updated 10/7/2008 2:37:07 PM ET 2008-10-07T18:37:07

Former top executives of insurance giant American International Group Inc. were on the receiving end of a verbal smackdown Tuesday as a congressional panel probed the chain of events that forced the government to bail out the conglomerate.

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Maurice “Hank” Greenberg, who ran AIG for 38 years until 2005, again blamed the company’s financial woes on his successors, former CEOs Martin Sullivan and Robert Willumstad. They, in turn, cast much of the blame on accounting rules that forced AIG to take tens of billions of dollars in losses stemming from exposure to toxic mortgage-related securities.

AIG, crippled by huge losses linked to mortgage defaults, was forced last month to accept an $85 billion government loan that gives the U.S. an 80 percent stake in the company. Last week, AIG said it has drawn down $61 billion of the loan, and planned to sell off some of its business units to pay off the loan.

“Both of you seem to be saying that those events had nothing to do with your management, it had to do with a tsunami of activities over which you had no control,” said a House Oversight Committee Chairman Henry Waxman, D-Calif.

“You have cost my constituents and the taxpayers of this country $85 billion and run into the ground one of the most respected insurance companies in the history of our country,” said Rep. Carolyn Maloney, D-N.Y. “You were just gambling billions, possibly trillions of dollars.”

Lawmakers also upbraided Sullivan, who ran the firm from 2005 until June of this year, for urging AIG’s board of directors to waive pay guidelines to win a $5 million bonus for 2007 — even as the company lost $5 billion in the 4th quarter of that year. Sullivan countered that he was mainly concerned with helping other senior executives.

Sullivan also came under fire for reassuring shareholders about the health of the company last December, just days after its auditor, Pricewaterhouse Cooper, warned of him that AIG was displaying “material weakness” in its huge exposure to potential losses from insuring mortgage-related securities.

AIG’s problems did not come from its traditional insurance subsidiaries, which remain healthy, but instead from its financial services operations, primarily its insurance of mortgage-backed securities and other risky debt against default. Government officials feared a panic might occur if AIG couldn’t make good on its promise to cover losses on the securities; investors feared the consequences would pose a threat to the U.S. financial system, which led to the government bailout.

AIG suffered huge losses when its credit rating was cut, thanks largely to complex financial transactions known as “credit default swaps.” AIG was a major seller of the swaps, which are a form of insurance, though they are not regulated that way.

The swap contracts promise payment to investors in mortgage bonds in the event of a default. AIG has been forced to raise billions of dollars in collateral to back up those guarantees. AIG stopped selling credit default swaps in 2005 to limit its exposure, but the damage was done.

Waxman unveiled documents showing AIG executives hid the full extent of the firm’s risky financial products from auditors, both outside and inside the firm, as losses mounted.

For instance, Federal regulators at the Office of Thrift Supervision warned in March that “corporate oversight of AIG Financial Products ... lack critical elements of independence.”

At the same time, Pricewaterhouse Cooper confidentially warned the company that the “root cause” of its mounting problems was denying internal overseers in charge of limiting AIG’s exposure access to what was going on in its highly leveraged financial products branch.

Waxman also released testimony from former AIG auditor Joseph St. Denis, who resigned after being blocked from giving his input on how the firm estimated its liabilities.

In prepared testimony, former AIG chief executive Sullivan said many of the firm’s problems stemmed from “mark to market” accounting rules mandating that its positions guaranteeing troubled mortgage securities be carried as tens of billions of dollars in losses on its balance sheet.

This in turn, said former AIG chief executive Willumstad, who ran the company for just three months after Sullivan left, forced the firm to raise billions of dollars in capital. The federal rescue came after AIG suffered disastrous liquidity problems after its credit rating was lowered, forcing the company to come up with even more capital.

“AIG was caught in a vicious cycle,” Willumstad said in the testimony.

Former AIG CEO Greenberg issued a written statement but canceled his appearance before the committee, citing illness. In his prepared testimony, Greenberg said his successors were responsible for AIG’s demise.

“When I left AIG, the company operated in 130 countries and employed approximately 92,000 people,” Greenberg said. “Today, the company we built up over almost four decades has been virtually destroyed.”

Greenberg said that AIG “wrote as many credit default swaps ... in the nine months following my departure as it had written in the entire previous seven years combined. Moreover, “unlike what had been true during my tenure, the majority of the credit default swaps that AIGFP wrote in the nine months after I retired were reportedly exposed to subprime mortgages.”

But Sullivan said the complex swaps had underlying value, even as the market for them froze, sending their book value plummeting and forcing AIG to scramble for collateral.

“When the credit markets seized up, like many other financial institutions, we were forced to mark our swap positions at fire-sale prices as if we owned the underlying bonds, even though we believed that our swap positions had value if held to maturity,” Sullivan said.

The hearing is the second in two days into financial excesses and regulatory mistakes that have spooked stock and credit markets and heightened fears about a global recession.

Waxman opened the hearing by lambasting the company for spending more than $440,000 to hold a weeklong retreat for its executives at a luxury resort in California less than a week after receiving its $85 billion federal bailout.

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