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American International Group’s (ÌìÃÀÍøÕ¾´«Ã½´«Ã½) exposure to the subprime mortgage market that precipitated the government’s $85 billion bailout came as a result of business conducted after he left the company, according to Maurice “Hank” Greenberg, who was chief executive officer from the late 1960s until first quarter 2005.

Greenberg was at the helm in 1987 when ÌìÃÀÍøÕ¾´«Ã½´«Ã½ Financial Products was born and in 1998 when it started getting involved in credit default swap insurance. But Greenberg said in recent Congressional testimony that ÌìÃÀÍøÕ¾´«Ã½´«Ã½FP was not involved in much subprime while he was in charge. Greenberg left ÌìÃÀÍøÕ¾´«Ã½´«Ã½ in March 2005 in the wake of a probe into accounting practices at the company.

Martin Sullivan, Greenberg ‘s successor, said he was focused on other priorities including repairing ÌìÃÀÍøÕ¾´«Ã½´«Ã½’s standing, cooperating with government probes and helping manage losses from Hurricane Katrina. His efforts succeeded, he said, as ÌìÃÀÍøÕ¾´«Ã½´«Ã½ enjoyed good years in 2006 and most of 2007.

“However as we now know, a different storm was gathering over the global financial markets,” Sullivan said.

The two told their tales in testimony given to the House Committee on Oversight and Government Reform. Robert Willumstad, the ÌìÃÀÍøÕ¾´«Ã½´«Ã½ board chairman who succeeded Sullivan as CEO on June 15, also testified.

In 1987, the derivative market was small but growing. Greenberg said ÌìÃÀÍøÕ¾´«Ã½´«Ã½’s approach was to conduct its business on a “hedged” basis” so that ÌìÃÀÍøÕ¾´«Ã½´«Ã½FP would not be exposed to directional changes in the fixed income, foreign exchange or equity markets. He said ÌìÃÀÍøÕ¾´«Ã½´«Ã½FP reported directly to him and to ÌìÃÀÍøÕ¾´«Ã½´«Ã½ Senior Vice Chairman Ed Matthews and later to William Dooley, senior vice president.

Controls in Place

Greenberg said he had management controls that included weekly meetings to keep an eye on ÌìÃÀÍøÕ¾´«Ã½´«Ã½FP and its risk portfolio, as well as credit risk monitoring by several independent units of ÌìÃÀÍøÕ¾´«Ã½´«Ã½, outside auditors and consultants and scrutiny by ÌìÃÀÍøÕ¾´«Ã½´«Ã½’s board.

Greenberg says the system worked, as ÌìÃÀÍøÕ¾´«Ã½´«Ã½FP contributed more than $5 billion to ÌìÃÀÍøÕ¾´«Ã½´«Ã½’s pre-tax income from 1987 to 2004.

However, he said, ÌìÃÀÍøÕ¾´«Ã½´«Ã½’s sales of credit default swaps “exploded” after he left the company and ÌìÃÀÍøÕ¾´«Ã½´«Ã½FP reportedly wrote as many credit default swaps in the nine months after he left than it did during the previous seven years combined, with much of that tied to the subprime market.

How did this exposure to the subprime market happen? “I was not there, so I cannot answer that question with precision. But reports indicate that the risk controls my team and I put in place were weakened or eliminated after my retirement,” Greenberg said.

Sullivan denies risk controls were watered down, saying the same controls remained after March 2005 and argues ÌìÃÀÍøÕ¾´«Ã½´«Ã½ heeded signs that the credit quality and pricing were changing, as ÌìÃÀÍøÕ¾´«Ã½´«Ã½FP stopped writing the products after 2005. “Until I left, ÌìÃÀÍøÕ¾´«Ã½´«Ã½ had not suffered $1 of losses” on credit default swaps, he said.

However, the testimony suggests ÌìÃÀÍøÕ¾´«Ã½´«Ã½ missed several warning signs that its ÌìÃÀÍøÕ¾´«Ã½´«Ã½FP portfolio was in trouble. These included a report from its own internal auditor, PricewaterhouseCoopers, which found ÌìÃÀÍøÕ¾´«Ã½´«Ã½ had a “material weakness” in its internal controls relating to ÌìÃÀÍøÕ¾´«Ã½´«Ã½FP’s credit default swap insurance. A 2008 letter from the Office of Thrift Supervision raised similar concerns. Back in in November 2007, Joseph W. St. Denis, an accountant hired to oversee ÌìÃÀÍøÕ¾´«Ã½´«Ã½FP transactions, resigned, he said, because his efforts to determine the value of the firm’s default swap portfolio were blocked by ÌìÃÀÍøÕ¾´«Ã½´«Ã½FP President Joseph Cassano, who drove the credit swap insurance business.

Sullivan said ÌìÃÀÍøÕ¾´«Ã½´«Ã½ staff who looked into the warnings decided the company had already put controls in place.