Law and Order: AIG

President Obama's Department of Justice [1] announced last week that there would be no indictments in the collapse of AIG, an event which led to a worldwide economic collapse and cost the American taxpayer trillions. As someone who once worked for AIG [2] I was shocked, but apparently that's how this mystery ends: Hundreds of millions of victims, smoking guns in every room, and not a perp to be found anywhere.

Yves Smith is disappointed [3]that PriceWaterhouseCoopers, the auditors who signed off on AIG's financial claims despite mounds of disturbing evidence, escaped serious legal scrutiny. She observes that our "Potemkin" financial reform (her word) won't remove the barriers that prosecutors face in pursuing secondary parties like auditors (although I believe the Supreme Court ruling she cited only addressed civil suits.) Not only is the auditor protected, but that allows the fraudster himself to use the defense that he kept his auditor informed - kind of like Bush and Cheney using John Yoo's legal opinion to inoculate themselves from criminal prosecution.

Here's another possible reason there won't be a prosecution: Our economy was shattered by a syndicate, a ring, a cabal at the top of the financial pyramid. To move against any one of them - AIG's Joe Cassano, the auditors, Goldman Sachs, or even the credit agencies - would trigger a chain reaction of rats turning on one another, summoning each other to testify, and spilling each other's dirty secrets in an attempt to save themselves.

Of course, that's exactly what most prosecutors want. But doing that could topple that pyramid at the top of our economy, and it looks like our leaders don't recognize that this would be a good thing. We must protect the booming stock market, whatever it takes. If it means leaving the con artists in power, leave 'em in power. If it mean breaking America's longstanding social contract in the name of "deficit reduction," that's okay too. (There's an irony in the fact that Great Britain's new government is under pressure to make cuts to keep its AAA rating. and that we may be next. The ratings agencies are part of the problem, and now it looks like they're controlling governments instead of the other way around.)

Was there reasonable suspicion regarding Cassano and AIG Financial Products? Let's review the record: AIG paid $80 million to settle criminal charges against Cassano's unit in 2004 when it helped PNC Financial conceal assets. AIG didn't just pay a settlement. It also signed a deferred prosecution agreement with the Justice Department leaving it open to criminal prosecution if it misbehaved again. (There's a good timeline here [4].)

After that Cassano kept reassuring the public - and investors - that his products were safe throughout 2007. (It's illegal to mislead investors.) Cassano fought the independent auditor who was brought in to watch his books, preventing him from looking at certain critical books of business and eventually driving him to resign. Cassano insisted that PwC stay out of his way when he prepared for a presentation to investors in December 2007 (hello, Securities and Exchange Commission!)

Then, of course, all hell broke loose. With that history, why didn't Cassano face trial? As the Wall Street Journal [1]reports, "prosecutors obtained information about Mr. Cassano's disclosures to AIG senior executives and AIG's outside auditor, PricewaterhouseCoopers LLP. That changed the course of the investigation, these people said." So he stonewalled the outside auditor, but he shared info with the cozy inside one? Apparently a compliant auditor is even better than a Father Confessor - you're absolved when you tell him your sins, and he'll never give you "go and sin no more" nonsense.

PriceWaterhouseCoopers weren't just AIG's auditors. They were Goldman Sachs', too. That's right: they had another huge contract with the counterparty whose thirteen billion dollar claim was paid in full on the instructions of Tim Geithner's New York Federal Reserve. So PwC let two massive financial institutions engage in a highly speculative venture - one possibly misleading the other - and raised no warning flags.

Publicly traded companies are required to disclose corporate threats in their 10-K statements, which are approved by their auditors. Here's what AIG said in its 2005 statement (buried several pages into the "Risk Factors" section): "AIG's liquidity could be impaired by an inability to access capital markets or by unforeseen significant outflows of cash." (Gee, ya think?) That's about it for risks. PwC either ignored or missed the warning signs as AIG accumulated losses great enough to break the world's economy.

How have they suffered for this dismal track record? Their revenues rose 8% to $28.2 billion in 2008, and operating profits grew in the fiscal year ending June 2009. And why not? A lot of businesses enjoy the, uh, shall we say flexibility that comes with an auditor like that. Of course, there's no proof their conduct was criminal. They may have just overlooked the worst meltdown in modern financial history.

How about the ratings agencies? The warning signs were there: A plea deal on a charge of criminal fraud, ongoing negotiations with the New York Attorney General, leading economists expressing concern about the stability of the housing market. Yet remarkably (or not), leading ratings agencies S&P and Moody's were rating AIG well right up until September of 2008, when it became clear that it had already lost $18.5 billion and the worst was yet to be revealed. Until that point, S&P had given AIG's counterparty deals the top rating of A-1+, which means "obligor's capacity to meet its financial commitment on the obligation is (very) strong."

In 2007, well after the Spitzer investigation was underway, Best's affirmed that in its judgment AIG's creditworthiness was "superior," [5] saying that "AIG's renewed focus on accounting integrity and future successful remediation of accounting concerns provides a level of stability."

Accounting integrity? Write your own joke, as Ed McMahon used to say. When it comes to PwC and the ratings agencies, Upton Sinclair got it right: "It is difficult to get a man to understand something when his job depends on not understanding it."

We've already reviewed the emails and internal documents [6] showing that ratings agencies were always selling their services to these institutions, a hopeless conflict of interest. The Franken Amendment would improve that situation significantly, but there's no guarantee it will survive the House/Senate negotiations - which should be fully transparent to the public (sign the petition to televise them here [7], folks.)

My own background as an AIG exec adds an extra dimension to my sense of outrage. The company was destroyed by the ratings agencies, the auditors, and Goldman Sachs (AIG's replacement CEO, Edward Liddy, served on the Goldman board). I heard horror stories about hard-working people who had nothing to do with the scandal receiving death threats or having to pull their kids out of school. Joe Cassano kept his ill-earned salary and bonuses, and for a while after he left was paid $1 million every month at Liddy's behest. PwC had a boom year, and the ratings agencies still (remarkably) have some credibility.

But a once-thriving company is dead. We've paid hundreds of billions of dollars directly, and trillions of dollars indirectly. 15 million people are out of work. The gamblers in the Wall Street casino are still placing bets, secure in the knowledge we'll cover their debts. As they said about Nicky in Casino, they "had a good system: When they won, they collected. When they lost, they told the bookies to go f**k themselves."

And now we're told that nobody's guilty. That's getting it backward. It's like Murder On the Orient Express: They all did it. But apparently we're the only ones who are going to pay for it.
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(We'll be discussing financial reform and other critical issues with Simon Johnson, Nancy Pelosi, Alan Grayson, Robert Kuttner, Arianna Huffington, Bob Herbert, and a host of other luminaries at the Campaign For America's Future Annual Conference on June 7-9.(1) Walk-ins welcome! More info here [8]. Come on in!)

(1) As they (never) taught me on Wall Street, "always be closing."