me about this at December—November/December 2007 going into 2008? If I was audit committee Chair, I

would feel almost blinded that the auditors hadn’t come and told

me about this beforehand as well. So—and quite frankly, if the

auditors were just coming and telling me this as CEO, if I was sitting there in Mr. Sullivan’s position, I would be raising the same

question with the auditors.

Ms. WATSON. OK. And I would just like to get Mr. Dinallo’s opinion on this, too, as well.

Mr. DINALLO. I think that those are—I think that those would

certainly get my attention. Whether they were rectified or not, I

can’t say. So I think it’s—I think it’s important. I think you want

outside auditors and risk management to come in and make those

kinds of assessments. And the way you should—this is my modest

opinion. The way you should judge sometimes is what the company

did in response.

Ms. WATSON. Thank you very much, gentlemen.

Chairman WAXMAN. Thank you, Ms. Watson.

Mr. Shays.

Mr. SHAYS. Thank you. Mr. Turner, Fannie Mae had assets ranking at No. 2—only Citigroup had a larger asset ranking. Freddie

Mac ranked No. 5. Just to give you some perspective, GE ranked

No. 11, Goldman Sachs No. 12, Ford Motor Co. 15. That was in the

year 2002 when I introduce a bill to say they need to be under the

SEC. Did it ever strike you as curious that the second highest

ranking asset company in the marketplace and the fourth were not

under any oversight by the SEC?

Mr. TURNER. I just think it was flat out wrong. That’s the only

way to say it. I think that someone that’s selling that much of—

you know in the securities market in trading and being held by

public investors, I think unquestionably it should have been from

the git-go underneath SEC regulation, nonexempted.

Mr. SHAYS. Would you take issue with Federal Chairman Alan

Greenspan’s warning to Congress in 2005 about the growth of

Fannie and Freddie’s portfolios when he said, so I think that going

forward, enabling these institutions to increase in size, we are placing this total financial system of the future at a substantial risk.

Would you disagree with that?

Mr. TURNER. At the beginning of 2007 I think these two institutions were doing somewhere in the mid 30, 35 percent of the total

mortgage loans in the country. And by September or so of last year

it had gotten up to about 75 to 78 percent. There is no question

as that risk expanded—and keep in mind the decision was made

quite frankly going back into the late 90’s to allow these two institutions to grow the way they did. If you allow them to grow, you

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have to make sure you’ve got adequate controls and processes

around them. And regulator. And quite frankly——

Mr. SHAYS. And we had a weak regulator named OFHEO.

Mr. TURNER. A very weak regulator.

Mr. SHAYS. The Federal Housing Enterprise Regulatory Reform

Act of 2005, under the previous Congress, passed and was sent to

the Senate. It would establish what we basically did in 2008. But

when it got to the Senate, it was unanimously opposed in committee by, candidly, the Democrats. And therefore it never had a vote

on the House floor.

When I introduced this bill with Mr. Markey, it had 22 cosponsors. And one of the individuals when we were talking about having a stronger regulation in committee said that this was a political

lynching because we were questioning Frank Raines and our oversight of this committee. I want to know, do you think that somehow

Mr. Raines who got $190 million, do you think that somehow he

should be exempt from coming before this committee if we’re going

to have others with less responsibility getting the same sums? If

you don’t want to answer, you don’t have to.

Mr. TURNER. No, no. You asked the question, and the question’s

fair, OK? First of all, I go back to what Congresswoman Maloney

said at the beginning. This is not a partisan issue. And as I said,

this issue needs to be dealt with on a bipartisan basis. I think you

need to drain the entire swamp, Congressman, and I think you

need to take a good look at what went wrong at all of these institutions. Freddie and Fannie are two humongous institutions that

we’ve had to bailout here and it has an impact. And having worked

with OFHEO on both of those institutions, I would encourage you

to bring the executives, the appropriate executives and appropriate

board members before the committee.

Mr. SHAYS. In that bill that we sent to the Senate we had a

clawback provision to be able to go back after these outrageous salaries. Would you recommend that be part of any bill?

Mr. TURNER. As I said earlier, I am a big supporter of the

clawback. What was in the bill was exceedingly weak to the extent

that Congress can determine that there is a legal—an appropriate

legal remedy to go back and give power to someone to claw back.

For prior severance where there was no performance, I would certainly support that.

Mr. SHAYS. Thank you, Mr. Turner.

Chairman WAXMAN. The gentleman yields back the balance of

his time. I agree with you, Mr. Turner, that this should not be a

partisan issue. And that’s why I was somewhat taken aback when

the Republicans on—some Republicans on this committee started

making a big deal about Freddie and Fannie. It is an important

issue. And they’re right. And our committee staff has already been

looking into this thing, and we are going to hold a hearing on it.

So I think it’s appropriate.

Mr. SHAYS. When?

Chairman WAXMAN. We’ll have to negotiate that with the minority to get a day that will be convenient for the staff. But obviously

we’re going to do it.

Mr. Shays talked about a bill that he introduced which you

thought was a good idea. I’m a cosponsor of that bill. And some of

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the proposals that have been put forward Democrats and Republicans have supported. Unfortunately some of the proposals have

not been agreed to, as we were discussing with the clawback provision in the Barney Frank bill that was just adopted. We would

have wanted it to be stronger. The transparency provisions that we

suggested to Chairman Frank as well as some of the other provisions that you’ve mentioned that we ought to adopt, we’ve also recommended should have been in that bill. When you do legislation,

you get what you can. You don’t always get what you want.

But I want to thank both of you for your presentation. I think

you’ve been superb witnesses. You’ve educated this committee enormously. And I have to say about the members on both sides of the

aisle, I thought the questions had been asked of the two of you in

the conversation—more of a conversation than anything else has

been very, very constructive and generally not partisan because

these are not partisan issues. Our country and our economy is at

stake, and therefore we’ve got to work together and not look for—

even though we’re a short time before an election—opportunities to

try to zing the other party. These are not the kind of issues that

ought to be put out—in my view—on a partisan basis. They’re the

kinds of things that we need to look at very carefully together. I

don’t know that there’s a Republican or a Democratic response to

abuses of shareholders and taxpayers. I don’t think there’s going to

be any difference as we look at those issues together. And that’s

why we’re holding these hearings to find out how we got to where

we are and what kinds of suggestions we want to put forward for

the future. We don’t have the jurisdiction that the Banking Committee has, but we certainly can put ideas out there. And I would

hope that on a bipartisan basis not only are we going to hold these

hearings but we may come out with some suggested proposals that

I hope the committees in charge and the leadership of both the

Democratic and Republican side of the House and the Senate will

entertain.

Mr. SHAYS. Would the gentleman yield for a question?

Chairman WAXMAN. Yes.

Mr. SHAYS. Thank you. I want to compliment this committee on

the way they have asked their questions. I do think we’re trying

to get at the answer both on a bipartisan basis. What is troubling

to us though is we scheduled five hearings. And Fannie Mae and

Freddie Mac are not scheduled. And we didn’t hear that you were

even doing this investigation, which our side isn’t a part of, until

we raised this question. Is it fair to assume that we will have this

hearing within this five hearing range? Or is it your intention to

do it after the election?

Chairman WAXMAN. Well, we’ll have to look at the schedule. We

have, for the interest of the witnesses and the public, we had a

hearing yesterday on Lehman, which many people say triggered

the stampede. We had the hearing today on AIG. Next week we’re

going to have a hearing on the rating—I think it’s the rating agencies. And we’re going to hear—have a hearing from the regulators.

And what is—what am I missing?

Mrs. MALONEY. Hedge funds.

Chairman WAXMAN. And we’re going to have a hearing on hedge

funds, because they’re involved in this whole new world that our

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regulatory system did not anticipate. So while we’ve scheduled

those hearings, Members on the other side of the aisle say, well,

what about Freddie and Fannie, Fannie Mae and Freddie Mac?

Well, we’re looking at that in preparation for hearings. I will work

with the Republican staff and Republican Members to make sure

that we have all the hearings that’s necessary and I think it’s appropriate that we will look at them and we will hold a hearing on

it. And we will have to discuss the date.

Mr. DAVIS OF VIRGINIA. Mr. Chairman, let me just add that we

look forward to working with you on that. I think Freddie and

Fannie are huge pieces of this puzzle, and our testimony today illustrates that as well. It’s a shame that the committees of jurisdiction didn’t hold hearings on this 18 months ago. I think we might

not have been in the bind we’re in. But I very much appreciate you

calling this now and that we can examine what happened and what

we might do as we move forward in the future.

Chairman WAXMAN. Thank you. I do want to mention that one

of the reasons we hadn’t scheduled that as the first hearing, as

some Members suggested, is that the committee of jurisdiction just

held a hearing on Freddie Mac and Fannie Mae 2 weeks ago with

their CEOs. So we thought we would go into this in a different direction.

Mr. SHAYS. Would the gentleman yield just for a second question?

Chairman WAXMAN. Yes.

Mr. SHAYS. We have 360 degrees jurisdiction over every activity

of government for investigation. We have no jurisdiction in any of

these issues to promulgate legislation. So I just don’t want there

to be the impression that somehow we don’t have jurisdiction over

Fannie and Freddie. We have total jurisdiction to examine anything they have done.

Chairman WAXMAN. I don’t think anybody would deny that.

Mr. DAVIS OF VIRGINIA. We don’t have jurisdiction over anyone.

We have oversight.

Chairman WAXMAN. Oversight jurisdiction. I think that’s what

the gentleman from Connecticut was referring to.

You’ve been very generous in your time and in your answers to

the questions.

Mr. DAVIS OF VIRGINIA. Mr. Chairman, can I just say thank you

very much. I think they’re great witnesses. I think you’ve added a

lot to both sides of the record.

Chairman WAXMAN. And let me ask unanimous consent of the

committee that all the documents and exhibits that have been referred to by members of the committee be made a part of the hearing record.

Mr. DAVIS OF VIRGINIA. Mr. Chairman I also just ask unanimous

consent to have AIG’s PAC contributions over the last decade be

put in the record as well.

Chairman WAXMAN. Without objection, they will be put in the

record as well.

Thank you very much. We will move on to the next panel, but

we will break for sufficient time for these witnesses to leave and

for the next two witnesses to come to the table.

[Brief recess.]

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Chairman WAXMAN. The committee will please come back to

order.

We’re pleased now to welcome to our committee hearing Martin

Sullivan, who served as the CEO of AIG from March 2005 until

June 2008. Before being named CEO, Mr. Sullivan served as vice

chairman and co-chief operating officer of AIG. And Robert

Willumstad, who served as CEO of AIG from June 2008 until September 2008. Prior to being named CEO, Mr. Willumstad served as

chairman of AIG’s Board of Directors beginning in November 2006.

He was first elected to AIG’s Board of Directors in January 2006.

We’re pleased to welcome both of you to the hearing. It’s the

practice of this committee that all witnesses who testify before us

do so under oath. So I’d like to ask if you would to please stand

and raise your right hands.

[Witnesses sworn.]

Chairman WAXMAN. The record will indicate that both the witnesses answered in the affirmative. And before we even begin, I’d

like the police officer in charge to take the person who’s holding up

a sign and let’s get that cleared out of the room right now. That

woman who was holding up the sign, who intends to hold up a sign

and to make a raucous. I don’t think it’s appropriate in a congressional committee.

Gentlemen, your prepared statements will be in the record in

full. And we want to recognize you for any oral presentation that

you wish to make. While we usually give 5 minutes and I know

you’re mindful of that, I don’t want to limit you in any way in the

amount of time you have to make your statement.

Mr. Sullivan, why don’t we begin with you?

Mr. SULLIVAN. Thank you very much, Mr. Chairman.

Chairman WAXMAN. There’s a button on the base of the mic.

Mr. SULLIVAN. It’s on. Is that much better? OK. I have it now.

Thank you.

Chairman WAXMAN. OK. That’s better.

STATEMENTS OF MARTIN J. SULLIVAN, FORMER CHIEF EXECUTIVE OFFICER, AIG; AND ROBERT B. WILLUMSTAD,

FORMER CHIEF EXECUTIVE OFFICER, AIG

STATEMENT OF MARTIN J. SULLIVAN

Mr. SULLIVAN. Thank you, Mr. Chairman, and a very good afternoon. My name is Martin Sullivan. As you said, from March 2005

until June of this year, I was president and chief executive officer

of AIG. Though I was no longer with the company as the events

of last month unfolded, I’m here today to assist the committee in

understanding the events that led to the Federal rescue of AIG,

how the example of AIG fits into the broader financial crisis currently plaguing the world economy, and the regulatory lessons that

we can learn from AIG’s experience.

People around the world are reeling from the financial tsunami

that has ravaged the global economy. While we had all hoped the

unfortunate collapse of Bear Stearns this past spring would be an

isolated incident, instead the financial storm gained momentum

and many of the world’s most respected financial institutions crumbled one after another. The Federal Government took control of

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Freddie Mac and Fannie Mae, Lehman Brothers and IndyMac declared bankruptcy and Washington Mutual and Wachovia had to be

taken over to avoid a similar fate.

Meanwhile, other prominent institutions sought additional capital, merger partners and redefined their corporate status. Of

course AIG avoided potential bankruptcy only with the help of the

government. Now the U.S. Government is establishing a $700 billion fund to

provide additional relief to threatened financial institutions.

I hope that my testimony about these events that occurred during my tenure at AIG can help the committee understand the formation of what is best described as a global financial tsunami.

While we’re all struggling to understand how this crisis happened

in the first place and to find out what might have prevented it,

there are no simple answers to these questions. I’m not an accountant nor an economist. I’ve been an insurance man all my life. However, many factors appear to have been at play, including lending

and borrowing practices, illiquid markets, the absence of credit,

loss of investor confidence, and even accounting rules which require

companies like AIG to take billions of dollars of unrealized markto-market losses.

When in 2005 the AIG board asked me to step into the role of

Chief Executive Officer, the company was straining under the

weight of several crises very different from the financial crisis currently threatening our financial institutions. I became COO of AIG

at a time when the company was in the midst of governmental investigations that had cast a cloud of suspicion over the company’s

future. In the face of that crisis my responsibility was to stabilize

the ship and improve our relationships with our regulators. I think

I succeeded.

It was against that backdrop that I began my tenure as CEO of

the company. I’m very proud to say that in spite of these challenges

AIG emerged as a successful and resilient company. In 2006 and

in early 2007 AIG was enjoying great success, and those of us within the company’s management had tremendous confidence in our

company’s future.

However, as we now know, the different storm was gathering

over the global financial markets. No disaster as massive or as unforeseen and as unprecedented financial market disruption that

has occurred over the past year is the result of a simple or single

cause. The world’s current economic challenges are obviously related to multiple actions by multiple parties.

To assist the committee, I would like to focus on one particular

factor, the role played by one accounting rule applied to corporations. The accounting rules require that certain assets be mark to

market. In other words, companies must declare the value of those

assets on a quarterly basis at the price such assets could sell for

on the market at that point in time. Companies must declare these

values on their books even if they have no intention of or immediate need to sell the assets or even if they have not realized any

actual gain or actual loss.

FAS 157, which was adopted relatively recently, set out specific

guidelines as to how companies must determine the market price

of certain categories of assets. However well FAS 157 operates

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under any reasonably foreseeable market conditions in the unprecedented credit crisis which began in the summer of 2007, FAS 157

had, in my opinion, unintended consequences. In a distressed market where assets cannot be readily sold companies are forced to declare the value of those assets at fire sale prices.

Just last week the SEC made changes with respect to the application of FAS 157 when entire markets stop functioning. Of course

AIG did not have the benefit of this guidance during my tenure.

