Greenberg (pg. 6)

Defense lawyers argued that the transactions were legal, albeit aggressive, and that the defendants didn't believe they were committing crimes. On cross-examination, they were able to get a prosecution witness to recant the claim that Greenberg asked for a risk-free transaction in his initial call with Ferguson, a claim that Spitzer had made when he first brought charges in the New York State case. The defense lawyers ridiculed the prosecution theory that Greenberg was so upset about a tiny drop in loss reserves that he was prepared to commit securities fraud.

The jury delivered unanimous verdicts against the defendants on all counts.

Over the next several months the noose around Greenberg seemed to be tightening. Without mentioning him by name, prosecutors indicated their desire to "go up the ladder." In May the federal judge stated that there was "sufficient evidence" to find that the conspiracy was initiated by Greenberg. That same week, Greenberg got more bad news. The Securities and Exchange Commission's staff indicated that it was inclined to charge him with civil fraud for his role in the Gen Re matter and for other purported accounting misdeeds.

***

Greenberg was growing increasingly alarmed by the deteriorating financial situation at his old company. Also in May, AIG reported a first-quarter net loss of $7.8 billion. It said it needed to raise $12.5 billion in capital. Shares fell 9%.

Problems had been escalating. Five months earlier the company had disclosed a decline of as much as $1.15 billion in its senior default swap portfolio. In February it hiked its estimates to $6 billion and said that auditors had found a material weakness in internal controls. Two weeks later AIG announced a loss of $11 billion, though it assured investors that it still had a strong capital base.

The May disclosures came just days before the annual meeting. Greenberg wrote a letter to the board urging it to delay the meeting to give shareholders time to understand the events. "The company is in crisis," he wrote.

Other major shareholders soon joined the crusade. By the end of May, CEO Sullivan was fighting for his job.

The roots of the troubles lay in a series of insurance-like contracts that AIG had entered into almost as an afterthought from 1998 through 2005. Nearly half the deals were initiated under Greenberg's regime. Here's how it happened:

Starting in 1998, Wall Street's major mortgage-bond underwriters - Merrill Lynch, UBS, Citigroup, and others - approached AIG to insure certain classes of a then-arcane type of security called a collateralized debt obligation. AIG executives liked the fact that the company didn't have to own this illiquid paper. If the credit rating of the CDOs deteriorated, the swap owner could get AIG to pay them the face value of the CDOs no matter where they were valued in the market. There was a risk, of course, but it seemed almost impossibly remote.

Under Greenberg's supervision, AIG wrote credit default swaps on 200 or so CDO deals, charging an average of $750,000 per deal - but only a handful were exposed to subprime mortgages. After Greenberg left the company, Sullivan accelerated the use of those derivatives. Between Greenberg's departure in March 2005 and the end of that year, AIG insured another 200 or so CDO transactions - the majority of which were subprime. In all there were about 420 deals done that brought in between $315 million and $400 million, according to AIG executives and Wall Street brokerage officials. The risk managers started getting the jitters in late summer and decided to stop both the swap insurance business and all subprime mortgage issuance.

But by then, AIG had committed its once-pristine balance sheet to backing about $63 billion in increasingly illiquid CDOs. Sullivan had risen through the brokerage side of the business and wasn't familiar with complex financial instruments. He took office in a period of turmoil at the company, when it was under siege by the government. But he made missteps too. At a time when the company was trying to raise capital, he hiked the dividend, a move that even his supporters say was a horrible mistake.

In June the board ousted Sullivan and installed the company's chairman, Robert Willumstad, as CEO. Willumstad, a former president and COO of Citigroup, said the board needed to reach out to Greenberg, its largest shareholder, as soon as possible. At that point someone looked at director Richard Holbrooke, whom Greenberg regards as a traitor, and said, "Would you like to make that call, Dick?" Holbrooke smiled thinly. Willumstad called Greenberg that night.

NEXT: Greenberg (pg. 7)

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