Following the financial crisis of 2008, the financial industry suffered backlash from the public following a historic and infamous series of events that threatened America’s economy. From media pundits to organized efforts such as the “Occupy: Wall Street” movement, there has been a continual protest against the ‘injustice’ and corruption of greed that supposedly plagues large financial institutions. However, many Americans rely on financial services for retirement savings, investment opportunities, the ability to get a mortgage and more. Despite the complexity of many financial systems, which may be simply understood by the general public, the causes of the crisis held blame with those behind-the-scenes, and an ethical analysis can bring these actors and their decisions to light and provide a clear picture of what was done wrong and why. Looking into AIG, a major player in the financial crisis, a history of ethically questionable management can be seen, with blatantly unethical choices leading underlying collapse of the financial system in 2008.
AIG’s ethical troubles began to affect the company in 2004, brought on by a series of reporting choices made by executive management, namely, CEO Maurice Greenberg. Greenberg began working for AIG in 1960, transforming the company into an insurance giant. Greenberg was named CEO in 1968, a year before the company went public, and strategically grew the company over the next 35 years into one of the largest insurance companies in the world. Following steady earnings growth in the 90’s, AIG touted impressive increases in net income in the early 2000’s; attracting investors left and right. During Greenberg’s time as CEO, AIG became one of the most valuable companies in the US, with $50 billion in acquisitions and a market cap of $166 billion. AIG reported a 68% increase of net income in 2003, which prompted financial analysts to take a closer look at their accounting practices and financial records. David Schiff, an industry reporter, calculated earnings gains of 15% in 2003 based on AIG’s previous methodologies. This finding provoked Schiff to look into AIG’s previous company reports where he discovered a shocking level of inconsistency. Taking advantage of a number of different valuation metrics, AIG had reported its profits in a way that always emphasized the company’s returns and losses in the most positive light possible. (AIG’s accounting lesson. The Economist) On the heels of a $10 million penalty for insurance fraud in 2003, this news did not bode well for AIG and gained the full attention of the Securities and Exchange Commission (SEC) and New York Attorney General Eliot Spitzer. (AIG Agrees To Pay $10 Million Civil Penalty, SEC) Investigations into deceptive accounting claims, reporting investment income as underwriting income (window-dressing), as well as a scheme to hide workers’ compensation put AIG in the spotlight and triggered a change in leadership for the first time since Greenberg took over.
Chief Operating Officer Martin Sullivan replaced Greenberg in March of 2005, looking to get the company back on track and restore trust in AIG’s leadership. Sullivan had been with AIG for over 30 years as well, working in the finance department of an AIG subsidiary in the UK. (Westbrook, AIG’s Greenberg Steps Down as CEO; Sullivan Succeeds) His first order of business as CEO was the analysis and restatement of AIG’s earnings reports going back to 2000, with the revisions showing $2 billion less shareholders’ equity and almost $4 billion less in profits. Even with the restatement, AIG touted earnings $9.7 billion in 2004, surpassing all of their competition. (Westbrook, Plumb. AIG Lowers Net Income $3.9 Billion Over Fiver Years) The deceptive accounting practices to understate claim liabilities, misrepresenting underwriting profits, and the fraudulent reinsurance contracts reflect the inability of AIG’s management to make consistently ethical decisions. With earnings that trump their competitors, the unethical decisions become impossible to rationalize, and emphasize the failure to consider the consequences of their actions. AIG’s management had set a precedent for unethical practices and a complete disregard for their stakeholders, when the company was still viably dominant.
During the following years, AIG released statements in accordance with the generally accepted accounting principles (GAAP) and began working to fix persisting issues, providing a clearer view of the struggling company going forward. Unfortunately, AIG continued to engage in ethically questionable operations during these years as well, taking on considerable risk in the form of derivatives. AIG’s London unit, AIG Financial Products, had begun insuring derivatives that carried a significant risk without collateral.
Led by Joseph Cassano, AIG Financial Products’ core business centered around the derivatives market, namely in selling interest rate swaps, a “vanilla product.” These swaps allow investors to bet on the direction of interest rates and hedge their risk against systematic risk from unforeseen financial events. After learning about collateralized debt obligations (CDOs) from JP Morgan derivatives specialists who dealt with Cassano, the London unit began insuring CDOs. Collateralized debt obligations are sold as a pool of loans divided into pieces, based on the credit quality of the underlying securities. Cassano aimed to utilize AIG’s services to provide insurance to financial institutions holding CDO’s and other debts in case of defaulting. The branch generated $3.26 billion in profit in 2005, compared to $737 million in 1999, and increased their percentage of AIG’s overall operating income to 17.5% from 4.2% in the same years. AIG sold these credit default swaps with no regard for the potential risk carried by the policies, as they firmly believed that they wouldn’t end up obligated to fill any claims. In addition, AIG had the benefit of a high investment grade credit rating, and was able to write insurance without needing the collateral. While these policies were meant to provide funds in the case of default, the inherent risk taken on by the massive number of policies and more importantly, the effect that default would have on stakeholders, was brushed off by AIG. Cassano himself was quoted on this view in 2007, stating, “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 one dollar in any of those transactions.”