At AIG I encountered FAS 157’s unintended effects through the

credit default swap portfolio of AIG financial products, the business

that my predecessor had established and funded many years earlier. These credit default swaps essentially provided insurance to

counterparties in the case of default on underlying bonds. The underlying bonds were very highly rated and the risk of default was

viewed as extremely remote.

Finally, the credit default swap business had since its inception

in the late 1990’s generated a reliable and steady source of income

for AIG-FP. In fact, AIG-FP intended to retain its derivative interest in these highly rated bonds until they reach maturity. When

the credit market seized up, like many other financial institutions,

we were forced to mark our swap positions at fire sale prices as if

we owned the underlying bonds even though we believed that our

swap positions had value if held to maturity. The company nevertheless began reporting billions of dollars of unrealized losses on

the basis of then current market valuations. Suddenly a company

with a trillion dollars of assets was reporting unrealized losses on

its income statement that ultimately climbed into the tens of billions. As AIG’s reported losses mounted, there was a domino like

series of repercussions. Although we had raised approximately $20

billion in capital, it appears that even this precaution was not sufficient protection in the face of the overwhelming and unprecedented

market crisis that exists today. AIG nevertheless suffered credit

rating downgrades which triggered billions of dollars in collateral

cause leading to the most recent events.

Of course by the time the board was presented with the Federal

plan, I had been out of the company for 3 months. In fact, just last

week both the Securities and Exchange Commission and this Congress recognized the effects of FAS 157. The SEC recognized that

FAS 157 can have unintended consequences for financial institutions where markets seize up. The SEC has attempted to provide

more flexibility for companies operating and reporting under the

rule.

In the recently passed legislation Congress directs the SEC to

further examine mark-to-market accounting and grants the SEC

authority to suspend mark-to-market accounting requirements.

These measures make a lot of sense to me.

I have spent my entire adult life in service to AIG, and I am

heartbroken as to what has happened. I hope to see the company

and indeed the entire global economy emerge from this crisis.

I hope that my testimony today has been helpful to the committee, and I will do my very best to answer any questions you may

have. Thank you, sir.

[The prepared statement of Mr. Sullivan follows:]

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Chairman WAXMAN. Thank you very much, Mr. Sullivan. Mr.

Willumstad.

STATEMENT OF ROBERT B. WILLUMSTAD

Mr. WILLUMSTAD. Good morning, Chairman Waxman, Ranking

Member Davis, and members of the committee.

AIG remains a great company, and I want to stress that AIG’s

problems never threatened AIG’s policyholders. The crisis that required AIG to accept assistance from the Federal Reserve is a crisis

in confidence that has affected the entire global economy. When I

became CEO of AIG in June of this year, the decline in the U.S.

housing market had already been underway for months. Though

most homeowners were still making their mortgage payments,

there was an unexpected and unprecedented breakdown in the

market for mortgage-backed securities that were held by many

banks and other financial institutions.

Mark-to-market accounting rules forced AIG along with

Citigroup, Merrill Lynch, and others to book tens of billions of dollars in accounting losses. By the end of the second quarter of 2008,

AIG had booked $50 billion of losses. AIG was downgraded by the

major rating agencies in early May. And AIG’s stock price fell from

a high in 2007 of $72 per share to $26 per share this June. This

decline occurred despite raising $20 billion in new capital and the

vigorous actions of AIG’s board and Martin Sullivan before I became CEO.

In June 2008, the board asked me to replace Martin Sullivan as

CEO. I was initially reluctant to do so. However, the board ultimately persuaded me that my experience in the financial services

industry, including my time as President and Chief Operating Officer of Citigroup, put me in a position to lead AIG in this difficult

period.

On my first day as CEO I publicly announced that I would

present my plan for AIG in 90 days. It became apparent that if the

markets continued to decline and if AIG were further downgraded

by the rating agencies, AIG could potentially face a liquidity problem.

I met with the rating agencies in July, and they told me they

would not review AIG’s ratings until after I announced our plan,

which was then scheduled for September 25. Even so, I immediately took steps to cut expenses and further protect AIG in the

event of a liquidity problem.

We identified nonstrategic businesses, retained financial advisers

and began the process of selling those businesses to raise cash. To

conserve cash, we stopped discussions relating to a number of acquisitions. We were negotiating a transaction with Berkshire

Hathaway that would have protected billions of dollars of AIG’s liquidity.

In late July I met with the President of the Federal Reserve

Bank of New York to discuss the situation. These were precautionary steps. Through the first week of September we believed AIG

could weather the difficulties in the financial markets. When the

market meltdown began the week of September 8th, the rating

agencies indicated they would no longer wait to review AIG’s ratings until September 25. AIG was in a vicious circle. The rating

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agencies were considering a downgrade largely because of marketdriven liquidity concerns. But it was a downgrade or the threat of

one that would trigger a liquidity crisis.

We worked around the clock during the week of September 8th

to take measures that would provide AIG the liquidity needed to

make it through the crisis, but the private markets simply could

not provide enough liquidity. On September 9th I met again with

the Federal Reserve Bank, and during the rest of the week I stayed

in contact with the Federal Reserve and the Treasury Department.

On Tuesday, September 16, 2008, AIG was preparing for the unthinkable, bankruptcy. That afternoon the Federal Reserve and the

Treasury Department told AIG they would provide the necessary liquidity because an AIG bankruptcy would have massive negative

effects on the stability of the entire financial system. Terms of the

offer were nonnegotiable. After a long discussion and with the advice of counsel and our financial advisers, the AIG Board of Directors accepted the Federal Reserve’s plan as the best available option.

As part of that plan I was asked by the Treasury Department

and the Federal Reserve to step down as CEO, and I did so.

Looking back on my time as CEO, I don’t believe AIG could have

done anything differently. The credit default swap contracts had

been in place for years. The market seizure was an unprecedented

global catastrophe. We and our advisers explored every avenue.

There was no private market solution to AIG’s situation.

I regret the pain that events in the market have caused AIG employees and its shareholders. I’m grateful that the Treasury and

the Federal Reserve and, most important, the American people offered their assistance to preserve a vital part of the financial system and a great American institution.

Because my 3-month tenure as Chief Executive Officer did not

provide me the opportunity to execute my restructuring plan and

in light of the fact that AIG shareholders and employees have lost

so much value, I have notified the company I do not intend to accept the payments available to me under the AIG severance plan.

Thank you.

[The prepared statement of Mr. Willumstad follows:]

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Chairman WAXMAN. Thank you both very much. We are now

going to have questions for members of the panel. And without objection, the chairman and the ranking member will be allotted 10

minutes each to use as they see fit. And without objection, that will

be the order.

Both of you seem to be saying that these events had nothing to

do with your management. It had to do with the tsunami of activities over which you had no control. And we’re trying to assess

whether that’s true or whether there was mismanagement by the

executives at AIG.

Now I want to submit for the record a disturbing letter that I’ve

received from Joseph St. Denis. He’s a very reputable man. He was

Assistant Chief Accountant at the SEC Enforcement Division. He

was hired by AIG to address material weaknesses cited by AIG’s

auditors and to provide greater visibility and control with respect

to the operations and accounting policy process of AIG-FP. Mr. St.

Denis says that in 2007—and without objection, his letter will be

made part of the record—he says in 2007 he became concerned

about the valuation model used by AIG’s Financial Products Division. But when he tried to audit this division he was blocked by

Mr. Cassano, who was the head of that division. Mr. St. Denis

wrote the committee that the only—what Mr. Cassano said was

that I have deliberately excluded you from the valuation of the

super seniors because I was concerned that you would pollute the

process. That’s what Mr. Cassano said to Mr. St. Denis. And Mr.

St. Denis said to the committee, the only pollution Mr. Cassano

was concerned about was the transparency I brought to AIG-FP’s

accounting policy process.

[The information referred to follows:]

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Chairman WAXMAN. Mr. Sullivan, you were the CEO at the time.

Mr. St. Denis was hired to give you insight into Mr. Cassano’s activities. And he said he was blocked from doing that. And he resigned.

Were you aware of this?

Mr. SULLIVAN. To the very best of my knowledge, sir, I don’t believe I ever saw the letter. But I do recall the content being

brought to my attention. And I understand that a very thorough

investigation both from our compliance people and from I believe

the audit committee—I’m not sure on that. But certainly compliance and legal looked into what Mr. St. Denis was saying. Of

course at that time we were already putting in place compensating

controls to make sure that our valuation process was obviously accurate.

Chairman WAXMAN. You were trying to put these controls in, but

the man who was hired by your company to give you the information as to what controls were needed was fired because he was told

he couldn’t look into what was happening in this particular division

of AIG, the FP Division, from which all the problems seemed to

arise.

Mr. SULLIVAN. From the very little I know about Mr. St. Denis,

and I have no reason to believe he’s not a first-class individual, I

think he resigned, sir. I don’t think he was terminated.

Chairman WAXMAN. He resigned because he was blocked from

doing his job.

Mr. SULLIVAN. Exactly. And I think, as I said, from what I recall

about the letter, it was investigated from the legal and compliance

people. But at the same time obviously we were trying to put compensating controls in there to make sure that our results were as

accurate as possible.

Chairman WAXMAN. He said he reported Mr. Cassano’s actions to

AIG’s independent auditors. He also said that he spoke with AIG’s

Director of Internal Audit Michael Roemer. Mr. Roemer thought

this was a serious matter, and on November 6, 2007, he personally

briefed the board’s audit committee on Mr. St. Dennis’ resignation,

according to minutes from that meeting.

Mr. Willumstad, you were the chairman of the board at this

time. What steps did you and the board take to investigate this

matter?

Mr. WILLUMSTAD. I actually don’t remember the comments in the

audit committee.

Chairman WAXMAN. You do not remember?

Mr. WILLUMSTAD. I do not.

Chairman WAXMAN. Well, we don’t have a full record of the committee. But we did request all the minutes of the audit committee.

And there’s nothing we can see that indicates that AIG took any

action to respond to Mr. St. Dennis’ concerns. So it looks like you

both brushed it aside. Is that an unfair characterization?

Mr. WILLUMSTAD. I don’t recall the audit committee or the comments. So I can’t answer that.

Chairman WAXMAN. And you were the chairman of the board at

that time?

Mr. WILLUMSTAD. I was.

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Chairman WAXMAN. And Mr. Sullivan, you were the CEO. And

you don’t have much recollection of this either.

Mr. SULLIVAN. Other than I believe I recall that it was investigated by legal-compliance, and as you refer to, the internal audit

division, sir.

Chairman WAXMAN. Well, the reason of course why this is significant is that this man was brought in to find out about these

kinds of problems which ended up bringing AIG to its knees, and

it could have given you that information except he was blocked by

the fellow in London, Mr. Cassano, who didn’t want him to know

what Mr. Cassano was up to. So I just find that very disturbing.

I’m going to reserve the balance of my time and recognize Mr.

Davis.

Mr. DAVIS OF VIRGINIA. Thank you, Mr. Chairman. Mr. Sullivan,

according to the documents obtained by the committee, on March

11, 2008, it was recommended that losses in AIG-FP not be considered when calculating your compensation package. How do you justify this while also advocating pay for performance as a prudential

standard for executive compensation?

Mr. SULLIVAN. First of all, sir, can I just clarify that my compensation was obviously discussed in executive session and with

the compensation committee. And they ultimately made a recommendation to the board at large who ultimately had to approve

my compensation. From what I can recall, and if—if you’re referring—it would be helpful if I could know the minutes you’re referring to, but some were put up on the screen earlier. But if you’re

referring to the discussions we had on the super senior—the senior

partners and the partners plan, is that what you’re referring to,

sir?

Mr. DAVIS OF VIRGINIA. We asked the staff to get that. I will go

on for another question.

I was just looking at your resume. And I saw that you went to

the Sydney Russell School and were very generous to them afterward. Did you have further education after that?

Mr. SULLIVAN. I put myself through night school, sir, and became

a chartered insurer. I received my associateship at the Charter Insurance Institute in the United Kingdom.

Mr. DAVIS OF VIRGINIA. OK. You joined AIG in 1971?

Mr. SULLIVAN. Yes, sir, when I was 17.

Mr. DAVIS OF VIRGINIA. When you were 17 years old.

Mr. Willumstad, can you tell us how the mark-to-market accounting rules affected AIG’s position and do you think it contributed to the deterioration of the company?

Mr. WILLUMSTAD. Well, I would like to make a couple of comments. I have no concern or problems——

Mr. DAVIS OF VIRGINIA. Could you move that closer to you?

Thank you.

Mr. WILLUMSTAD. I would make a couple comments about mark

to market. One, I have no concerns about the validity of mark-tomarket accounting. I think the concerns that I’ve shared in my

written statement is that when there is no market, the ability to

value securities based on FAS 157 becomes somewhat difficult and

requires a fair amount of judgment. There are, as I said, no specific

market for these securities. And the company, along with others,

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has to go through a process which uses formulas and other indicative prices to come up with these values. So accordingly, it’s very

difficult to determine whether the values are actually correct.

According to the procedures that AIG followed, there were very

substantial writedowns in these securities.

Mr. DAVIS OF VIRGINIA. So did it help or hurt you?

Mr. WILLUMSTAD. Well, it obviously resulted in substantial

writedowns, which were obviously not helpful to the company.

Mr. DAVIS OF VIRGINIA. Your statement alludes to the fact that

in 2005 AIG stopped writing policies on multi-sector credit default

swaps. So somebody I guess at AIG saw that there were problems

or questions with this portion of the business. Why did AIG stop

writing these policies?

Mr. WILLUMSTAD. I don’t know. I was not on the board at that

time.

Mr. DAVIS. Mr. Sullivan, do you know why?

Mr. SULLIVAN. Sorry, sir?

Mr. DAVIS OF VIRGINIA. In Mr. Willumstad’s statement he talked

about that AIG in 2005 stopped writing policies on multi-sector

credit default swaps. Obviously they did that—somebody recommended this inside and this was an early warning signal. Can

you tell us——

Mr. SULLIVAN. Yes. From the best of my recollection based on

what I understood, because obviously at that time I was very focused on resolving the regulatory issues that AIG was facing and

making sure that we got our accounts issued. Obviously there was

a big delay in 2005 in our issuing our accounts. From what I understand on investigation, that decision was made by AIG-FP in

conjunction with the risk management—the risk—the chief risk officer and chief credit officer of AIG.

Mr. DAVIS OF VIRGINIA. So they saw a problem obviously.

Mr. SULLIVAN. Again, from what I understand, they saw a deterioration in pricing and were beginning to get concerned about

credit quality. So they took a very proactive step in 2005.

Mr. DAVIS OF VIRGINIA. Did AIG rely heavily on the mortgagebacked assets of Fannie Mae and Freddie Mac? And did their demise play a role?

Mr. SULLIVAN. I don’t know the answer to that, sir.

Mr. DAVIS OF VIRGINIA. Is there any linkage between AIG and

the GSEs in terms of what was happening with Freddie and

Fannie buying these with implied government backing?

Mr. SULLIVAN. I’m not aware of what our exposure was to

Freddie or Fannie off the top of my head, sir.

Mr. DAVIS OF VIRGINIA. OK. I have your statement up here on

the board. And I’ll ask you——

Mr. SULLIVAN. Thank you for putting that up. I appreciate that.

When I was talking to the compensation committee on March

11th, what I was proposing there was the—what they—proposing

what they should actually award the partners and the senior partners. And as I think somebody mentioned earlier, there was 700

partners and there were about 70 senior partners. And I was making a recommendation—and by the way, I should stress, nobody in

AIG-FP participated in this partners plan or senior partners plan.

