Book Review: Fatal Risk

I am just going to get out there and say it: "Fatal Risk - A Cautionary Tale of AIG's Corporate Suicide" is the best book on the financial crisis, and probably my favorite piece of non-fiction work since Michael Lewis' The Big Short. Now to the review...

Fatal Risk is about the history of AIG and its downfall, with a specific focus on AIG Financial Products ("FP"), one of the subsidiaries that eventually caused AIG to need to be bailed out by the U.S. Government. Author Roddy Boyd traces how FP got started (for those that do not know, it was started by a bunch of Drexel guys), its interactions with Hank Greenberg, its many wins, and how, to chase a couple of basis points, they went on to insure hundreds of billions of dollars of the AAA tranche of CDOs for 8 months and effectively destroy the hard work of AIG's founder Cornelius Vander Starr and legendary CEO Hank Greenberg.

The reporting here is incredible. While reading the book, all I could think about was: I need to hire Roddy Boyd to do due diligence on companies for me. Apparently I'm not the only one: In the acknowledgments Boyd writes of Greenlight Capital founder David Einhorn: "A stout fellow, but then I knew that already, as I'd shared a trench with him on occasion on a few investigative projects I had been involved with."

What I loved about the book was its depiction of risk or the lack thereof, that ran through the culture of AIG. While I do not want to quote him on it, my feeling is that Boyd believes that if Hank Greenberg was not forced out by the AIG board due to the attacks and investigations of philandering (and megalomaniac) Elliot Spitzer, FP would have never been allowed to write insurance at single digit basis points, AIG's securities lending pool's fate would not have been tied to sub prime RMBS, and inevitably, AIG would not have failed.

And you know what, I agree with him.

In my day to day job, I am a generalist. I cover a wide variety of industries. But by far, my set of contacts, knowledge of companies, and skill resides in the insurance industry. To me, it is one of the most inefficiently covered sectors on Wall Street, and that creates value opportunities up and down the capital structure. When people tell me "These things are black boxes", I tell them they are not working hard enough. What other industry can a diligent analyst get a near PERFECT picture of the left side of the balance sheet (CUSIP data for daily pricing) and a very thorough understanding of the right side of the balance sheet. Yes - Catastrophes happen, storms hit where they should not, tragedies like the tsunami is Japan happens seemingly at random - but in the end, an insurance management team that understands risk, and can price it correctly, that's the kind of investment I can hold for years.

And of all the CEO's I've encountered or studied in the many years I've followed the insurance industry, Hank Greenberg was the best when it came to risk. Fan boy or not, Hank Greenberg is someone I truly admire in business, and this book (like Fall from Grace did with Michael Milken) gives the other side of the story that we, as New Yorkers, read in the Post for months on end in 2004/5.

Say what you will about the finite reinsurance deal that was struck with Gen Re (no proof every links Hank to the deal that was penned), but you cannot argue with me that Elliot Spitzer, in a bid to trump his last successes (many have eventually turned out to be duds) wanted to go after larger fish in the sea to better his chances at the governorship. And in the insurance world, the Great White Shark was Hank Greenberg. Spitzer, according to the book, threatened to go after the Starr Foundation unless Greenberg settled for $750 million dollars - all on the mistake of a summer intern that was working for Spitzer at the time.

As the book lays out Hank Greenberg's dismissal from the company he built, it moves into the complete lack of oversight Martin Sullivan had on the individual business units that eventually sunk AIG. What I found incredible was the fact that various business units at AIG did not communicate with one another - so when certain business units stopped dealing in subprime mortgages, other units happily invested in and insured the same stuff their counterparts across the company were saying were worthless. The author again postulates that Greenberg had such a immaculate understanding of EVERYTHING that was going on at AIG (apparently he chewed out a corporate bond analyst for a $10M loss when AIG's balance sheet was nearly $500 billion), he would have never let this happen.

