Anger grows at the worst examples of corporate excess: Kohler

The searchlight of post-bust outrage is settling on the top executives of insurance giant American International Group.

The searchlight of post-bust outrage is settling on the top executives of insurance giant American International Group.

But it’s not the fact that AIG led a massive fraud using credit default swaps to subvert the rules on bank gearing ratios that’s causing the outrage.

It’s the partridge shooting party that four of the executives, and four guests, went on in rural England two weeks ago that cost more than $100,000, and the $650,000 week-long retreat for the sales team at St Regis Monarch Beach resort near Los Angeles a week after the US Government bailed the company out.

The News of the World newspaper sent some undercover operatives to spy on the AIG “bigwigs” and reported some fabulous details of their tweeded excess (the capital letters are the newspaper’s):

“During their luxury stay at the 17th Century Plumber Manor in Dorset, the four AIG big shots and their four guests blew US taxpayers’ cash on:

• FOUR aristocratic-style shooting parties costing a whopping £25,000 in total.
• A PRIVATE JET for two of them from Germany costing £10,000.
• FLIGHTS to and from Madrid and a fleet of CHAUFFEUR DRIVEN cars at £5000.
• SUMPTUOUS feasts washed down with bottles of fine wines and liqueurs costing £5000 – plus giant PICNIC HAMPERS to guzzle in-between slaughtering birds.
• LUXURY rooms totalling £5000.”

One of the reporters managed to engage one of them in conversation at the bar: “One bigwig at the four-day English country manor beano – Dr Sebastian Preil – told our undercover investigators: ‘The recession will go on until about 2011 – but the shooting was great today and we are all relaxing fine.’”

And then there was this about the AIG chief: “Another, AIG chief Alvaro Mengotti, who later repeatedly LIED that he hadn’t been on the trip of shame, slurped fine wine as he kept pace with the world crash on his BlackBerry mobile. ‘It’s going to get a lot worse before it gets better,’ he sighed, before heading off with the eight-strong AIG party in tweeds to gun down some birds.”

Separately, according to The Times, the junket for the sales team at St Regis cost $US442,000, including $US139,000 on hotel rooms, $US147,000 on banquets, $US23,400 on spa treatments, and $US6950 on the golf course. Room service and bar tabs topped $US10,000. This was all on 22 September, a week after AIG collapsed and the US Government had to bail the company out.

After it was pinged for this, AIG issued a statement: “This type of gathering is standard practice in the industry and was planned a year in advance of the Federal Reserve’s loan to AIG. We recognise, however, that even activities that have long been considered standard practice may be perceived negatively. As a result, we are re-evaluating various aspects of our operations in light of the new times in which we operate.”

Also standard practice was AIG’s central role in the systemic subversion of Basel II risk asset rules that led to the credit bubble and collapse.

AIG used credit default swaps to insure the high yielding, sub-prime mortgages that the banks invested in to get to their profits up. The Basel II rules determine how much capital a bank must have, based on the quality of the bank’s loan book – the riskier the loans, the more capital and therefore the less gearing that can be employed.

AIG offered a way around this for a small fee. And it was able to do so because the credit default swap market is unregulated, so that no capital at all was required on the swaps. That’s because AIG had a AAA credit rating, which was effectively being bestowed upon the sub-prime mortgages via the credit default swaps (CDS) insurance.

So banks were able to tell their regulators that high yielding sub-prime mortgages were actually AAA assets requiring minimal capital, even though AIG was insuring them using no capital itself.

And what’s more, using mark-to-market accounting, AIG could book the profit from a five year CDS as soon as it was sold, based on the expected default rate. That is, whatever a computer said AIG was likely to make on a contract, the accountants could book as immediate, actual profit, and the broker that sold the contract could be paid an immediate bonus.

It was all a colossal fraud. The capital did not exist and the profits being booked – both by AIG and the banks – never materialised.

Meanwhile, at the other end of the scale – the selling of the mortgages themselves – those involved were also engaging in fraud, usually by simply lying on the application. These were mortgages, remember, that would have been sub-prime had the forms been filled out correctly – but they weren’t. And then the banks pretended they were AAA-rated.

Yesterday’s New York Times has a story that the FBI is now struggling to deal with the explosion of mortgage fraud in the US because its resources were shifted to counter-terrorism.

The FBI is investigating AIG, Fannie Mae, Freddie Mac and Lehman Brothers, and has 1500 other mortgage-related investigations underway.

State agencies are also busy with mortgage fraud cases and, as previously reported here, the State of California is suing the mortgage originator, Countrywide Financial, for deception and “unfair competition”.

Meanwhile, over the weekend the US President George W Bush concluded his radio address with these words: “America is the best place in the world to start and run a business, the most attractive destination for investors around the globe, and home to the most talented, enterprising, and creative workers in the world. We’re a country where all people have the freedom to realise their potential and chase their dreams. This promise has defined our nation since its founding, this promise will guide us through the challenges we face today, and this promise will continue to define our nation for generations to come.”

And pretty soon the most talented, enterprising and creative workers will be behind bars.

This article first appeared on Business Spectator