And what obviously I was anxious to do was to make sure that we

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retained our key people. See, shareholders would expect me to be

focused on retaining our key people in those parts of the business,

the insurance businesses and other sectors of the businesses that

were performing well whilst these unrealized losses but nonetheless losses—nobody is differentiating between——

Mr. DAVIS OF VIRGINIA. So what you are saying is with these sectors, they were meeting their goals, they were doing their job. In

other sectors they weren’t.

Mr. SULLIVAN. Not everybody was hitting targets. Some were exceeding, some were not exceeding, as you would expect in a business. But what I was anxious to do is to make sure that we retained the 700 key executives that, you know, were running other

parts of our business and participating in other parts of our business and were not in AIG-FP. The important distinction there is

nobody is in AIG-FP participated in these programs.

Mr. DAVIS OF VIRGINIA. Mr. Willumstad, you don’t see any relation between what was happening with Freddie and Fannie and

what was happening with AIG then? Do you agree with Mr. Sullivan?

Mr. WILLUMSTAD. I do not.

Mr. DAVIS OF VIRGINIA. Did the accounting scandals there raise

a red flag, that you were insuring investments that could be tainted that were coming out of there?

Mr. WILLUMSTAD. I’m sorry. Could you——

Mr. DAVIS OF VIRGINIA. You were buying, you were getting into

some of the business. Did the accounting scandals at Fannie and

Freddie raise any red flags as to whether you were insuring investments that might be tainted?

Mr. WILLUMSTAD. No.

Mr. DAVIS OF VIRGINIA. OK. Let’s take you both to the early 2000

timeframe. Is there anything in government regulation going back

to this early timeframe that would have changed your business

model and would have prevented this catastrophe?

You were somewhere else at that point, Mr. Willumstad. But

with Citigroup.

Mr. WILLUMSTAD. That’s correct.

Mr. DAVIS OF VIRGINIA. Mr. Sullivan.

Mr. SULLIVAN. Can I just clarify? You mentioned the year 2000,

sir?

Mr. DAVIS OF VIRGINIA. In that timeframe, yes.

Mr. SULLIVAN. Maybe it’s helpful for the committee there. But

from the best of my knowledge, the CDS portfolio started to be underwritten in the late 1990’s, 1998. And obviously as I testified——

Mr. DAVIS OF VIRGINIA. But the rules were changing as we

speak. What happened in that timeframe of course is you had several rule changes taking place at Congress statutorily.

Mr. SULLIVAN. Well, if you’re referring to my comments regarding FAS 157 in particular?

Mr. DAVIS OF VIRGINIA. Well, no, I’m talking about the regulatory framework on the commodities futures and Glass-Steagall

repeal, those kinds of things.

Mr. SULLIVAN. Right. I don’t think anything in the regulatory

field to the very best of my knowledge would have changed what

occurred. You’re going back to 1998.

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Mr. DAVIS OF VIRGINIA. That’s what I’m asking.

Mr. SULLIVAN. I don’t.

Mr. DAVIS OF VIRGINIA. I’ll reserve the balance of my time.

Chairman WAXMAN. Mr. Sullivan, just so I have this correct, you

asked that your bonus based on performance not count the losses

at AIG-FP, is that right?

Mr. SULLIVAN. No, sir. What I was referring to here was what

should be paid under our partners and senior partners plan.

Chairman WAXMAN. You were included in that.

Mr. SULLIVAN. I was included in that. But at the time I was

speaking——

Chairman WAXMAN. So everybody in that group, including you,

got the bonuses as if you performed very well because you didn’t

count the losses?

Mr. SULLIVAN. But with respect, sir, the compensation committee

of our board sets my remuneration and it’s then discussed with the

board at large. They could have.

Chairman WAXMAN. But you requested the board to take that position?

Mr. SULLIVAN. On behalf of the employees of AIG, yes, sir.

Chairman WAXMAN. Including yourself?

Mr. SULLIVAN. But trust me, I was focusing on them more than

me.

Chairman WAXMAN. AIG-FP, they were getting paid bonuses that

were even higher than the bonuses you were getting, isn’t that correct?

Mr. SULLIVAN. In certain instances, yes, sir. In most instances.

Chairman WAXMAN. So everybody did really well even though

there were losses. You didn’t get penalized, you and the others you

represented. You are getting penalized because of the losses, even

though your bonus was dependent on—getting a bonus higher if

you got earnings, higher earnings, higher bonus. You got lower

earnings and therefore you still got the bonus. And AIG-FP got

their bonuses because they were being handled in a different way

even though they were the ones bringing on the losses. Is that a

fair statement?

Mr. SULLIVAN. Just for clarity, sir, with regard to my bonus it

was substantially reduced in 2007 by AIG’s Board of Directors,

which I concurred with. With regard to AIG-FP, I don’t believe—

and again, this is from the very best of my recollection—that they

received their bonuses in 2007. I think we put in place a deferred

compensation plan—again I’m doing this from memory. But they

certainly received their bonus for 2006 and prior.

Chairman WAXMAN. OK. Mrs. Maloney.

Mrs. MALONEY. Thank you, Mr. Chairman. We heard from our

first panel that one of the key factors that caused this financial

mess was not accounting rules that shed light on these risky exotic

tools that you were investing in, have no value and that people

don’t want to buy them. What the first panel said was that one of

the key factors was inadequate deregulation of so-called credit default swaps. And it is a $58 trillion market, double the size of the

entire New York Stock Exchange. The market is four times larger

than our national debt. But unlike the stock exchange, the swap

market has no transparency, no rules and no oversight.

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The result of the failure to regulate these credit default swaps

seems pretty clear. AIG had to be bailed out by the taxpayers because of your risky investment in credit default swaps. And I for

one don’t think any of the management deserves a bonus or any

pay from the taxpayers’ purse and certainly not an exotic weekend

to discuss the future of AIG, which was a great company.

You have cost my constituents and the taxpayers of this country

$85 billion and run into the ground one of the most respected insurance companies in the history of our country. And the company’s failure has tremendous implications in our entire economy. I

got hundreds of calls from constituents concerned about AIG because of their interaction with this company.

So I would like first to ask you, Mr. Sullivan, do you believe the

swaps markets should be regulated?

Mr. SULLIVAN. Well, obviously with the benefit of considerable

hindsight, if there is good regulation that can be put in place, personally I would support that.

Mrs. MALONEY. And Mr. Willumstad, do you believe that a swap

market should be regulated?

Mr. WILLUMSTAD. Yes.

Mrs. MALONEY. Could you give to this committee how much AIG

lost in these swaps? Do you have any idea? Out of the $58 trillion,

how much is held by AIG? Could you get to us back in writing?

Maybe that is something you would need to look at.

I would also like to ask you, Mr. Sullivan, that if the same rules

that had applied to your insurance company where you had some

backup and some reserves, would this have avoided the bailout

that AIG is confronting now?

Mr. SULLIVAN. Well, Congresswoman, at the time I left the company I believed it was well capitalized and had the liquidity to

work its way through.

Mrs. MALONEY. But the swaps had no capital behind them. Do

swaps have any capital behind them?

Mr. SULLIVAN. Well, only the capital ultimately of AIG.

Mrs. MALONEY. Pardon me?

Mr. SULLIVAN. Only the capital ultimately of the holding company.

Mrs. MALONEY. I’m talking about the swaps. There was no capital reserve behind those swaps, right?

Mr. SULLIVAN. That’s right.

Mrs. MALONEY. So you were gambling billions, possibly trillions

of dollars.

Mr. SULLIVAN. Well, I wouldn’t refer to it as gambling. These

transactions were individually underwritten very carefully. And

maybe I can provide some more background to you that may be

helpful.

Mrs. MALONEY. If they were carefully underwritten how come no

one wants to buy them? And our first panel said when you

securitize them the first time, maybe the second time they had

value. But when you get to the sixth and seventh time that there’s

no value there. That’s what the first panel said. And you did not

follow the insurance rules of having any collateral or capital behind

these risky swaps.

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Mr. SULLIVAN. Maybe it would be helpful—because there was a

lot of generalization in the first panel. Maybe it would be helpful

if I just explain. And as I say, I’m not an accountant.

Mrs. MALONEY. But you did make a good decision not to sell

them anymore after 2005?

Mr. SULLIVAN. Or underwrite. To accept any more swaps after

2005.

Mrs. MALONEY. You must have realized that they didn’t have any

value. And what I’m angry about now is when you blame accountants for coming forward looking at a product and saying it has no

value because absolutely no one in the entire world wants to buy

it. It’s not their fault. You want them to say there’s value there

when there’s none? I believe in the fair market value. If no one

wants to buy it, I think there’s an indication that there’s no value

there, that you were generating fees, making all of your employees

rich, wrecking a great company, and tearing down our economy,

and now turning to the taxpayers and asking us to bail you out.

I think you should be apologizing to the American people for your

mismanagement.

Mr. SULLIVAN. Well, maybe it would be helpful if I can. First of

all, I’m not blaming accountants. I said in my testimony——

Mrs. MALONEY. You said the mark-to-market rules, which is how

accountants determine whether there is fair market value, they

have determined no one wants to buy it. Therefore, it does not help

their market value. That—I believe they’re shedding light on the

problem. And there have been many memos from many executives

saying they should change the accounting rules and say there’s

value there when there is no value.

Chairman WAXMAN. The gentlelady’s time has expired.

Do you want to make any comment?

Mr. SULLIVAN. With the utmost respect, what I said in my testimony was the unintended consequences of FAS 157. I have never

criticized FAS 157. My concern, which ultimately the SEC and this

Congress have concurred with, when I made my remarks, I started

making these remarks back in March of this year, was the unintended consequences of trying to mark to market these assets in

an illiquid market.

And one of the concerns I had, if I may, again which may be educational, is back many years ago, many of you may recall the Piper

Alpha exploded in the North Sea, if you remember the tragic circumstances of Piper Alpha exploding. There was something in the

London market insurance area that was called the London market

spiral. And what Piper Alpha precipitated was a spiraling effect

throughout the market that forced the market ultimately to collapse. The London market insurance fire was no longer there.

What I saw in early 2008 was what I believe was an unintended

consequence of FAS 157. I wasn’t attempting in any way, shape, or

form to criticize it. What I was trying bring to everybody’s attention and what I’m trying to bring to everybody’s attention today

was the unintended consequence of trying to mark to market assets

that had value, that you were happy to hold to maturity, that interest was being paid, dividends were being paid, but you couldn’t

mark to market in an illiquid market. And that was, with the

greatest respect, the point I was trying to make.

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I don’t think there is any one individual, any one entity, any one

body that you can point the finger to. I think when you look back

and see these great institutions that we are addressing today and

this committee has addressed in the past, if you look at the German Government guaranteeing bank deposits, you look at the Irish

government——

Chairman WAXMAN. Mr. Sullivan, we’re going to have more questions.

Mr. SULLIVAN. I’m terribly sorry, but I’m trying to bring it in perspective if I may. I’m not trying to point the finger at accountants

or FAS 157; I’m trying to raise the issue of unintended consequences.

Chairman WAXMAN. Mr. Davis you wanted to say something

else?

Mr. DAVIS OF VIRGINIA. I yield myself a couple of minutes because I’m still puzzled by both of your comments about not relying

on Freddie and Fannie.

My understanding is people would buy these secondary mortgages. And you had said you would sell them credit default swaps;

isn’t that what happened?

Mr. SULLIVAN. Yes. We were selling, to the very best of

knowledge——

Mr. DAVIS OF VIRGINIA. But you weren’t relying on the fact that

this government-backed group was insuring them and that had

bought them originally. That had nothing.

Now let me just tell where you I’m going with this. In documents

submitted to the committee, a former AIG CEO Hank Greenberg

asserts that in the 8 years from 1988 to March 2005 AIG wrote

credit default swaps on only about 200 CDOs; those are

collateralized debt obligations. Only a handful, he says, of these

were exposed to subprime mortgages. He goes on to assert that

after his departure from AIG, the company under your leadership,

Mr. Sullivan, wrote about 200 CDO credit default swaps in just 10

months, from March to December 2005, but that these, unlike his

CDOs, were heavily exposed to subprime mortgages.

Essentially, as I read it, Mr. Greenberg is blaming you for exposing AIG to the most risky credit default swaps. Do you agree with

that assertion or not?

Mr. SULLIVAN. Clearly not, sir. But what I again would point out,

that these CDS swaps were being written since the late 1990’s, not

just in 2005——

Mr. DAVIS OF VIRGINIA. I know they were written in the 1990’s.

But my question here is, he’s saying that in the early stages, it was

not heavy on subprimes; that after this, it became very heavy with

subprimes.

You claim Freddie and Fannie have nothing to do with this, is

what I heard you saying. You weren’t relying on the fact that they

were buying these up and that they had government backed. But

you went ahead with this, according to Mr. Greenberg, and that in

the 10 months before you stopped, that the alarm went out, that

you were buying these up and that he says that’s basically what

put you at risky credit default swaps.

In fact, in earlier testimony from Mr. Willumstad, he notes that

the FP wrote a large number of instruments called credit default

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swaps over time, that they wrote insurance bank swaps on bonds

with a face value of over $500 billion. Is that correct?

Mr. SULLIVAN. From recollection, I don’t believe the number got to $500 billion, but it was certainly in totality around $400 billion,

yes.

Mr. DAVIS OF VIRGINIA. And what are they actually worth?

Mr. SULLIVAN. Well, that’s the notional value, sir. Let me just

point out if I may. Up until the time I left AIG, to the very best

of my knowledge AIG had not suffered $1 realized loss.

Mr. DAVIS OF VIRGINIA. They’re still holding them, aren’t they?

Mr. SULLIVAN. They’re still holding them. At the time, this valuation can come back. As these contracts mature, and they have an

average tenure of 4 or 5 years, as these contracts mature, the valuation, assuming there is no loss under the contract, the valuations

would come back.

Mr. DAVIS OF VIRGINIA. But you carry them on the books as zero.

Mr. SULLIVAN. Well, I’m not sure they’re carried at zero, sir.

They’re mark-to-market valuation. But coming back to the point of

2005, I don’t want to underestimate the fact that AIG was in a different sort of crisis in 2005. We had advised the market that they

couldn’t rely on our accounts. We had major regulatory issues that

were dominating the focus of my attention. I had to negotiate with

the SEC, the DOJ, my friends at the New York Insurance Department, as well as the New York Attorney General. And we had to

stabilize a ship that could have come very much unglued. During

that process of time obviously the capital markets division, AIGFP, continued to write their business. Nobody had any concerns

about the profitability of that business at the time. And as they

progressed through 2005, as the Congresswoman said, you know,

fortunately, you know, those people involved in the underwriting of

that, including the corporate risk and corporate credit offices, made

the determination that the market was deteriorating, not only in

pricing but in credit quality, and made the decision fortunately to

stop. That’s the point I would like to make.

The day I left the company, sir, all of these losses to the best of

my knowledge were unrealized at the time, nonetheless losses but

unrealized.

Chairman WAXMAN. Thank you, Mr. Davis.

Mr. Cummings.

Mr. CUMMINGS. Thank you very much, Mr. Chairman.

Mr. Sullivan, are you, like Mr. Willumstad, considering giving

back some of that money?

Mr. SULLIVAN. No, I’m not, sir.

Mr. CUMMINGS. After the bailout on September 16th, the taxpayers in effect became the owners of AIG. That should have

meant a change in its approach to executive compensation and benefits, but apparently, it did not. The committee has learned that a

week after the bailout, executives from AIG’s main life insurance

subsidiary, AIG American General, held this week-long conference

at an exclusive resort in California. Are you all familiar? Are you

familiar with that at all?

