Is Buffett in Trouble?

Sorting out the insurance scandal.

Warren Buffett

It’s hard to think of a business less exciting than insurance (well, maybe accounting). But in the last two weeks, a scandal in the sleepy industry has grabbed front-page headlines, destroyed the career of one American business giant, and now may tarnish the good name of another.

First, Maurice “Hank” Greenberg, the force of nature who turned American International Group into a global titan, was forced to resign on March 28, finally brought down by transactions that seemed designed to dress up AIG’s balance sheet. (Monica Langley’s front-page Wall Street Journal article about his final years at the helm—the Chinese butler, Greenberg yelling at corporate directors that they didn’t know how to spell the word “insurance,” the restricted use of the good bathroom on the corporate jet—is worth the price of a year’s subscription.)

The Greenberg fiasco has dragged in Warren Buffett, because General Re, a subsidiary of Buffett’s Berkshire Hathaway, was the other side of one of the suspect AIG transactions. Buffett is at best a peripheral player in the drama. He is scheduled to meet with investigators on April 11, but New York Attorney General Eliot Spitzer’s office has taken pains to note that Buffett is being called in as a witness, not a target. This still may damage Buffett’s reputation. The folksy billionaire and investor par excellence is the self-appointed conscience of the American capitalist democrat. The spirit of the transactions, and Buffett’s public reaction to them, stand in stark contrast to what has come to be known as the Warren Buffett way. (Disclosure: Buffett is a director of the Washington Post Company, which owns Slate.)

The AIG scandal involves the unusually arcane and obscure world of reinsurance. Insurers don’t simply take premiums and hope you don’t collect. They insure themselves with other insurers. By doing so, they move risk and liabilities off their balance sheets and onto others’. Because the transactions are complicated and ambiguous, both insurers and reinsurers may be tempted to engage in transactions that seem to be insurance but are really just deals to make earnings or balance sheets look better. AIG seems to have done that to keep its stock price healthy. Here’s AIG’s release describing a bunch of questionable accounting tactics. 

The deal that helped end Greenberg’s career and that now looms over Buffett was a 2000 transaction between AIG and General Re. AIG counted this as an insurance deal but now says that it “has concluded that the Gen Re transaction documentation was improper and, in light of the lack of evidence of risk transfer, these transactions should not have been recorded as insurance.” It appears that General Re profited from AIG’s desire to clean up its balance sheet. Buffett was briefed—briefly—on the AIG transaction.

Did General Re realize the deal wasn’t kosher at the time? And if so, did Buffett know? The obvious—and plausible—defense for both parties is that General Re had no way of knowing that AIG was going to improperly account for the deal.

For most other CEOs, such an excuse might be enough. But is it enough for Buffett? After all, the nation’s second-wealthiest man has used his pulpit to lecture politicians, corporate executives, and his fellow citizens—in plain-spoken and direct terms—on policy and business and etiquette. And on several counts, the behavior of one of his companies seems to have fallen short of Buffett’s standards.

Buffett has been a constant preacher against the nefarious and widespread practice of managing for the short term, engaging in behavior and strategy geared at meeting the quarterly numbers. AIG plainly used reinsurance to make its balance sheets—and perhaps its earnings—look better in the short term.

What’s more, Buffett’s insurance operations have apparently been willing to profit from helping other companies engage in this sort of behavior. Monica Langley reported last week as well that the SEC is looking into a bunch of other General Re transactions with other customers, “apparently meant to look like reinsurance transactions but not transferring risk.”

Berkshire Hathaway under Buffett has been a model of transparency and honesty. He famously noted that he writes his annual reports as if he were writing a letter to his Aunt Alice or his sister Doris, aiming for clarity, simplicity, and an absence of jargon or Clintonesque parsing. Buffett is also unique among CEOs for his willingness to criticize himself—he’ll cop to a lousy year. (If you’re the second-wealthiest man in America, it’s easy to play humble.) But it’s doubtful whether any of Buffett’s relatives would have understood what was being done in these transactions. And thus far he has studiously avoided any public mention of the investigations. If he similarly skirts the issue at the upcoming Buffett-palooza in May, it would be both surprising and telling.

Finally, the AIG transactions plainly failed what Buffett himself had referred to as the New York Times test” (and which should perhaps be relabeled the Wall Street Journal test). When considering an action, executives and managers should think about how it would look if it were splashed on the front page of the New York Times. So far, this is one test the Sage of Omaha is failing.