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April 12, 2005

Warren Buffett, Hank Greenberg, and Eliot Spitzer

Ellen Kelleher of the Financial Times reports:

http://news.ft.com/cms/s/6aabc3da-aac5-11d9-98d7-00000e2511c8,_i_rssPage=80fdaff6-cbe5-11d7-81c6-0820abe49a01.html: Buffett knew of Greenberg’s reserves concerns. By Ellen Kelleher in New York: Warren Buffett on Monday admitted to regulators that he knew Maurice "Hank" Greenberg was upset about AIG's reserves around the time that Mr Greenberg arranged a controversial reinsurance contract with General Re, a subsidiary of Berkshire Hathaway. The contract inflated AIG's reserves by $500m in the last quarter of 2000 and the first quarter of 2001.

Mr Buffett displayed a down-to-earth demeanour while testifying on Monday at the offices of the Securities and Exchange Commission about the deal, which is at the centre of the widening inquiry into the misuse of finite reinsurance. Mr Buffett is considered a witness, not a suspect in the investigation by US regulators. The famed investor told regulators he knew few details about the transaction, which Mr Greenberg arranged by placing a call to Ronald Ferguson, the former chief executive of General Re in late 2000. Last month, AIG admitted the transaction was improper.

Mr Buffett's testimony came as news emerged that Mr Greenberg would remain silent about AIG's accounting methods. In a last-minute decision, Mr Greenberg will invoke his fifth amendment rights...

What responsibility does a financial institution have if a counterparty suggests a trade that the counterparty wants to use to defraud or mislead its own shareholders? If you knew or should have known that the transaction was a step in a plan by your counterparty to violate the securities laws of the United States, what are your obligations?

A decade or two ago--before Adelphia, before WorldCom, before Enron, before AIG--the overwhelming point of view on Wall Street would have been that this provides you with an opportunity to put the squeeze on your counterparty and get better terms: after all, the management wouldn't be trying to mislead their shareholders unless they were really in a tight place. In the 1980s, when John Gutfreund of Salomon Brothers asked Warren Buffett to help him keep control of Salomon and scare off predators who wanted to buy it out (and in the process give Salomon's shareholders lots of money), Buffett was eager to help for a very handsome price that Gutfreund willingly paid. (However in the end Buffett had to do a lot of real work to keep form losing his money: Salomon imploded when its attempts to manipulate the Treasury bond market were revealed.) It was the responsibility of Salomon's shareholders to watch what their CEO was doing--and organize to fire him if they did not like it. It was the responsibility of AIG's shareholders to take steps to ensure that Hank Greenberg was giving them the straight accounting dope.

Now Eliot Spitzer has a different idea about corporate responsibility to the shareholders of your counterparties: you are not supposed to be an enabler.

Posted by DeLong at April 12, 2005 01:19 PM