Mr. WILLUMSTAD. I am not.

Mr. CUMMINGS. The resort is called the St. Regis Monarch Beach

Resort. We’ve gotten somepictures, and we put them up. And let

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me give you a sense of how exclusive the resort was. Rooms start

at $425. Some cost as much as $1,200. And it’s interesting, they’ve

got, 5 nights they had a room for, a Presidential suite, for $1,600.

And then they had 5 nights the royal suite, really nice and swanky,

another $1,600 for 5 nights; that was $8,000. And we contacted the

resort, and we got a copy of the bill. AIG spent $200,000, $200,000,

Mr. Sullivan, for rooms and $150,000 for banquets. They spent

$23,000 for the hotel spa. I don’t know whether you heard me asking the experts questions earlier. And of course, that was for the

pedicures manicures facials massages and whatever they do in the

spa. And they spent about $1,400 at the salon. The guests in the

spa and salon actually had different amenities. They had all kinds

of things at St. Regis. But they spent $7,000 on something very,

very, important; that is green fees at the golf course. And then, I’m

not even sure what this charge means, but my colleagues tell me

that the $10,000 for leisure dining was for drinking.

Mr. Willumstad, you’re no longer CEO, and I understand that.

When this all happened, do you—I mean, what’s your opinion? I

mean, you seem to be a very honorable man. Would you have gone

along with that?

Mr. WILLUMSTAD. Absolutely not.

Mr. CUMMINGS. And what do you think of it.

Mr. WILLUMSTAD. It seems very inappropriate.

Mr. CUMMINGS. And it seems kind of—a very bad thing when you

think about the fact that the U.S. taxpayers would be basically

ending up paying for this, was that not correct?

Mr. WILLUMSTAD. I’m not aware of the facts, but I’ll take your

word for it.

Mr. CUMMINGS. But could you understand why taxpayers would

be upset?

Mr. WILLUMSTAD. Of course.

Mr. CUMMINGS. And, Mr. Sullivan, I’m curious what were your

views on this?

Mr. SULLIVAN. Well, obviously I share Mr. Willumstad’s comments. You know, obviously, I left the company many months earlier prior to Mr. Willumstad.

Mr. CUMMINGS. I understand.

Mr. SULLIVAN. But if I had seen bills like that, I can assure you,

as the CEO, I would have been asking questions. At the time I left,

AIG within its travel department had a unit that organized conferences that were supposed to, obviously, get the best rates and

make sure that the conferences were being held in appropriate locations. This is obviously some months later.

Mr. CUMMINGS. But you can understand why taxpayers would be

very upset, wouldn’t you? Couldn’t you?

Mr. SULLIVAN. Yes, sir.

Mr. CUMMINGS. I’m going to contact the AIG to find out who was

responsible for all of this, because I think that person ought to be

fired don’t you.

Mr. SULLIVAN. Well, without knowing the full facts, you may

reach that conclusion when you reach those facts, but I don’t know

the facts, sir. I had left many months earlier.

Mr. CUMMINGS. One of the experts earlier said they wanted to

make sure these kind of things did not happen again. What kind

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of—now that we the taxpayers of America are part of this process,

what kind of things and procedures can we put in place to make

sure these kinds of things don’t happen again?

Mr. SULLIVAN. Well, I think you have to look, and I think with

respect to, Mr. Dinallo mentioned this at the time, that you need

to look at for what purpose is this conference being used. You

know, obviously, the company at that stage had gone through a

transition. Maybe they believed it was an appropriate thing to calm

everybody down. I think Mr. Dinallo made some reference to that.

But as you look going forward as a manager, you would look at

the appropriateness of, one, what’s the reason for the conference?

Is it appropriate? And what’s the benefit to the company? And

what’s the appropriate cost that should be associated with that, as

you would do with any management——

Mr. CUMMINGS. I do find it interesting that Mr. Willumstad

knows nothing about it, but this came just a week after you left.

Did you know that, Mr. Willumstad?

Mr. WILLUMSTAD. I’ve heard you say that, but I was totally unaware that there was any plan for any conference.

Mr. CUMMINGS. So you wouldn’t have been aware of this subsidiary spending some $500,000——

Mr. WILLUMSTAD. I was not aware of that.

Mr. CUMMINGS [continuing]. In a week.

Mr. WILLUMSTAD. I was not aware of it. And had I been aware

of it, I would have prevented it from happening.

Mr. CUMMINGS. Thank you very much.

Mrs. MALONEY [presiding]. Mr. Cummings’ time is expired.

The Chair recognizes Mr. Souder.

Mr. SOUDER. Thank you. One of the big frustrations that anybody watching this across America has is, both of you used the

term market driven, financial tsunami, as if you weren’t part of it.

Do you feel you have any responsibility for what’s happened in our

economy with a huge company that the taxpayers now have put

$61 billion in with $85 going, do you feel you have any personal

responsibility?

Mr. Sullivan.

Mr. SULLIVAN. I take responsibility for everything that occurred

as my tenure as AIG’s president and chief executive. And that’s the

role of a president and chief executive——

Mr. SOUDER. In other words, you’re acting like, during your period, you were doing fine. You were having all these nice profits,

and that somewhere between July and September, your company

lost $61 billion that we’ve already had to bail out that—and you’re

claiming that the accounting rule which was the law, it was just

a matter of interpretation of how to apply it, and I basically don’t

agree with how it was enforced and like many others have argued

that was a wrong enforcement, but quite frankly, what it did was

it showed up that your assets didn’t have great value. And do you

acknowledge that you are part what triggered the financial tsunami? That your risky strategies in your company—let me ask you

another question. Your insurance division is fine, correct?

Mr. SULLIVAN. To the very best of my knowledge at the time I

left, certainly.

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Mr. SOUDER. Mr. Willumstad, wouldn’t you say your financial division, we heard earlier, your financial division appears to be in

good shape—I mean your insurance division.

Mr. WILLUMSTAD. That’s correct.

Mr. SOUDER. Now, if your insurance division is in good shape, it

means that this is concentrated in your financial services division.

And your insurance division, which is also investing assets, chose

not to invest in as risky of assets that didn’t yield as much but

were less risky. Is that not true? Or how would you explain that

one division in a short period of time could have had $61 billion

in taxpayer investment and your other division not needing it when

your other division, as insurance companies do, also invests in

properties, also have been struggling with mark to market, have

also had, but have more regulation on the value of those assets

prior to that decision? Why does not your risky strategies in the financial services show that, in fact, to get higher return you went

for more risk in that category?

Mr. Sullivan.

Mr. SULLIVAN. Well, again, what I would like to point out is that

we actually stopped running that business, thank goodness, in

2005. That’s a point I would like to, because I don’t think it was

made clear in the first session that, fortunately, we had been in

that business for some 10 years. But as my colleagues determined

that market—you know, the credit quality was changing and the

pricing of these——

Mr. SOUDER. Let me clarify, because you referred to this several times. Are you saying that the $61 billion that we put in is mostly

of things that were pre-2005.

Mr. SULLIVAN. I don’t know what the $61 million is, sir.

Mr. SOUDER. $61 billion is what the taxpayers have already put

in of the 85 to cover the losses of AIG. And are you maintaining

that this is just to rescue bad decisions pre-2005, or is any of that

money because you had questionable decisions between 2005 and

2008? Do you bear any responsibility? That’s what I’m asking.

Mr. SULLIVAN. Well, I want to be clear——

Mr. SOUDER. You asked for raises because you said you were

making profits a little bit ago. You said that you were making profits, that you hadn’t lost any money. But yeah, but you had a shell

that was anchored in less than secured mortgages that had been

leveraged multiple times. Your insurance division, which also presumably has mortgages and other types of investments, seems fine.

The question is, why weren’t you warning your stockholders? Why

weren’t you making declarations that would leave your company—

I mean, I have a business background, an MBA, just a small town

business guy. But at the same time, you took incredible risk without warning people, and the evidence of that risk is that, one accounting—by your own explanation, one accounting rules change

put your company under, and the taxpayers are putting $61 billion

in; how in the world does an executive leave their company so vulnerable that, when they leave, all of a sudden they go broke when

they were claiming they were making money before, and they act

astounded like everything was just fine if they hadn’t done this one

accounting rule, which I don’t agree that you have to balance out

when the assets are going to be sold, I understand that, you’re

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holding them long term. But the reason they’re trying to do some

of this kind of thing is we might have had a complete collapse if

we hadn’t done any mark to market here, we hadn’t done any of

these kind of accounting changes. Our assets were deteriorating,

and we would have had an even bigger blowup later potentially.

We needed some kind of a mix in there. But in effect, you left your

company so exposed that when a little bit of softness came to the

economy and it started down and they do an accounting change,

you go belly up and stick everybody else in America with it, and

you’re saying, oh, it was a market tsunami, as if you didn’t help

cause it.

Mr. SULLIVAN. Again, if I may, sir, with the utmost respect, in

my testimony, if I emphasize FAS 157 as being the only cause, it

was not, again with the greatest respect, I was not criticizing FAS

157. I was referring to its unintended consequences, which of

course this Congress has now and the SEC have now recognized.

There were many other reasons that have affected many other

companies and many other countries around the world. It’s not just

the United States. This tsunami that many have referred to—others have mentioned the equivalent of financial Pearl Harbor, you

know, much more intelligent people than I. There were many

issues that contributed to this. As I mentioned, whether it was inappropriate lending or borrowing, whether it was lack of investor

confidence, whether it was the freezing of the credit markets, I just

in my testimony to be helpful to the committee focused on what I

believed back in my tenor as AIG something that I was concerned

about, which was the unintended consequences of FAS 157.

And I responded to the Congressman earlier, at the time I left,

as Mr. Willumstad articulated in his testimony, we had taken substantial unrealized losses, losses nonetheless. But at the end of the

day, these CDS transactions at the time I had left the company

had not incurred, to the best of my knowledge, $1 of realize. That’s

not to say they wouldn’t as the situation progressed. But at the

time I left the company, this was multiple issues, not one entity,

not one individual. And that was the point I was trying to make.

If I referred to FAS 157 too much in my testimony, it was only because that was something I was particularly concerned about as—

not being an accountant, but as, again, like you. Sir——

Mrs. MALONEY. The gentleman’s time has expired.

I yield 1 minute to the ranking member.

Mr. DAVIS OF VIRGINIA. I guess the thing to all of us is puzzling

is, how come you get bailed out, Lehman doesn’t? Who makes these

choices? It is kind of mysterious, I think, to a lot of us. The regrettable thing here is that you get bailed out. Your employees get to

stay. Your shareholders take a bath, but you’re bailed out because

there would be a lot of collateral damage if we were to have not

stepped in. That’s at least the rationale that we are hearing from

Treasury. But, frankly, given the quality of some of the decisions

that were made, you deserve to fail.

And it is, I think for a lot of us, puzzling why you were singled

out and kept your doors open, your employees kept moving, while

other companies were left to fail and just fall on their sword. And

I think that’s what’s troubling to me and I think to a lot of other

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Members up here. And I think we’ll explore more of that in the testimony and the questions as we follow.

Thank you.

Mrs. MALONEY. Thank you.

The Chair recognizes Congressman Kucinich for 5 minutes.

Mr. KUCINICH. I thank the gentlelady.

It appears that in the last month this country has taken steps,

unprecedented circumstances, unprecedented steps. We interfered

in the free market. We bailed out Wall Street. The market is not

responding. We see today’s headline in the Wall Street Journal,

‘‘Markets Fall on Doubts Rescues Will Succeed.’’ And I think what

this does is I think it raises questions as to whether it was wise

for government to intervene directly in the markets and whether

or not a financial rescue plan should have addressed the core problem, which is, tens of millions of Americans losing their homes,

needing government to get a controlling interest in these mortgagebacked securities, so that we can work out a plan where people can

get a break on their interest rates, on their principal, extended

terms of their loan, and help people save their loans. We had other

choices of priming or pumping the economy. We didn’t do any of

that.

Now, questions are raised. For example, you talk about mark to

market. AIG went into the government’s hands on about September 18th. Interesting, mark to market was basically suspended on

the 30th. I think the timing of that needs to be explored a little

bit more carefully. We know it went into effect on November 15th.

We’ve got a bailout plan by the Secretary of the Treasury which

clearly is not working, and we’ve got—which the taxpayers are paying for, and we’ve got another $85 billion of a bailout for AIG.

And according to the testimony submitted to this committee by

former CEO of AIG Mr. Greenberg, he raises questions as to

whether or not a government bailout of AIG was absolutely necessary. In fact, he admits there was a liquidity crisis that required

action. But he goes on to say in his testimony, the action was, it

was not necessary to do a government bailout. He said that it was

not necessary to wipe out virtually all of the shareholder value held

by AIG’s millions of shareholders, including tens of thousands of

employees and many more pensioners and other Americans on

fixed income. He said that perhaps they could have filed bankruptcy, limited the parent company, and that millions of stockholders would have fared better. This goes back to a question of my

friend that the stockholders would have fared better. But he says

that other stakeholders, like AIG’s Wall Street counterparties,

would have fared worse.

So, according to the testimony of another CEO of AIG, private

sector solutions for AIG were rejected. He talked about the tens of

billions of capital that were offered. He talked about the State of

New York ready to permit AIG to use $20 billion in excess capital

of its insurance subsidiaries, plus he says there was no effort made

for a temporary and limited bridge fund from the government; plus

we have this mark-to-market problem, and plus you have, without

the mark-to-market problem, you have possibly $1 trillion that

could have been pledged to secure an, instead of trying to secure

an $85 billion loan from the government.

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Now, instead, the government takes over. AIG, now we have 85

percent ownership of AIG. Here’s what’s going on with AIG. AIG

is paying interest on undrawn capital. They’re paying interest on

money it doesn’t borrow. The company is encouraged to draw down

the full amount of the loan even if it doesn’t need the money. Now,

in order to service the principal and loan, the AIG has to engage

in a fire sale of profitable assets.

Who buys though assets, Mr. Sullivan, who buys AIG assets.

Mr. SULLIVAN. Well, obviously, I can’t comment on the events

that——

Mr. KUCINICH. Who buys their assets?

Mr. SULLIVAN. Well, if you recruit investment bankers, they will

go out and I assume get the best deal that they possibly can for

the assets for sale.

Mr. KUCINICH. Mr. Willumstad, you were involved with negotiations with Treasury Secretary Paulson. Why do you think AIG was

bailed out while Lehman Brothers was allowed to fail?

Mr. WILLUMSTAD. I’m not sure why Lehman Brothers was allowed to fail. I think it was understood that the consequences to

the financial system if AIG failed would be very significant.

Mr. KUCINICH. My time is expired, Madam.

Mrs. MALONEY. The Chair recognizes Congressman Bilbray of

California for 5 minutes.

Mr. BILBRAY. Thank you, Madam Chair.

You know, Madam Chair, I do an editorial note. I’m not going to

ask you gentlemen from prepared statements that somebody else

has written up before this hearing. I’m going to ask questions that

basically respond to your testimony.

Madam Chair, I do have to point out that it’s sort of interesting

the way we throw around terminologies. And somebody born and

raised on the ocean and spent some time in the water myself, I find

it funny that we use the terminology like tsunami. We can’t even

use plain language like tidal wave. But maybe because some people

don’t understand some of the words they’re using.

Gentlemen, the term tsunami or tidal wave is not just a wave

coming in. You land lovers and people that don’t surf may not understand that long before that crest breaks, there’s an indication

that something is going on. Granted, usually tourists see the tide

going out and think it’s a good time to go out and pick up seashells.

