A to the I to the G

What I like about the AIG mess is the way it serves as a microcosm for the current economic ‘apocalypse’. Not only has the insurance colossus become the Zelig of the financial media (Lost your home to foreclosure? There’s AIG backing the banks that sold your mortgage to the Inuit Retirement Board of Southwest Greenland. Pissed off about executive compensation in a tough economy? Look, it’s one of those AIG execs who got a chunk of the $165 million paid out last week. It is said that even now there are people walking around deep in the ornate buildings of the AIG empire wearing ‘Got TARP?’ tee shirts.) its being used as a ‘what’s wrong with capitalism this week kind of Transformer doll. A politician can pull on it one way, twist a little here, and see it’s a perfect example of why we need more regulation and government control of the economy. Slow news night? Not an issue; Tuck this piece under like so and then swivel the middle around and push this thing out a bit. Pow! CBS news has a perfect example of how cowboy capitalism is very bad for us mouth breathing consumaholics and can now show us the way to the collectivist dreams of Katie Couric!

Overly constructed metaphors aside, AIG can serve as soup to nuts example of what can go horribly wrong in building a large financial institution in an age of intense global competition and ruthless pressure for profit growth. I’ve picked three gotchas that seem to define what can go wrong.

First, let’s look at the mission of the company. This is supposed to be its soul, its reason for existence. Once the mission gets foggy it’s only a matter of time before a company starts selling the Bass-O-Matic, the product from a classic Saturday Night Live skit that could chop, dice, and puree even the biggest bass. The mission is essentially how you want to make money and if you stray, you will pay. When AIG decided it was better to sell insurance, called Credit Default Swaps, for derivatives (a.k.a. derivatives for derivatives) it passed a point of no return. AIG thought it could make more money faster by leveraging its AAA credit rating to provide large banks and investment houses with an unregulated source of faux liquidity instead of selling highly regulated insurance products for homes, cars, and people. In a nutshell banks and other investment concerns could not sell as many Collateralized Debt Obligations (CDOs – What the Inuits bought in the example above) as they wanted to because pesky regulators insisted that they keep enough money in their vaults to cover obligations they had already made. So through purchasing Credit Default Swaps these buyers could use AIG’s assets as backing for selling more CDOs. This was good eatin’ until many of the mortgages contained in pieces of the CDOs called ‘tranches’ suddenly took a dirt nap. Now AIG had to pay up to make the banks and other buyers whole. When more and more CDOs began to look like the financial equivalent of Karen Carpenter circa 1982, AIG’s credit rating began to suffer. With its credit rating downgraded not only did AIG have less attractive ‘insurance’ to sell to CDO pimps, it also had to pay out large sums to existing customers as part of the underlying insurance contracts the Credit Default Swaps were based on. Oh shit! Suddenly the people at Geico look like geniuses.

Next, let’s look at leadership. Corporate leaders are best known as the guys who make lots of money saying things that enable you to win Bullshit Bingo in under 30 seconds. They’re also in charge of coming up with strategies and plans to ensure a company can ‘execute on the mission’. How’d this go for AIG? Usually when a U.S. Senator suggests that a group of executives should either quit or kill themselves it’s generally a sign of outstanding ‘execution on the mission’ on the part of said executives. However, when a company takes a lot of money from the government and doesn’t understand that taxpayers might get a bit miffed at paying bonuses and commissions to the folks who sold financial crack to the banking equivalents of Roger Rabbit, hari-kari is not out of the question. So where was daddy while the kids were driving the car into the pool? Picture the reaction of a CEO whose stock price ping-ponged roughly between $60 and $80 for much of the last ten years (while those better looking and cooler guys at Goldman-Sachs saw theirs pull the proverbial ‘hockey stick’) to a slick presentation extolling the virtues of a high benefit, low risk product offering for selling insurance for derivatives that only a seventeen time Jeopardy champ could understand. Not having a fly on the wall perspective, we can assume it went over well and everyone went to lunch with that 2:00 in the morning Jerry Maguire feeling. Did he (they?) forget AIG was in the insurance business? Did they think they could send some guy over to London to run this out of the glare of what passed for regulators or the executive fellating financial media? Who knows? The facts and results strongly suggest there was either too much group think, excessive hubris, or outright ignorance or all of the above and they thought they could innovate and hang with the hedge funds and cutting edge investment houses. One could make a strong argument that long term financial success and stability come to firms that do not follow the pack. These firms (a.k.a. senior executives and leaders), believe it or not, do not feel comfortable with risk. They place lots of small bets (investments) and let grow those that flourish within their business models. Companies like Southwest Airlines, Microsoft, and Federal Express have been reasonably successful for a long time using this strategy. Even when firms bet the farm (Apple, Nintendo, and NPR) on an unproven strategy or buck the trend they do it in a focused, all hands on deck manner. What was the leadership of AIG thinking? Did they understand the risk they were taking on? Did they weigh the downside against exposure to their other businesses? It’s easy (and fun!) to Monday morning quarterback like this but come on, any real banker or investment manager with integrity will tell you not to invest in things you don’t understand.

Rounding out the top three reasons why being the John D. Rockefeller of global finance is so tough these days is perhaps the most important and tricky to get right: People. Let’s face it, people suck. Che Guevara once said “I love the People, not people”. I have the sneaking suspicion that this is how many senior executives feel about their employees and customers: Pleasant in the abstract, indifferent in reality. Who you hire and what you hire them for is critical to the success of any business. This is especially important when it comes to CEOs and their staff. No one knows it all and few have the courage to admit a mistake and fewer have the insight to see one coming. I’ll wrap this one up quick. We as a society let too many people get away with too much. There are many reasons why we have become a kind of backwards tolerant society but with AIG and its ilk we are seeing what happens to people when they live too long in a culture or sub-culture that has dismissed self control and abandoned the concept that caring for others more than for yourself is the surest path to happiness.

Sigh…. I feel better already.

Later