Alice Schroeder, author of Warren Buffett's biography, "The Snowball", has said that the first thing that Warren Buffett thinks about when looking at an investment is the probability or chance of a permanent loss of capital on the business. If it is anything more than remote, he will pass on the investment. This is how Hank ran AIG from Day 1. Here is a great series of paragraphs from the book:
"He kidded himself not. Understanding risk was not something many, perhaps most, could readily grasp. So, with a healthy sense of paranoia, he had a staff that kept watch against the most obvious sorts of threads. One of the core ones was that Wall Street worked for you. At the end of the day, for 35 years at the helm of AIG, Wall Street brought his people ideas, came to them for favors, looked to his company for capital, and it was never the other way around. Everything AIG did was, in a sense, to become and remain self-supporting. He had never seen, not once, a company that was reliant of the capital markets not run into some epic trouble.

And the first thing that happened after he left AIG - pushed as he saw it, by ungrateful traitors on a board afraid of a power-mad attorney general - was that the company went to work for Wall Street. They hung up a shingle and happily solicited business insuring the most diabolical instruments Wall Street had ever cooked up, for pennies per billion dollars of risk.

Pure, unrefined risk."
Before I close with a final thought, my favorite description of Hank Greenberg was that "he valued information so highly - and discounted opinions so readily..." As investors, on a day-to-day basis we are bombarded with opinions from the sell side, friends, management teams, etc. While these may be starting grounds for research, you need to have FACTS to create your own insights on particular situation. Raw quantitative or qualitative data, whether from a 10K, or a credit agreement, a proxy, or a regulatory filing, is the bread and butter of great investors. We know Warren Buffett PORES over all the data that his subsidiaries bring him - how many rings Borsheims sold this month vs. last month, how many train cars were full for Burlington Northern this week, how many new NetJets customers were signed last quarter, etc. That my friend, is what makes him more effective, as a capital allocator, than ever.

As I stated in the first paragraph, Fatal Risk is one of the best non-fiction pieces I've read in sometime. I very strongly recommend it - you will not be disappointed. And I bet, like me, you'll start to think that Elliot Spitzer should really be the one to blame for the collapse of AIG.


David Merkel 7/01/2011  

Dear Hunter,

You know I'm a fan of yours. I wrote my own review of this book and had a Q&A at my blog with Roddy. If you want to talk with Roddy, just e-mail me, and I will introduce you.

I am not a fan of Spitzer, but I am also not a fan of Greenberg. My review gives the details. The quick summary is that he smoothed earnings for years, and built up the debt over his tenure. He did not stay true to his own credo of being willing to exit markets where he could not earn a decent ROE.

Greenberg was an intensely bright and driven guy, but I worked in his "culture of fear" for four years, and saw the perverse effects five times with how employees would hide bad news. It made me permanently skeptical of AIG's accounting.

Anonymous,  7/01/2011  

Surely a system where only 1 man understood the whole corporation is an incredibly risky one. What if Hank wasnt dismissed but instead suffered from a stroke?

Hunter 7/01/2011  

Nice try Elliot...

Anonymous,  7/02/2011  

It's possible... but if he was to know everything that was going on and to stop it, Hank would have needed information, i.e. profit and loss, exposures, etc.

Is there any evidence that his successors got that information and didn't look at it; or is it the case that the info didn't get to the CEO's office, and wouldn't have done no matter who was in it.

Buckingham Badger,  7/06/2011  

You recommendation of the book came on the same day as a different friend recommended the book to me and almost verbatim. I'm now concerned that if you are my friend I have lost a lot of respect for you. Ha! ;)

That said, if your description of AIG is right this in not a fault of Spitzer but of Greenberg's mgmt. A business of any size and particularly AIG cannot be so focused and driven by 1 man. All this did was destroy AIG faster and sooner than what would have happened over years in the future when Greenberg wasn't there.

I've watched first hand how small companies such as a local bakery can fail switching from one head to another and it requires a much bigger for me to invest in a company that is so focused on one man. I have never felt comfortable with AAPL or BRK for that reason specifically.

I want to own businesses that idiot can run and can't destroy. See KO, P&G.


hunter [at] distressed-debt-investing [dot] com

About Me

I have spent the majority of my career as a value investor. For the past 8 years, I have worked on the buy side as a distressed debt and high yield investor.