And a lot of people seem to have seen that the tide shifting and

the major changes that were happening were an opportunity to go

in and clean out, and they got caught below the high water mark.

I hope the Chair doesn’t mind me using that analogy, but as an

old surfer, I just can’t go back addressing that. When Freddie and

Fannie went from 30 percent to 70 percent of a certain part of the

market; when we saw major portions of our oil money that’s going

overseas coming back and buying up paper and inflating a market;

don’t you think that we should have seen some concern there, when

we say—well, let me just ask it out.

When Freddie and Fannie went from 30 to 70 percent, how much

of the problem should have been seen by all of us that we have a

portion of the market that was very, very vulnerable, and did that

vulnerability have an effect to your operation and the problems

we’re facing with AIG, with Freddie and Fannie?

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Mr. SULLIVAN. Would you like me to respond, sir?

Mr. BILBRAY. Yes.

Mr. SULLIVAN. First of all, I don’t believe, with the greatest respect, I’m qualified to comment on Freddie and Fannie and the implications thereof.

But what I did say in my testimony was one of the factors that

I think has contributed to, and the tsunami equivalent, I defer to

your expertise, sir, but what’s contributed to what has impacted

the global financial economy is, you know, one of the things could

be inappropriate borrowing and lending. And if that correlates to

your analogy of Freddie and Fannie, maybe that’s helpful, I don’t

know. But I certainly don’t know enough about Freddie and Fannie

to pass any qualified opinion.

Mr. BILBRAY. And I apologize, I had to fly back from the West

Coast just to be here at this hearing, and I just got to look at the

waves and didn’t get to enjoy them at all this weekend, so we’re

here getting our work done.

Let’s just talk about the mark to market. We developed a concept

based on the Enron model of how to address Enron. Now, would

you agree that when it applies to mortgage-backed securities, when

there’s real estate involved, the existing or the traditional accounting process with mark to market really didn’t reflect the real value,

the real assets, and the real situation on the ground and gave an

artificial appearance of volatility that scared the hell out of the

market in a lot of ways that maybe it shouldn’t have.

Mr. SULLIVAN. I would agree with that statement.

As I testified, sir, I think what occurred was when FAS 157 of

mark-to-market accounting was put in place, you know, it was really the ability to mark to market in an illiquid market when there

is no visible valuation. And again, maybe it’s helpful if I can just

give an example. It’s like owning an apartment block. And the

valuation of that apartment block goes up and down. But all of the

tenants, you’re the owner of that building, and you’ve got it fully

occupied. Everybody is paying their rent on time. You can pay your

mortgage, and you can pay your—any capital expense you have in

repairs or whatever. And you don’t have to sell that building. You

can hold it for as long as you want. It doesn’t really matter what

the valuation of that building is because you can hold it, and you’ll

get in all the cash that you need in from that.

And what’s occurred in the illiquid markets is that you’re trying

to value assets that are still paying their rent, they’re still providing you with the cash-flow that you need, but there isn’t a valuation that—you know, response to that in an illiquid market. And

that was the point—that’s a very simplistic example. But that was

the point I was trying to make about the unintended consequences.

Mr. BILBRAY. So, in other words, our theory of trying to go in and

correct the Enron, we need to go back and readdress it because

we’ve moved too far the other way to where it doesn’t reflect the

reality. And I think one of the things a lot of people were interested

in those mortgage-backed securities because they always knew that

there was real estate involved, but the accounting process doesn’t

reflect that reality.

Mr. SULLIVAN. Well, I think, obviously, as I said, it wasn’t a criticism of FAS 157. I think there was an unintended consequence

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that I am pleased that Congress and the SEC have agreed to at

least take a look at.

Mr. BILBRAY. Thank you, Mr. Chairman.

Chairman WAXMAN [presiding]. The gentleman’s time has expired.

Mr. Tierney.

Mr. TIERNEY. Thank you, Mr. Chairman.

Gentlemen, I think people are a little bit baffled here. We look

at Mr. Greenberg’s testimony, and it’s not his fault; according to

him, it all happened after his watch.

Mr. Sullivan, you say no mistakes were made as events unfolded.

Mr. Willumstad, you say AIG couldn’t have done it any differently.

And yet I think that people really expected the management of

the company, you as the leaders of the company, would have seen

what risk you were taking and been able to just know what they

were and assess them.

We took a look at the internal minutes from your audit committee meetings. They’re not public, but we were able to get them.

They seem to tell a different story on that. And let me just go

down.

On January 15th, the audit committee minutes say this: Ongoing

discussions revealed that PricewaterhouseCoopers believes to be an

expectation gap among key parties, including the board, management and the internal control functions.

The next month, on February 7th, the audit committee meeting:

PWC warns the role or reporting of risk management needs a higher profile at AIG.

At a February 26th meeting: PWC says, indicated that the process at AIG seemed to break down and that, unlike other companies

where there was a good dialog and appropriate levels of management on the approach, alternatives considered and key decisions,

at AIG, only AIG-FP, the Financial Products Division, was involved

in a December valuation process.

And that may have something to do with the chairman’s letter

that he received from Mr. St. Denis that he brought it to people’s

attention, and he couldn’t get by that office over there.

Then you have March 10, 2008, you get the Office of Thrift Supervision. They weigh in on this, and they say that your management of the company and your oversight of AIG subsidiaries, including in particular the Financial Products Division led by Mr.

Cassano, should be criticized. And they also say that supervisory

concerns regarding the corporate oversight of key AIG’s subsidiaries exist, and they write that we are concerned that corporate

oversight of AIG Financial Products lacks critical elements of independence, transparency and granularity.

And the next day, PricewaterhouseCoopers reports that there is

a common control issue, the root cause for these problems, and that

AIG does not have the appropriate access or clarity around the

roles and responsibilities of critical control functions.

Gentlemen, that seems to stretch from January 15th all the way

to March 11th, your own internal audits, your own

PricewaterhouseCoopers group and the Office of Thrift Supervision

repeatedly saying the serious lapses are there. They describe them,

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both the auditors and the regulators. Don’t you think that management has some responsibility for what went on here?

Mr. Willumstad.

Mr. WILLUMSTAD. Yes, management has some responsibility.

Mr. TIERNEY. Mr. Sullivan, do you agree?

Mr. SULLIVAN. Yes, I would also say that, at the same time, we

were putting compensating controls in place. You read the chronological list there, but we had put compensating controls in place

that enabled us, obviously, to issue our financials for 2007 with a

clean audit.

Mr. TIERNEY. I guess the problem is, people expect management

to be ahead of the curve, not to wait for the regulators and

PricewaterhouseCoopers to start blowing the whistle late. The salaries that you gentlemen pulled down, you and your team on that,

means to us that you anticipate these things and that you start

putting those things in place before the whistle is blown, before

these people come in and point out the seriousness of the situation.

And I think that’s what disturbs people on this and what continues to be a theme through here that it’s not—and Mr. Chairman,

I would like unanimous consent to put copies of the audit reports

and the minutes, as well as the Office of Thrift Supervision letter

of March 10, 2008, in the record, because I think it shows clearly

that this is not something that external factors are responsible for

solely on this; it’s a fundamental failure here of management. And

I’m glad that you both take responsibility for it. I hope your whole

management team does, because certainly the price is extremely

high on that.

Chairman WAXMAN. Without objection those documents will be

made part of the record.

Mr. SULLIVAN. Can I just respond on one point?

One of the things that we set out to do in March 2005 was to

make tremendous investments in a number of areas that previously had been underinvested. So we added a lot of staff in internal audit and legal compliance, risk management etc. So I wanted

you to at least know there were compensating controls put in place.

Mr. TIERNEY. And I appreciate that, if I may, Mr. Chairman, except these are reports from January, February and March 2008. So,

obviously, not enough had happened even remotely close to settling

the qualms of the regulators and the auditors on that. So I think

it shows some management issues there.

Chairman WAXMAN. And if the gentleman will yield to me. And

Mr. St. Denis, who was working for you to alert you to these problems, tried to get through in November 2007, and neither of you

remember him complaining or know anything about his concerns.

So you did have an alarm, even in the previous year.

Mr. Turner, I think you’re next.

Mr. TURNER OF OHIO. Thank you, Mr. Chairman.

Yesterday we had a hearing concerning Lehman Brothers, and

there was a discussion that Lehman Brothers had it’s own

subprime lender, BNC Mortgage I believe it was, where they were

issuing subprime loans. With AIG, my understanding is that you

were an insurer and you also traded mortgage-backed securities.

I’m not certain, though, did you also have a lending function of

subprime mortgages? And also, then, did you package loans,

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issuing them, selling them as mortgage-backed securities. In the

subprime crisis that we’re seeing, what activity in the subprime

market did AIG have?

Mr. SULLIVAN. We did have a—they do have—sorry. It is hard

to differentiate when you’ve been there 37 years. AIG does have a

consumer finance that’s called AIG.

Mr. TURNER OF OHIO. Then you also packaged and sold those

loans as mortgage-backed securities; you also traded in them.

Mr. SULLIVAN. What I was going to point out is that fortunately,

AGF did not participate in, it is my understanding, any of the exotic mortgage products during that period of time and didn’t participate in lending in what we’re seeing to be the hot markets that

we now discover. So whilst their results have not been at the level

that we would normally expect them to be, they have not been as

bad as others in their industry.

Mr. TURNER OF OHIO. Because the first panel indicated that you

were invested heavily in subprime mortgages. So that’s direct.

That’s not mortgage-backed securities. That’s in the mortgages

themselves?

Mr. SULLIVAN. I’m sorry, sir, I don’t quite understand the question.

Mr. TURNER OF OHIO. The first panel indicated that part of AIG’s

problems were that your financial services institutions invested

heavily in subprime mortgages. In what form was that investment

held?

Mr. SULLIVAN. Again, I think that’s the clarity that’s required.

These are super senior credit default swaps. These are the transactions that AIG-FP participated in, so there are—and we’ve made

very, very fulsome disclosure on this. In fact, we’ve been complimented by the investment community and others about the fulsome disclosure that we’ve made. It’s all on our Web site and has

been for many quarters. Is that they were effectively insuring, and

I’m no expert on this, but effectively insuring the super senior level

of the transaction. So there are tranches of bonds, the CDOs below

that, whether they are equity, triple B, double A minus, double A,

triple A, and then there’s another layer of protection before you get

to the super senior. And what you’re doing, and again, I’m no accountant, but you’re valuing the assets that are underlying the

super senior transaction. So that’s, what FP wrote was a super senior credit default swap portfolio.

Mr. TURNER OF OHIO. My concern that I have mentioned in

many of these hearings is—I’m from Ohio. We’re one of the leaders

in foreclosures. You can go drive through neighborhoods in my community, and you can see the abandoned houses that are there. Our

experience has been that predominantly these are a result of refinances where the loan, ultimately where the consumer gets in trouble, the value of the loan exceeds the value of the house at origination; that there are terms many times capitalization of the fees.

There are terms that ultimately caused the home owners to get

into trouble. Sometimes it’s financial circumstances of the consumer that causes that they can’t keep up with the payments. But

usually, it’s something to do with the mortgage product itself that

causes the initial stress and a realization by the consumer that the

mortgage value is higher than the house value itself. So they don’t

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even have the ability to sell the home, which you would find in normal then real estate transactions, to escape their liability. They are

in effect trapped and have the only recourse, not having the financial resources themselves to make up the gap, of abandoning the

property, causing therefore the foreclosure because they’re not able

to keep up.

In the county in which I reside, it’s about 5,000 foreclosures a

year now in a community of about half a million people. The State

of Ohio is experiencing somewhere around 80,000 a year. Every 3

years, that’s a geographic size of one full congressional district.

It’s been interesting listening to you, Mr. Sullivan, about your

discussion of mark to market because I was actually, until you

began talking about it, kind of leaning toward perhaps maybe it

was a policy that was a problem. But after hearing your statement

on giving bonuses based upon excluding losses and your statement

of these aren’t really realized losses, that mark to markets, as you

said, unintended consequences followed, I’m beginning to think

that the advocates for significantly reducing mark-to-market applications are trying to say that we shouldn’t look at value without

looking at current value, which is kind of like your bonus description.

So my concern here, though, is that if mark to market is a process that people get concerned with when markets fluctuate, if we

have a situation where the loans are originated at a higher than

the value, the mark to market on day one would tell you that the

underlying mortgage security is not properly collateralized. In your

discussions on the subprime effect, mortgage-backed securities, as

you were saying with the swaps, did you ever have any discussions

in your company where you heard that in fact some of these mortgages perhaps exceeded the value at loan origination?

I would like you both to answer.

Mr. WILLUMSTAD. Not to my knowledge.

Mr. SULLIVAN. Not to my knowledge, sir.

Chairman WAXMAN. The gentleman’s time is expired now.

We go to Mr. Yarmuth.

Mr. YARMUTH. Thank you, Mr. Chairman.

I think it was Mr. Bilbray earlier asked a question if you knew

why AIG was bailed out and not Lehman. I’m going to ask a little

bit more direct question.

Mr. Willumstad, did Goldman Sachs have anything to lose if AIG

went under?

Mr. WILLUMSTAD. Goldman Sachs was a significant counterparty

for AIG.

Mr. YARMUTH. To what extent are the relationships intertwined,

and how much do you think Goldman Sachs would have suffered

financially? What kind of stake was there for Goldman Sachs and

AIG’s survival?

Mr. WILLUMSTAD. I can’t tell you what losses Goldman Sachs

might have suffered because I don’t know. The only thing I can tell

you is that Goldman Sachs was a counterparty on approximately

$20 billion worth of credit default swaps that AIG-FP had.

Mr. YARMUTH. So it’s a significant interest in AIG’s survival it

sounds like.

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Mr. WILLUMSTAD. Again, I don’t want to jump to that conclusion.

I don’t know how those securities carried on Goldman Sachs’ books,

and I don’t know whether they were hedged by Goldman Sachs, so

it would be very difficult to draw that conclusion.

Mr. YARMUTH. It sounds like a question we need to ask, Mr.

Chairman.

Several comments have been made about the fact that AIG was

too big to fail. And we saw, I think you were in the room earlier,

when the statement of Alan Greenspan about size and the question

of whether we let companies get too big. Clearly, by your own admission, in this case the implications of AIG’s failure on the financial markets would be substantial. Is this something that troubles

you, that companies are able to reach the size where they can disrupt an entire economy? And I guess the corollary question or the

followup question is, what benefits to society, our society, get by

letting a company get so big that it puts the entire Nation’s financial system at stake or at risk?

Mr. WILLUMSTAD. I’m sorry, I’m not sure I understand the question.

Mr. YARMUTH. Well, I mean, you’re running a company now, albeit for just a few months—Mr. Sullivan ran the company for several years—that apparently was so big that its failure went—the

implications of its failure, potential failure went far beyond its

shareholders and its employees, and that’s why our government decided that it needed to step in, because of that impact. Do you

think that it is good that corporations can get to that size in our

economy where their mistakes don’t just affect them? And do you

think there are benefits—you know, if we’re going to allow companies to get that big, that their failures and their mistakes can affect all of us, then what does society get in return for allowing the

company to get so large?

Mr. WILLUMSTAD. Well, again, I think the size of AIG and the

interconnection between AIG and the rest of the capital markets

are really the issue. I’m not sure purely size by itself is the determinant factor. I would say also that there have been plenty of benefits to AIG’s size, its ability to serve broad markets, to provide a

competitive marketplace so customers and policy holders can get a

good deal if you will, that AIG was a strong well-capitalized insurance operation that provided many benefits to its customers and

consumers that did business with it.