By 2007, AIG Financial Products’ portfolio of credit default swaps was valued around $500 billion, generating as much as $250 million a year in income on insurance premiums, as described to investors by Cassano. As mortgage foreclosures triggered system-wide questions about the quality of debt across the credit spectrum, calls for collateral on the credit default swaps left AIG in a bad position. In the quarter ending September 30, 2007, AIG reported a $352 million unrealized loss on the credit default swap portfolio. As the London bank was responsible for providing collateral to its trading partners, AIG as a whole was required to meet the obligations and the growing problem served to undermine the company’s financial stability. After AIG Financial Products’ losses hit $25 billion, AIG’s stock price plummeted, and instilled fear among the other companies it does business with, as well as the tremendous amount of stakeholders and businesses tied to AIG as a whole. (Morgenson, Gretchen. “Behind Insurer’s Crisis, Blind eye to a Web of Risk.”) The events that followed, including a bailout of AIG by the Federal Reserve to the tune of $85 billion (supplement over time up to $182 billion) and the now infamous financial crisis of 2008, stand testament to the severity of AIG’s ethical lapses and poor decisions.
Analyzing the operations and actions taken by AIG during this time period through the lens of utilitarianism reveals a significant shortcoming in the ethical basis of the company’s decisions. Utilitarianism is a common theory of consequentialist philosophies, emphasizing decisions that maximize benefits to society and minimize harms. As described by Treviño and Nelson, “The ‘best’ ethical decision would be the one that yielded the greatest net benefits for society, and the ‘worst’ decision would be the one that yielded the greatest net harms for society.” (Treviño, Linda Klebe, and Katherine A. Nelson. Managing business ethics: straight talk about how to do it right) AIG’s egregious risk taking clearly resulted in a net harm for society, and falls far from an ethically sound decision based on utility. While economics is not a zero-sum game, many individuals lost significant assets and bore the burden of the financial collapse with no way of knowing if they had lost their money or homes forever. Meanwhile, AIG was engaged in another scandal as they planned to pay executives at AIG Financial Products bonuses totaling $165 million, despite their actions leading up to the need for a bailout. (Andrews, Edmund L. and Peter Baker. AIG Planning Huge Bonuses After $170 Billion Bailout.) AIG was effectively feeding the societal fire beneath them, and the outrage was demonstrably justified. AIG took on obligations without adequate collateral and a stated negligence of the risk carried by them in the name of profits. As the company flourished, the fundamental question of ‘what is the potential worst outcome?’ seems to have never occurred to Cassano and the AIG executives making decisions.
From the early millennium, it was clear that AIG was a loose cannon, with a disregard for the outcomes of their decisions so long as it benefitted them personally. Poor ethical decision-making is evident from the early 2000’s: AIG incurred millions in fines and faced prosecution from decisions to fabricate reports that portrayed a superior AIG while the company was an industry leader, already outperforming its competition under the defined standards. As the financial crisis of 2008 uncovered the truth behind AIG’s actions and the decisions leading up the company’s collapse, it became indisputably clear that management did not take the potential societal harm of their actions into account. The utility of hedging risk among financial institutions to generate additional revenues and personal wealth is far outweighed by the underlying harm to those carrying the risk. Regardless of the inherent risk assumed in these transactions and swaps, the required collateral provides a safeguard for default, but AIG wrote policies worth hundreds of millions of dollars in total while consciously deciding to take them on without adequate collateral. Homeowners, investors, and taxpayers (through the bailout) all paid for the careless and unethical choices of AIG, while those choices benefitted the executives handsomely.
When evaluating the net benefit or harm resulting from AIG’s series of actions from 2004-2008, it can be clearly seen that the societal harm outweighs any benefits gained, and it could be argued that the financial crisis of 2008 yielded the greatest net harm to society seen in a generation, stemming from decisions made by institutions like AIG. While it might not be fair to say AIG made the ‘worst’ decision ethically, the actions taken during this time period reflect extremely unethical choices and practices that directly contradict any potential benefits they may have had. In the world of finance, ethics are paramount due the nature of the industry and the trust necessary to perpetuate the system, from adequate capital funds to the trust in our government that gives a dollar bill its value. AIG’s atrocious ethical judgment stands as a quintessential testament to importance of consequences and the societal imperative of ethical reasoning from window-dressing to derivative trading.
AIG’s accounting lesson. The Economist, Mar 4, 2004. New York. http://www.economist.com/node/2483451
AIG Agrees To Pay $10 Million Civil Penalty. US Securities and Exchange Commission, Sept 11, 2003. http://www.sec.gov/news/press/2003-111.htm
AIG to Pay $800 Million to Settle Securities Fraud Charges by SEC. US Securities and Exchange Commission, Feb 9, 2006. http://www.sec.gov/news/press/2006-19.htm
Andrews, Edmund L. and Peter Baker. AIG Planning Huge Bonuses After $170 Billion Bailout. The New York Times, Mar 14, 2009. http://www.nytimes.com/2009/03/15/business/15AIG.html
June Oversight Report: The AIG Rescue, Its Impact on Markets, and the Government’s Exit Strategy. Congressional Oversight Panel. June 10, 2010. http://www.gpo.gov/fdsys/pkg/CPRT-111JPRT56698/pdf/CPRT-111JPRT56698.pdf
Morgenson, Gretchen. Behind Insurer’s Crisis, Blind Eye to a Web of Risk. The New York Times, Sept 27, 2008. http://www.nytimes.com/2008/09/28/business/28melt.html?_r=0
Treviño, Linda Klebe, and Katherine A. Nelson. Managing business ethics: straight talk about how to do it right. Pp. 88-90. 2006 John Wiley and Sons, Inc. New Jersey.
Westbrook, Jesse. AIG’s Greenberg Steps Down as CEO; Sullivan Succeeds. Bloomberg, Mar 14, 2005. http://www.bloomberg.com/apps/news?pid=newsarchive&sid=aBoMyUpXGIZE
Westbrook, Jesse, and David Plumb. AIG Lowers Net Income By $3.9 Billion Over Five Years. Bloomberg, May 31, 2005. http://www.bloomberg.com/apps/news?pid=newsarchive&sid=abtnHNabi1cQ&refer=us