Deconstructing AIG's Record Loss

Market participants will start doing some of their own analysis to gauge when financial markets might start to function again. They will be doing some stress testing, possibly vs. Texas during the oil bust, the 1990-1991 experience in Massachusetts or California, the Great Depression or possibly the 1974-1975 experience that AIG analyzed. So I find it hard to believe that the real losses that the insured portions of these CDOs would sustain would be off by a factor of 12 from AIG's analysis. I might grant naysayers the benefit of the doubt on the 2006-2007 vintages, which were so badly underwritten that normal analysis might possibly break down, but these are 2005 and prior vintages at issue, which have already had lots of ARM resets.

Investors should put credence in market value of assets, when the markets are functioning normally, but there is no accounting silver bullet. I look at the valuation that the market accords, the capital level of the company and its ability to earn income in concert with one another. In round numbers, AIG earns $22 billion a year in pretax income. Even if you believe that the $11 billion number is the right one based on the subprime situation now -- and everybody agrees that mark-to-market losses could get worse in the coming one or two quarters -- the company is not liquidating. It has to pay off obligations over time. And over the next two or three years, you get $44 billion to $66 billion of pretax to help cover even the mark-to-market losses, if they become real.

Management did say that losses could be substantial in a quarterly result, which was no surprise as the environment worsens.

I believe that the head of financial products was ousted for the accounting issues as much as anything else. In addition to the accounting scrubbing after Greenberg left, I am impressed that CEO Sullivan seems to have more executives wired into the quarterly calls than any company I have ever seen, and when there is a specific question, he calls on the executive closest to the situation to answer. In effect, he does not try to "orchestrate" what is said on the calls.

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At the time of publication, Thomas was long American International Group.