Mr. YARMUTH. And then that’s the question I was asking, because we see this now in—we’ve seen it in many situations recently

where companies that are so large that their failures just impact

taxpayers throughout the system. And I think the question we

have to ask as a society is, are the benefits of that size, whether

it’s a competitive—whether it’s competitive pricing or whatever,

adequate to justify the risk of a company disrupting, a company

making a mistake and disrupting the entire economy. But that’s

something that’s a little bit of a, I guess a 30,000-foot issue in this

particular case. Just a quick question again. We’ve had some testimony about the fact that only $60 billion has been drawn down of

the $85 billion. What specifically was the $85 billion needed for?

Mr. WILLUMSTAD. The $85 billion number was a number that

was obviously determined by the Federal Reserve. The $85 billion,

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I believe, was intended to be a loan to cover liquidity needs inside

the company. It’s been characterized before as covering losses

which I think is not an accurate representation. Again, the loan

was taken down after I left the company, so I can’t be specific

about it. But what happens in a crisis of confidence like this and

what was happening to AIG was not a question of losses. AIG has

had a lot of money borrowed over the years. And when you go

through one of these crises, people who have loaned you money in

the past stop lending to you. People who give you money or put

money on deposit with you want it back; that in another environment, without this crisis of confidence, AIG could have easily met

all of those obligations. But when you have a series of

counterparties who have decided for reasons of concern about the

viability of the company stop doing business with you, the company

can no longer meet its obligations.

It’s not very much different that if all the consumers of a particular bank showed up 1 day and asked for all of their money back,

there’s no bank in America that could provide that. Those dollars

of deposits that were given to that bank are loaned out in the communities to small businesses, consumers, credit cards. The whole

system is driven around confidence and viability. And once that

breaks down, there is no company, certainly in the United States

and I think anywhere around the world, that can sustain a run on

the institution.

Chairman WAXMAN. The gentleman’s time has expired.

Ms. Watson has requested that she be recognized next. Does anybody object to that? If not, the gentlelady is recognized.

Ms. WATSON. Thank you so much, Mr. Chairman.

I think you just about answered my question, but it’s about the $85 billion, Mr. Willumstad, that has been given to bail out. And

as I understand, last Friday, AIG reported it had already drawn

down $61 billion of the $85 billion loan. Does that align itself to

what you were just describing, that people want their money now?

Mr. WILLUMSTAD. Again, I don’t know what the use of the $61

billion was for because I wasn’t there. I’m not there. But I would

say, generally speaking, my assumption would be that’s exactly

what it was used for.

Ms. WATSON. In fact, AIG has drawn down the funds so quickly

that credit rating agencies have now begun downgrading AIG

again. And back on September 16th, AIG said that the bailout

would prevent further rating downgrades. And we know that you’re

not at the company anymore, and I’m sure you’re surprised by how

quickly the $85 billion line of credit has been consumed. So one

question that my constituents, and I’m sure that all American taxpayers, are asking, can you explain or try to how AIG could burn

through $61 billion in just 3 weeks?

Mr. WILLUMSTAD. Well, again, I don’t know what the source for

the use of that money was. But I’m assuming that counterparties

who would normally lend money to AIG are no longer lending

money to AIG, and consequently that’s where the money is going.

Ms. WATSON. The new CEO of AIG, Edward Liddy, publicly suggested that AIG might take a piece of the $700 billion bailout package that we just passed. So that would be in addition to the $85

billion that AIG already received. And my question would be to

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those who can look forward down the economic road, when is this

going to end? Will it end? How much are we going to have to spend

of the taxpayers’ money to keep AIG afloat? Would you have any

idea now that you’re not actively with the company?

Mr. WILLUMSTAD. I’m sorry, but I do not.

Ms. WATSON. OK.

Well, I appreciate the going out of line, and I appreciate the gentleman coming here and being straightforward. A little honesty

would help us very much.

Thank you so much, Mr. Chairman, for accommodating me.

Chairman WAXMAN. Thank you very much, Ms. Watson.

Mr. Braley.

Mr. BRALEY. Thank you, Mr. Chairman.

Mr. Sullivan and Mr. Willumstad, I would like to ask you about

the compensation paid to one particular AIG employee Joseph

Cassano. Mr. Cassano was president of AIG’s Financial Product Division, the unit that sold the credit default swaps that helped bring

down AIG. During his tenure at AIG, Mr. Cassano repeatedly denied that these swaps posed any risk to AIG or its shareholders.

And I’m going to quote to you from a September 28, 2008, article

in the New York Times by Gretchen Morgenson which attributes

this comment to Mr. Cassano in August 2007: ‘‘it is hard for us,

without being flippant, to even see a scenario within any kind of

realm of reason that would see us losing $1 in any of these transactions.’’

The committee has examined Mr. Cassano’s pay, and we were

shocked to find that AIG paid him more than it paid its CEOs.

Over the last 8 years, he earned a total of $280 million in cash,

and most of that money came from a bonus program. For every dollar that Mr. Cassano’s unit made $0.30 came back to him and the

other Financial Products executives.

On February 28, 2008, AIG posted losses of $5.3 billion. The main reason for these losses was the $11 billion lost by Mr.

Cassano’s division. The very next day, February 29th, Mr. Cassano

was terminated from his position as president of the Financial

Products Division. But when AIG terminated Mr. Cassano, it took

two actions that, quite frankly, are hard for your new partners, the

U.S. taxpayers, to comprehend. First, AIG let him keep up to $34

million in uninvested bonuses. And second, the company amazingly

hired Mr. Cassano as a consultant for the sum of $1 million a

month.

So, Mr. Willumstad, let me start with you. As CEO of AIG, you

had authority until September 17, 2008, to cancel Mr. Cassano’s

consulting agreement for cause, but you never did that, did you?

Mr. WILLUMSTAD. No.

Mr. BILBRAY. Mr. Sullivan, as CEO for AIG during the period

from March 11, 2008, when this severance agreement was signed

between AIG and Mr. Cassano, through June 15, 2008, you had authority to cancel Mr. Cassano’s consulting agreement for cause, but

you never took that action, did you?

Mr. SULLIVAN. That is correct.

Mr. BILBRAY. Mr. Chairman, I’m going to offer as part of the

record the consulting agreement of March 11, 2008, which provides

the CEO of AIG to terminate the consulting agreement for cause.

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And I certainly think that in light of what we’ve heard here today

there was ample justification based upon the misrepresentations

made by Mr. Cassano and based upon the financial peril he created

for this longstanding company of great reputation and our entire

financial marketplace, that option should have been exercised and

something should have been done for the taxpayers of the United

States.

Chairman WAXMAN. Without objection, the document will be

made part of the record.

Mr. BRALEY. And Mr. Chairman, I agree that this is not a partisan issue. But there have certainly been some partisan comments

made about the investigation by this committee of Fannie Mae and

Freddie Mac.

And I would just like to read for the record a portion of a Financial Times article dated September 9, 2008, titled, ‘‘Oxley Hits Back

at Ideologues.’’ This is an article interviewing the former chair of

the House Financial Services division, Mike Oxley, who, instead of

blaming Fannie Mae and Freddie Mac, headed the Financial Services Committee and blames the mess on ideologues within the

White House as well as Alan Greenspan, former chairman of the

Federal Reserve. In fact, he talked about the GSE reform bill that

passed the House overwhelmingly in 2005 and could have prevented the current crisis.

And here’s what he says: ‘‘all the handwringing and bedwetting

going on now without remembering how the House stepped up on

this, he says, what did we get from the White House? We got a one

finger salute.’’

And finally, he says, we missed a golden opportunity that would

have avoided a lot of the problems we’re facing now if we hadn’t

had such a firm ideological position at the White House and the

Treasury and the Fed, Mr. Oxley says.

And I would offer that as part of the record as well.

Chairman WAXMAN. Without objection, that will be made part of

the record.

[The information referred to follows:]

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Chairman WAXMAN. Will the gentleman yield?

Mr. BRALEY. Yes I would.

Chairman WAXMAN. Why didn’t you fire Mr. Cassano? You had

the ability under the rules under which your corporation operated

to fire him. And he’s been kept on at a million-dollars-a-month retainer. He was discharged. Why didn’t you fire him?

Mr. Willumstad.

Mr. WILLUMSTAD. Well, again, I was not the CEO at the time.

Mr. Sullivan had recommended to the board and the compensation

committee that Mr. Cassano’s assistance in helping unwind, if you

will, or work down the exposure in FP would be valuable to the

company and that, as part of his agreement, he would have a noncompete, nonsolicitation agreement. It was important to keep the

existing employees in FP to help work through the sizable exposure.

Chairman WAXMAN. You were the chairman of the board.

Mr. WILLUMSTAD. I was.

Chairman WAXMAN. And you could have insisted that he be fired,

but Mr. Sullivan told you not to fire him so he wouldn’t go out and

compete with you. I would have thought you would want him to go

to some other corporation the way he had put yours so deeply in

the hole.

Mr. Sullivan, why didn’t you fire him?

Mr. SULLIVAN. I recommended that course of action to the board,

and Mr. Willumstad articulated the reasons very well.

One of the things that I wanted to ensure is that we retained the

20-year knowledge that Mr. Cassano had about the businesses.

These are long-term transactions. These are not transactions that

go on the books and expire 12 months later. They’re very long

term, and you want to make sure that the key players and the key

employees within AIG-FP, that we retain that intellectual knowledge.

Chairman WAXMAN. What would he have to have done for you

to feel that you should fire him? He put you in a situation where

you had to come up with $60 billion immediately, and you couldn’t

do it. Isn’t that enough reason to feel that the guy shouldn’t be

kept on at a million-dollars-a-month salary just to be available?

Mr. SULLIVAN. Well, at the time, you know, obviously, we made

that decision. Mr. Casanno decided to retire, and I believed—and

I made the recommendation, as Mr. Willumstad articulated, that

his services be retained and——

Chairman WAXMAN. When I retire, I want to come to work for

you at $1 million a month. What a good deal that is. And what a

good signal that is. The man goes out on his own in these derivative deals that bring down AIG, and he gets $1 million a month retainer in case you need his advice. Is that what you’re telling us?

Mr. SULLIVAN. Well—and, in addition, Mr. Willumstad articulated all the reasons there, that he had a noncompete nonsolicitation so that we could retain the key employees in AIGFP, bearing

in mind these are multi-year contracts. This wasn’t the entirety of

FP’s businesses. There were other sectors that they were in as well.

Chairman WAXMAN. Ms. Norton, I think you’re next on the list.

Ms. NORTON. Thank you, Mr. Chairman.

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I’d like to ask both of you questions about your statements as the

company was collapsing. Because it didn’t suddenly fall, suddenly

collapse. Mr. Sullivan, let me ask you first.

In December 2007, you said the following: We believe we have a

remarkable business platform with great prospects that represent

tremendous value. How many superlatives in that sentence? And

then you posted $5.3 billion in losses for the quarter. That was December.

Move just a few months to February 2008, and then you said,

based upon our most current analysis, we believe that any credit

impairment losses realized over time by AIGFP would not be material to AIG’s consolidated financial condition. Then you went on to

post $7.8 billion or more in losses for the quarter.

A few months later, May 2008, you said, ‘‘sir—the underlying

fundamentals of our core business remain solid.’’ The next month

the board voted to replace you.

Let me ask you, Mr. Sullivan, what was the source of those glowing statements as you were posting loss after loss, quarter after

quarter?

Mr. SULLIVAN. Well, I think, because you made a reference to a

number of statements there, I need to break down my answer, if

I may.

First of all, my reference to the corporation is talking about

AIG’s global franchise. Because, obviously, AIG is in a number of

businesses, not just the super senior credit default swap arena. Obviously, we have leading market positions in many other businesses. I’m talking current. I keep on saying ‘‘we.’’ I’m no longer

there, but for 37 years I was there. They have market leading positions.

Ms. NORTON. Of course, there were the credit default swaps that

were collapsing your fundamental business. Go ahead, sir.

Mr. SULLIVAN. That’s correct. But I’m just trying to clarify some

of my remarks, because you’ve taken—there’s different topics being

covered there.

So one is referring to the core franchise and the market leading

positions that AIG holds in a number of businesses around the

world. The other comment is trying to differentiate between the realized loss potential of that portfolio as against the unrealized loss

potential.

As I mentioned earlier, at the time I left the company, to the

very best of my knowledge, certainly to the best of my knowledge

at the end of the first quarter, I don’t believe AIG had suffered any

realized losses. That’s not to say they wouldn’t suffer realized

losses as the market continued to deteriorate; and, in fact, we made

very fulsome disclosure. As I mentioned earlier, we had a tremendous amount of information on our exposures to the U.S. residential housing market on our investor Web site.

Ms. NORTON. Would not be material—credit losses realized over

time would not be material to AIG’s consolidated financial condition.

Mr. SULLIVAN. Based on what I knew——

Ms. NORTON. That is a pretty blanket, across-the-board statement. That’s a pretty across-the-board, blanket statement.

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Mr. SULLIVAN. But I was trying to differentiate there, to the very

best of my knowledge, the difference between the realized loss situation or the potential realized loss situation against the amount of

unrealized loss——

Ms. NORTON. It didn’t occur to you, Mr. Sullivan, that in parsing

your words this way that you might be misleading your shareholders?

Mr. SULLIVAN. Absolutely not.

Ms. NORTON. Do you think any of them were misled?

Mr. SULLIVAN. No. I would refer you—and I’m sure you’ve been

supplied with this information—very, very fulsome disclosures of

our exposures not only in the CDS portfolio but in our mortgage

insurance company which was clearly causing me some concerns in

the early part of this situation when the issue was——

Ms. NORTON. Well, you had departed very substantially from

your core business. Are you saying to me that you believe your

shareholders expected to be bailed out by the Federal Government

at some point?

Mr. SULLIVAN. Certainly not. As I testified earlier, when I left

the company I believed the company was in a position where it

would certainly not need intervention from the government. But

when—if I may go back to the disclosures that we made, one of the

things that I set out to do in March 2005, given the challenges that

we had with all of our regulators, we had——

Ms. NORTON. You mean disclosures of the losses?

Mr. SULLIVAN. No, no. When I took office, AIG was facing, as I

mentioned, a crisis very different from the financial crisis. But I

made it clear at day one that we were going to have an open and

transparent relationship not only with our regulators but with our

investors as well. We put very fulsome—I would encourage you to

look at that information—we have put very fulsome disclosure on

our Web site.

Ms. NORTON. So you believed these were fair and honest characterizations and that your shareholders were not misled by any of

the three statements even after they saw the losses posted?

Mr. SULLIVAN. Absolutely. I believe what I said at the time to be

truthful, very truthful based on all the information I was receiving

and clarifying, you know, the difference between realized and unrealized losses.

Ms. NORTON. Mr. Chairman, I’m going to yield back the balance

of my time.

But my question went to misleading; and I must say, in concluding, that it’s difficult for me to believe that shareholders were not

misled at least by the way in which you parsed your words and

framed the condition—phrased the condition of the company.

Thank you, Mr. Chairman.

Chairman WAXMAN. The gentlelady yields back the balance of

her time, and I now recognize Mr. Van Hollen.

Mr. VAN HOLLEN. Thank you, Mr. Chairman.

Gentlemen, I want to followup on some of the questions regarding executive compensation, including the bonus structure. And,

Mr. Sullivan, let me start with you and ask about your actions at

the meeting of the AIG compensation committee that took place on

March 11, 2008.

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According to the documents that this committee has received,

AIG has two bonus programs to reward executive performance. The

first is called the Partners Plan. It covers the top approximately

700 AIG executives. And the second is called the Senior Partners

Plan, which applies to roughly the top 70 executives. Now, as CEO,

you’re paid under both those executive compensation plans, is that

right?

