AIG's meltdown has roots in Greenberg era

AIG itself is clear that Greenberg should bear some of the responsibility.

"AIG FP from the way it operated to its compensation were all set up under Greenberg, and AIG was well into it by the time he left," said Nicholas Ashooh, a spokesman for AIG.

Greenberg, a World War II veteran who helped to liberate the Dachau concentration camp, set up the financial products unit in 1987 as he was seeking new business avenues to diversify his growing empire against the highs and lows that are a trademark of global insurance markets.

He hired a group of traders that had worked together at Drexel Burnham. He would later promote Joseph Cassano to lead the unit, which became a sought-after employer since it offered to share a third of all its profits with staff. Cassano is now at the center of U.S. and UK probes into what happened at AIG Financial Products.

A PLAN THAT BACKFIRED

Greenberg's diversification plan paid off handsomely at first. AIG Financial Products contributed $5 billion to the insurer's profits from the time it was formed in 1987 through 2004, Greenberg's last full year as CEO.

But the risks also grew exponentially as the unit, driven by a thirst for greater profits, racked up guarantees on CDS worth a total of about $450 billion. Cassano boasted in 2007 that the company did not expect to realize even $1 in losses on the portfolio.

"AIG jumped into the high-beta world of credit default swaps when there was a low default environment," said Whalen. "But when the market goes bad it all goes bad, and with the kind of exposure that AIG wrote, it is just rancid."

Greenberg, in written testimony to a U.S. congressional hearing last October, argued that risk controls were not maintained at AIG Financial Products after he left, and that he would have done more to hedge the risks and head off losses.

Gerry Pasciucco, a former Morgan Stanley executive who is now winding down the unit, told Reuters last month that everyone with the benefit of "20/20 hindsight" would have reacted differently. The reality is no one did, under Greenberg, or later, he said.

"The overwhelming majority of AIG FP's books were hedged, but some remote risks were not," said Pasciucco.

AIG withdrew from guaranteeing multi-sector asset-backed securities -- the area that has triggered AIG's worst losses -- about 8 months after Greenberg's departure.

To be sure, some experts say neither Greenberg nor AIG could have predicted the extent of the U.S. housing market bust, or the prolonged recession.

"The business of insuring credit is good, and there is a valid market, but it was left unregulated and unsupervised. Credit insurance was the blind area," said David Kotok, chief investment officer at Cumberland Advisors. "We are now paying the price."

(Reporting by Lilla Zuill; Editing by Gary Hill)