Mr. SULLIVAN. That is part of my compensation.

Mr. VAN HOLLEN. Now as I understood it and looked at the rules

that AIG had set, they tried to align pay with good performance.

Rewards were supposed to be based on the company’s performance.

If performance went down and the company lost money, bonuses

would be reduced or cut entirely. That was what was supposed to

happen in 2007. And as a result of the disastrous fourth quarter

results in 2007, bonuses under both those plans would have been

cut under the normal rules.

But according to the minutes of the meeting that took place on

March 11th, the meeting of the compensation committee, you personally urged the board to rewrite the rules. And according to the

minutes—and I don’t know if we’re going to post them on the

board. We had them earlier. But let me just read from the minutes

of that meeting.

It said, Mr. Sullivan next presented management’s recommendation with respect to the earnout for the senior partners for the

2005–2007 performance period, suggesting that the AIGFP unrealized market valuation losses should be excluded from the calculation.

I think it’s important to point out that just weeks earlier, on February 28th, AIG just posted a record fourth quarter loss, as we’ve

heard about, of $5.3 billion as a result of the AIGFP division. My

question is very simple. You have referred to the unintended consequences. The question is, why did you change the rules, the compensation rules that were supposed to pay for good performance?

Why did you change them to give yourself and other executives a

bigger bonus?

Mr. SULLIVAN. If I may, just for clarity, this was not the bonus

structure for AIG. These were long-term compensation programs

for AIG executives. So just to clarify that for you, sir.

And, second, I was not asking the compensation committee to rewrite the rules. I was asking them to use their discretion, which

I believe existed under both programs.

Coming back to—I testified earlier or responded earlier that my

concern was that these 700 people that participated in the Partners

Plan and the 70 in the senior Partners Plan, none of them were

in AIGFP. They had their—as others have mentioned—their own

compensation plan. And my concern was that, you know, other

parts of the business that were not being impacted by the events

in the credit markets, you know we would lose key individuals if

we didn’t at least acknowledge in their remuneration, which was

a long-term remuneration. They didn’t get their money until some

time later——

Mr. VAN HOLLEN. If I could ask, you, I understand, despite the

fact that you left approximately June of this year, you received the

$5.4 million bonus, isn’t that right? Is that not correct?

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Mr. SULLIVAN. The reference to a bonus—if that was a number

under the Senior Partner Plan, I don’t have the numbers in front

of me. That may be the number, but it’s not referred to as a bonus.

Mr. VAN HOLLEN. But you received this payment under the Senior Partners Plan, did you not?

Mr. SULLIVAN. It’s paid out over a number of years.

Mr. VAN HOLLEN. The question’s pretty clear. Your company had

just taken a record loss. Pay for performance is supposed to be

based on how the company performed. And yet you went before the

board of directors and specifically asked them to ignore those losses

for the purpose of a compensation plan which had the direct result

of giving you about $5.3, $5.4 million extra compensation.

If I could just ask you, Mr. Willumstad, because the minutes say

you were present——

Mr. WILLUMSTAD. That’s correct.

Mr. VAN HOLLEN [continuing]. At this particular compensation

meeting. I have to ask you, in your role as a fiduciary to the stockholders, how does that payment, including the payments to Mr.

Sullivan and the other executives, ignoring the losses that had just

taken place, how does that conform to the rules for pay for good

performance? And how does that benefit any stockholder?

Mr. WILLUMSTAD. If I could clarify some of the things you said.

There are actually three components to the incentive compensation

plan for Mr. Sullivan. It was the Partners Plan, it was the Senior

Partners Plan and there was a discretionary bonus. Mr. Sullivan

received a $9 million discretionary bonus in 2006 when the company had an exceptional year. Mr. Sullivan’s bonus was reduced to

in 2007 from $9 million to $2.5 million. So to put——

Mr. VAN HOLLEN. I understand that, Mr. Willumstad. I’m referring to a particular request that was made at the board meeting

with respect to the senior partners program. And the request was

made and complied with by the board, accepted by the board at a

time of record loss. And my question is very simple. How did that

decision help the shareholders at this particular point in time,

which is the responsibility of the board, is it not?

Mr. WILLUMSTAD. The Senior Partners Plan was a plan that recognized the performance over a 3-year time period. 2007 was one

of those 3 years. Mr. Sullivan’s recommendation was to postpone

the recognition of those losses because they were deemed to be unrealized losses. The understanding that the committee had and the

board had is that, as Mr. Sullivan mentioned, there were 70 employees who were part of the Senior Partners Plan, none of which

had anything to do with the FP operations. It was only Mr. Sullivan who had any direct responsibility for that. So his intention and

I think the board’s response was not to penalize the other 68 or 69

employees for the result of one business unit.

Mr. VAN HOLLEN. Well, Mr. Chairman, just to conclude, I mean,

it seems that pay for performance means you get paid whether it’s

bad performance or good performance and you change the rules

when it doesn’t work out the way you intended. If that’s what part

of the unintended consequences of this have been, I’ve got to say

a lot of people are scratching their heads when they look at how

in good times you stick with the general scheme for pay for perVerDate 11-MAY-2000 14:00 May 25, 2010 Jkt 000000 PO 00000 Frm 00144 Fmt 6633 Sfmt 6633 U:\DOCS\55767.TXT KATIE PsN: KATIE
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formance but in bad times it gets reinterpreted in a way that benefits executives. Anyway——

Chairman WAXMAN. Would the gentleman yield to me?

Mr. VAN HOLLEN. I would be happy to yield.

Chairman WAXMAN. Just so we can get this straight, Mr. Sullivan, you were the CEO of the whole company, which included the

FP in London, right?

Mr. SULLIVAN. That is correct.

Chairman WAXMAN. OK. And when it came to the question of the

bonuses for the 70 employees, which included you, you asked the

board, upon which Mr. Willumstad sat as the Chair, to disregard

the losses so that 3-year bonus wouldn’t be reduced. Is that right?

Mr. SULLIVAN. What I recommended to the compensation committee was that for the purposes of the Senior Partners Plan and

the Partners Plan that they use their discretion in the calculation

of the 2007 year, particularly——

Chairman WAXMAN. Not to count the losses. Just to count the

earnings but not the losses.

Mr. SULLIVAN. The unrealized losses.

Chairman WAXMAN. The unrealized losses. Now isn’t it also the

case that AIGFP changed the rules as well so that the bonuses

there did not calculate the losses, unrealized as they might have

been?

Mr. SULLIVAN. Um——

Mr. WILLUMSTAD. I don’t think that’s correct.

Chairman WAXMAN. Well, I have a document that says so. This

is the minutes of the meeting of the Compensation Management

and Resources Committee of the board of directors. And it says—

explained that AIG’s Mr. Dooley presented management’s recommendation and explained that AIG management believes it is

critical to provide a special incentive to assure retention of the

AIGFP team, while recognizing the serious effects of the valuation

losses and described the proposed terms of the alternative arrangements.

Then it goes on to say, no individual received compensation exceeding $1.25 million and employees affected by the reduced compensation would be eligible for the deferred compensation.

It just—that’s the way we read this document. I’ll put it into the

record, and we’ll be able to look at it.

But you’ve got this FP—you’ve got the bonus. You’ve got the 3-

year partners compensation. Did you get an ordinary salary as

well?

Mr. SULLIVAN. Yes, sir.

Chairman WAXMAN. And how much was that?

Mr. SULLIVAN. $1 million a year.

Chairman WAXMAN. So you got $1 million a year. Then you got

a bonus that was reduced from $9 million to $2.5 million, is that

right?

Mr. SULLIVAN. That’s correct, sir.

Chairman WAXMAN. Then what else did you get?

Mr. SULLIVAN. My participation in the Senior Partners and the

Partners Plan.

Chairman WAXMAN. And how much money was that for that period of time?

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Mr. SULLIVAN. I can’t recall.

Chairman WAXMAN. Take a guess. More than $1 million? More than $2 million?

Mr. SULLIVAN. I think my colleague here mentioned $5 million.

Yeah. I don’t have the schedule in front of me.

Chairman WAXMAN. We’d like to get it for the record.

Let me tell you one person that didn’t get a bonus while everybody else was getting bonuses. That was St. Dennis—Mr. St. Dennis, who tried to alert the two of you to the fact that you were running into big problems. He was blocked by the people in London

from even understanding what was going on so he could report to

you. He quit in frustration, and he didn’t get a bonus.

So the one guy that was really trying to do his job—and there

may have been others as well—lost out on his bonus completely

and was frustrated and felt he couldn’t do his job, so he left.

I thank the gentleman for yielding.

Mr. SULLIVAN. May I suggest, Chairman, with respect that the

company clarify the content of the compensation committee’s reports so that you have an understanding? My view, obviously, and

I think Mr. Willumstad may concur, was that was actually penalizing the FP folks at the time and trying to put a compensation

structure in place that they would get rewarded as and when the

marks came back.

Chairman WAXMAN. That’s not our understanding from the document.

Mr. SULLIVAN. That’s why I suggest, sir, for the subject of clarity

it may help if the company explained it.

Chairman WAXMAN. Whatever penalties you imposed upon them,

it’s hard to see how difficult it is when you have Mr. Casanno not

doing any work but getting $1 million a month in case you need

him in addition to whatever else he got by way of bonuses and salaries and other money sharing agreements. This is really quite a

good deal.

Mr. VAN HOLLEN. Mr. Chairman, I would just say—I mean, obviously, as CEO, you oversaw the whole FP division as well; and yet

you received a bonus despite the fact that they had these huge

losses. And so, again, it’s just people have to scratch their heads

and wonder what pay for performance means when you have that

kind of compensation structure and going before the board.

Anyway, my time is up. Thank you, Mr. Chairman.

Chairman WAXMAN. Thank you.

Mr. Sarbanes.

Mr. SARBANES. Thank you, Mr. Chairman.

I’m just fascinated by this guy Joseph Casanno, because it appears to me that he single-handedly brought AIG to its knees and

was the reason that taxpayers have had to step in with an $85 billion loan. So——

Mr. SHAYS. Mr. Sarbanes, could you speak a little louder?

Mr. SARBANES. Yeah. I was just talking about Joseph Casanno.

Is your office in New York?

Mr. SULLIVAN. When I was with AIG, yes, sir.

Mr. SARBANES. Was in New York?

And your office was in New York?

Mr. WILLUMSTAD. Yes.

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Mr. SARBANES. And Casanno’s office was in London?

Mr. SULLIVAN. He spent his time between London and the Wilton

offices, Wilton, Connecticut.

Mr. SARBANES. So how often would you see him?

Mr. SULLIVAN. Certainly at the FP board meetings and, obviously, occasionally when he was in town. He was not a direct report to me. He reported to Mr. Dooley, who was referenced earlier.

Mr. SARBANES. And how did—I mean, you weren’t there, I guess,

when the FP thing got started, right?

Mr. SULLIVAN. Well, I was certainly with AIG but in a completely

different division, sir.

Mr. SARBANES. OK. You weren’t heading the company up.

Mr. SULLIVAN. No. This is 20-odd years ago.

Mr. SARBANES. What’s the company lore on how that happened?

Did Mr. Casanno come to the powers that be and say, I have this

really neat idea of what we can do over in London. We can get into

this new product line. And off he went? What’s the story there?

Mr. SULLIVAN. Oh, no, no. I think from what I know—you say

folklore, but from what I know is that a number of executives came

out of Drexel and were recruited by AIG at that time to form the

capital markets division that became known as AIGFP. I don’t believe Mr. Casanno was leading that at the time. He was one of the

team that came in, and there were some management changes

thereafter where ultimately Mr. Casanno became the head of capital markets. But I think there were two other executives prior to

Mr. Casanno who ran that division.

Mr. SARBANES. Well, you’ve probably heard me refer to that office

in this hearing before as the London casino, because I think that

terminology captures as well as anything what was happening over

there.

What I can’t understand is why you were allowing these huge

losses to buildup with apparently no consequence for Mr. Casanno.

So I’m just curious, in December 2007, Mr. Casanno is telling the

investors, with the data that you have in front of you, you can play

this power game. And then, within weeks, AIG posts a loss of $5.3

billion. I assume most of that related to the activities of FP, right?

Mr. SULLIVAN. The unrealized loss, yes.

Mr. SARBANES. So when that happened—and this term ‘‘unrealized losses’’ which you are very careful to keep restating——

Mr. SULLIVAN. It’s a loss.

Mr. SARBANES. Yeah. They turned out to be realized in a big

way, it seems. Certainly the taxpayers are realizing these——

Mr. SULLIVAN. Just to clarify, at the time I left, as I said earlier,

none of it realized. What has happened since, I don’t know. But

just for clarity.

Mr. SARBANES. I understand. So $5.3 billion. So then, obviously,

you immediately get on the phone to Mr. Casanno and you say,

what’s going on over there at FP? Right?

Mr. SULLIVAN. Well, in the December——

Mr. SARBANES. I’m just assuming somebody calls him up or

catches him the next time he’s in town for a meeting and says, $5.3

billion of unrealized losses for the last quarter. What’s happening

over there, Mr. Casanno?

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And what does he say that gives you comfort? Does he tell you

the same thing he was telling the investors? Well, we’ve got all this

data, and we can play this power game. So then you say, OK, fine,

we’ll keep you in there. And then the next quarter he posts losses at $7.8 billion. And apparently that’s still not enough for him to be put on the hot seat.

So off he goes to the quarter after that and posts $5.5 billion of

losses.

I just don’t understand, in terms of the company and your stewardship of the company, how you can let this guy run up these

huge losses, apparently with no consequence to himself in terms of

the compensation. So just internally what was going on during that

period? What was the discussion with Mr. Casanno?

Mr. SULLIVAN. Well, clearly, at the time of December 2007, there

was a lot of discussion taking place within the organization on the

whole issue of the CDS super senior portfolio. There’s no question

about that.

Don’t forget—and I just want to point out that this business,

that’s been stopped writing in 2005. So effectively this portfolio was

in run-off. These contracts were mature over a period of time. And

as I said earlier, as they mature, if there’s no loss, you know, on

those contracts, that unrealized loss will then come back into the

income statement of AIG. So I mean that’s the point I wanted to

make here. This business was stopped in 2005. I think that’s an

important thing.

And, clearly, in December 2007 a lot of dialog is taking place between FP. There’s additional resources going in there to make sure

that we’re—you know, we obviously have the compensating controls

in there that I referenced to one of your colleagues earlier. So in

December 2005, there’s a lot of interaction taking place between FP

and the corporation.

Mr. SARBANES. So what you’re saying is by that time—by December 2007, when the losses first started appearing, it was too late.

You were already on a downward slide. And yet Mr. Casanno, having set off that situation, is still getting paid $1 million a month?

Mr. SULLIVAN. What I’m saying is the portfolio stopped writing

in 2005. And, obviously, as the credit market is starting to freeze

and the subprime issues are coming through, then the losses started to emerge.

Chairman WAXMAN. The gentleman’s time has expired.

Ms. Speier.

Ms. SPEIER. Thank you, Mr. Chairman.

To both of you gentlemen, I want to applaud you for the stiff

upper lip that you have shown today under intense questioning.

But I’ve got to tell you that you make a shameful profile of corporate America. To you, Mr. Willumstad, I will say thank you for

foregoing your golden parachute. And to you, Mr. Sullivan, shame

on you. The shareholders of that company have nothing, and you

walked away with $50 million.

Now I’d like to ask a question of you, Mr. Willumstad. In the

final days, evidently Goldman Sachs’ CEO was in on meetings. Is

that correct?

Mr. WILLUMSTAD. That’s my understanding.

Ms. SPEIER. You were not in those meetings?

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Mr. WILLUMSTAD. I was only at one meeting when the CEO of

Goldman Sachs was there.

Ms. SPEIER. And he was there. And what was he saying?

Mr. WILLUMSTAD. This was a meeting that took place on September 15th at the Federal Reserve. The Federal Reserve had gotten

Goldman Sachs and JPMorgan together to try and find a private

solution to AIG’s liquidity issues. That meeting was to discuss how

much capital the company might need. That meeting lasted for

about an hour and a half and then the meeting was adjourned.

Ms. SPEIER. So they weren’t interested in a private solution?

Mr. WILLUMSTAD. I’m sorry?

Ms. SPEIER. The CEO of Goldman Sachs was not interested in

purchasing AIG——

Mr. WILLUMSTAD. No. He was there to participate in looking for

a private solution.

Ms. SPEIER. Now you said that Goldman Sachs was one of the

counterparties——

Mr. WILLUMSTAD. Yes.

Ms. SPEIER [continuing]. Of AIG and that they are owed about

$20 billion, is that——

Mr. WILLUMSTAD. No. No. As a counterparty, if the securities defaulted, AIG would have to pay that counterparty, Goldman Sachs,

the amount of the insurance premium or the credit default swap.

Ms. SPEIER. So they would receive about $20 billion, though. I

used that term earlier. You actually referenced that amount of

money.

Mr. WILLUMSTAD. I did. That’s the correct number.

Ms. SPEIER. Now AIG has since taken up the taxpayers on $61

billion. Has $20 billion of that $61 billion gone back to Goldman

Sachs?

Mr. WILLUMSTAD. I don’t know.

Ms. SPEIER. Mr. Chairman, I think that’s a question we may

want to ask subsequently.

Mr. Willumstad, do you believe that naked short selling was part

of the problem?

Mr. WILLUMSTAD. Well, AIG stock was down to about $26 in

June. Up until September 12th, AIG stock was at $23. So during

the course of—from late June to early September, there was not

much movement on AIG stock. In the last week from September

8th to September 15th, AIG stock went from $23 to $4. I actually

don’t know that it was necessarily driven by short sellers, although

I would assume there’s been some short selling in there.

Ms. SPEIER. The rating was AA on Friday, and 2 days later you

needed a total bailout. How did you go from being AA on Friday

to needing a total bailout 2 days later?

Mr. WILLUMSTAD. Well, the AA minus rating that was provided

by S&P and Moody’s was the ratings. I had met with the rating

agencies actually the prior week and reviewed what our plan was.

They were considering a downgrade at that time. And on Friday

after 4 S&P put out a negative watch that indicated they might reduce their ratings anywhere from one to three notches. And then

I believe it was the following Monday or Tuesday—I’m not sure exactly which—both rating agencies downgraded the company.

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I’m not sure I’ve answered your question. But I’m not sure what

your question is.

Ms. SPEIER. I was trying to understand how you can be rated as AA on Friday and the following week you need a $85 billion bailout. I don’t know how you go from being—that kind of rating

doesn’t make sense to me.

Mr. WILLUMSTAD. You’d have to talk to the rating agencies about

that.

Ms. SPEIER. All right. One last question, Mr. Chairman; and this

gets back to Joseph Casanno. In August 2007, he says, it’s hard for

us with—and without being flippant to even see a scenario within

any kind of realm of reason that would see us losing $1 in any of

these transactions. It’s a lot of bravado.

In December 2007, he said, we have from time to time gotten collateral calls from people, and then we say to them, well, we don’t

agree with your numbers. And they go, oh, and they go away; and

you say, well, what was that? It’s like a drive-by in a way.

Also in December—and this is a real difficult one to believe—he

says, there are some morbid questions we get about what happens

if the world rolls off its axis and the world goes to hell in a hand

basket? But with the data that you now have in front of you, you

can play this power game.

Mr. Sullivan, you were on that same call. You knew that the

company was in trouble. You allowed Mr. Casanno to make these

statements, and you didn’t stop him. You didn’t suggest that he

was overstating the case.

Mr. SULLIVAN. Well——

Ms. SPEIER. Is that transparent? Is that what you should be

doing on behalf of the shareholders of the company?

Mr. SULLIVAN. The December 5th meeting which you refer to

there I think laterally we made a very fulsome presentation to the

investor community on AIG’s full exposure to the U.S. residential

housing market and made reference to not only to AIGFP but our

mortgage insurance company, our consumer finance company and

our investments.

And I don’t want to take any of Joe’s comments out of context,

but we’ve put a lot of information into—you know, made available

a lot of information to the investor community at that time. And

I don’t want to take the comments he’s making out of context without seeing the slides that he was referring to at that moment in

time.

You know, obviously, what we told the market—what I truly believed was accurate at the time, based on all the information I had

available.

Ms. SPEIER. I yield back.

Chairman WAXMAN. Thank you, Ms. Speier.

Mr. Shays, I want to recognize you to close out the questioning.

But before I do, I ask unanimous consent that we can put in the

record a letter that was sent today to Secretary Paulson.

This is a letter telling Mr. Paulson that we’re concerned about the profligate spending at AIG, including the $1 million a month

that’s being paid to Mr. Casanno. Mr. Casanno received up to $34

million, and even today he’s getting paid as a consultant for $1 million a month, and we think this is unfair to the taxpayers of this

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country. AIG received $85 billion of taxpayers’ money, and it’s lavishing these kinds of perks on Mr. Casanno and the event that was

taking place shortly after the government took over.

Without objection, the letter will be entered into the record.

[The information referred to follows:]

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Mr. KUCINICH. Mr. Chairman, could I ask who signed the letter?

Chairman WAXMAN. The letter has been signed by Mr. Braley,

Mr. Cummings, Ms. Speier and myself.

Mr. KUCINICH. I would like to be associated with that letter.

Chairman WAXMAN. OK.

Mr. KUCINICH. Thank you.

Chairman WAXMAN. Mr. Shays, you are now recognized.

Mr. SHAYS. Could we make it bipartisan and add my name to it?

Chairman WAXMAN. We certainly will.

Mr. Bilbray, do you want to join us?

Mr. BILBRAY. Yes, Mr. Chairman.

Mr. SHAYS. Mr. Willumstad and Mr. Sullivan, thank you for

being here.

There’s one thing I think there is unanimity on on the part of

Members from both sides of the aisle, that we’re deeply troubled by

the compensation that has been paid to executives who, frankly,

were not experiencing success and we don’t think it was truly the

executives’ money to take.

Ripples from defaults on subprime loans underwritten by the

toxic twins, Fannie and Freddie, grew to a tsunami that helped

swamp Lehman Brothers and others, including AIG; and Fannie

and Freddie were able to launch more than $1 trillion of bad paper

into the private market because regulators and Congress let them

do it. Now what I want to do is ask you——

And Mr. Chairman, I have a question for you as it relates to the

testimony of Mr. Greenberg. Mr. Greenberg—my reading of his

comments and testimony—Mr. Chairman, my reading of the testimony from Mr. Greenberg that was submitted to the committee is

basically accusing the two individuals who are in front of us for all

the problems of AIG. And I’m thinking how convenient we don’t get

to question him. And my question is, do we swear in the individual

to make sure that their statement is under oath and that they are

held accountable for what they say?

Chairman WAXMAN. Well, if the gentleman would yield, we invited to Mr. Greenberg to testify. He responded that he was not

well enough to come. He did submit information, testimony to us,

which will be part of the record.

[The prepared statement of Mr. Greenberg follows:]

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Chairman WAXMAN. While he wasn’t here to take the oath and

no oath was administered to him, there are laws that say if a congressional committee is doing an investigation and someone knowingly misleads or gives misinformation, that would be tantamount

to a crime in and of itself.

Mr. SHAYS. Thank you, Mr. Chairman.

Let me ask you to respond to his comments. He said, moreover—

and this is his testimony to the committee. Have you read his testimony?

Mr. WILLUMSTAD. No, sir.

Mr. SULLIVAN. No, sir.

Mr. SHAYS. Moreover, unlike what had been true during my tenure, the majority of the credit default swaps that AIG wrote in the

9 months after I retired were reportedly exposed to subprime mortgages. By contrast, only a handful of the credit default swaps written over the entire prior 7 years had any subprime exposure.

So later on he says, how did this happen? I was not there, so I

cannot answer the question with precision. But reports indicate

that the risk controls my team and I put in place were weakened

or eliminated after my retirement.

I would like to ask each of you, is this true? Were they weakened?

Mr. SULLIVAN. Well, I think there’s two parts there. I don’t know

what constituted the subprime exposure on the contracts written

when Mr. Greenberg was CEO and thereafter. So I can’t comment

on that. All I can tell from you a risk control standpoint——

Mr. SHAYS. I don’t understand that statement. I mean, you run

the company. You are not aware of the exposures you had earlier

on?

Mr. SULLIVAN. What I said is, I haven’t got an analysis at hand

as to what the percentages were in response to Mr. Greenberg’s

statements. Sorry, sir. What I can tell you from a risk control

standpoint, it was exactly the same risk control procedures that

were in place when Mr. Greenberg was in office that continued

thereafter, both at the subsidiary level and at the parent company

that ultimately resulted, obviously, in the decision taken to stop

writing that portfolio.

As I said, at that time I was focused on other issues that——

Mr. SHAYS. So he preceded you, correct?

Mr. SULLIVAN. Preceded me, yes, sir.

Mr. SHAYS. But he is basically blaming you primarily and he’s

blaming Mr. Willumstad as well for the short time that you were

on the board and so on and so on. So he’s blaming both of you.

Your testimony is that you did not change any of the controls that

existed before him.

Mr. SULLIVAN. In fact, what I would say from when I took office,

as I mentioned earlier in response to one other question, I set out

with the support of AIG’s board to actually put in additional resource and enhance systems not only in our risk area but in our

legal, compliance, finance and accounting areas.

Mr. SHAYS. So the point is, you take issue with the statement?

Mr. SULLIVAN. Yes, sir.

Mr. SHAYS. Mr. Dinallo who testified—and I thought it was very

interesting there, about four paragraphs, but he says, that brings

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us to the issue of what happened at AIG. The history has been well

reported in the press. Using its noninsurance operations, AIG, just

like many financial service institutions, invested heavily in

subprime mortgages; AIG’s financial products unit and noninsurance companies sold hundreds of billions of dollars of credit default

swaps and other financial products. As with other financial service

companies, AIG was forced to mark to market and so on.

But your credit default swaps were basically—how did they relate to the subprime mortgage? Weren’t you—you didn’t buy

subprime mortgages but you basically—my understanding is you

insured them in a sense, correct?

Mr. SULLIVAN. Correct. What I tried to explain to the previous

question that I had is that what we were underwriting was the

super senior portion of the CDS.

Mr. SHAYS. I know you’re trying to tell me you were trying to secure the best ones.

Mr. SULLIVAN. We actually wrote the super senior——

Mr. SHAYS. I understand. But you know what? They all were terrible.

Mr. SULLIVAN. The bonds—the way the structures flow—and it’s

not easy to explain in a few minutes—is that you’re writing a swap

on lots of bonds that sit below you. And they can be—it can be an

equity tranche. It can be a triple B tranche. And the way these

were structured was that AIG swaps sat over and above the triple

A and a little bit more additional protection. That is why, with respect, I’ve been trying to differentiate between the unintended consequences and the realized losses when you’ve had to mark to market in a liquid market.

Mr. SHAYS. Let me just—we’re going to deal with this in the Financial Services Committee, and it’s probably going to scare the

hell out of you. Because this committee, I’m sure, is going to look

at how we dice and slice all these mortgages so it’s very hard for

people to have any sense of what their values truly are. And I don’t

know what that will do to the marketplace. But, clearly, we are

going to be looking at that.

And what I want to establish on the record, though, is that you

were involved in the subprime market and you did have credit

swaps relating to the subprime market. And you can give me the

refinement of that. And I don’t want to listen to a long dialog. But

isn’t that true?

Mr. SULLIVAN. To the best of my ability——

Mr. SHAYS. You can say no or yes, if you want.

Mr. SULLIVAN. Some of the bonds below the tranche that we were

writing could have been in the subprime area.

Mr. SHAYS. Thank you.

Let me just ask you, as it relates to the compensation committee,

I am absolutely convinced that it’s one person scratching someone

else’s back. You’re on the board of one company. You serve as a

CEO of another. Do either of you serve on the boards of any other

companies?

Mr. SULLIVAN. Public companies, no, sir. No public companies.

Mr. SHAYS. You are the exception, not the rule. But the question

I want to ask you is, describe to me the compensation committee.

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Mr. SULLIVAN. The compensation committee, the structure of it,

sir?

Mr. SHAYS. Yes.

Mr. SULLIVAN. As I mentioned earlier, there was a base salary.

Mr. SHAYS. I want to know who appoints the compensation committee. Are they employees of the committee?

Mr. SULLIVAN. No, sir. The compensation committee consists of

independent directors of the board.

Mr. SHAYS. They are members on the board, correct?

Mr. SULLIVAN. Independent members, yes.

Mr. SHAYS. Not employees of the company.

Mr. SULLIVAN. That’s correct.

Mr. SHAYS. How are they appointed?

Mr. SULLIVAN. From what I can recall—and you can defer to my

chairman at the time—the recommendation of the committee membership is made by the nominating governance committee to the

board at large, I believe is the process.

Mr. WILLUMSTAD. That’s correct.

Mr. SHAYS. My sense is is that it’s a club, and the club basically

rewards their friends.

Chairman WAXMAN. Would the gentleman yield to me?

Mr. SHAYS. Yes.

Chairman WAXMAN. We’ve held a couple hearings in this committee about these compensation committees that are appointed or

consultants that are selected by the boards, and oftentimes the people that are selected are doing other consulting work for the corporation that’s much more profitable for them. And, of course, they

receive that from the management of the corporation. So they’re

then deciding what the compensation will be for the management

of the corporation with clear understanding that they may well

have a conflict of interest.

I think it’s an issue that we need to continue to explore on this

committee, and I thank you for raising it.

Mr. SHAYS. Thank you. Would you allow me one more minute to

close?

Chairman WAXMAN. Yes, sir.

Mr. SHAYS. We all have our constituents. I have a friend who

just wrote me, sent me an e-mail, and he said, my wife and I are

among those investors who got badly burned with Lehman bonds.

I am sure many in your district have a similar experience. We are

prudent investors who must rely on the store of capital we have accumulated over the years to live decently. We always save more

than we earn. Unlike the country and most citizens, we are completely debt free. We invested very significant amounts in what the

so-called rating agencies called triple A, double A Lehman Brothers

bonds. It now turns out that our trust in the rating agency was

sadly misplaced. Either through incompetence or criminal fraud

they led honest investors astray. Bonds that we bought are at par

and now worth 10 or 12 cents on the dollar.

This is why we’re having these hearings. Because you may see

your shareholders hurt, but there were far more than your shareholders that are hurt. And I won’t read the rest of it, but you

should see what it says about what it means to him to see CEOs

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of companies getting huge sums when they are working on 10 cents

on a dollar on money they saved for most of their life.

Chairman WAXMAN. Thank you, Mr. Shays.

I want to thank the two of you for being here. You came here

voluntarily. You’ve been here for many, many hours. You have

been very generous. I know it hasn’t been easy for you. But we very

much appreciate it.

That concludes our business, and we stand adjourned.

[Whereupon, at 3:05 p.m., the committee was adjourned.]

[Additional information submitted for the hearing record follows:]

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