The Man Who Saved AIG
The Larry McDonald Series
Featuring Jim Millstein
Published on: June 3rd, 2019 • Duration: 59 minutesJim Millstein, co-chairman of Guggenheim Securities, was the chief restructuring officer at the U.S. Department of the Treasury from 2009 to 2011. In that role, he was responsible for the oversight and management of the U.S. government’s largest financial sector rescues. In this timely interview, Millstein sits down with New York Times bestselling author Larry McDonald to recount the most important takeaways from his experience. He also offers a deep dive into his career in restructuring in the 1990s and 2000s. Filmed on May 8, 2019 in New York.
JIM MILLSTEIN: The most important thing is cash flow. Forget about adjusted EBITDA, forget about the net income. Look at the cash flow statement.
Of the 535 members of the Senate and the House, if you asked each of them, what is Fannie and Freddie, maybe 100 of them could answer that question.
Donald Trump said when he was running for president that he was the king of debt. And I think he's living up to that campaign promise.
LARRY MCDONALD: Hi, my name is Larry McDonald, creator of The Bear Traps Report. We're thrilled today to bring you Jim Millstein. Jim Millstein is restructuring legend on Wall Street, was the chief restructuring officer for the United States of America during the financial crisis, led the Puerto Rico restructuring in bankruptcy, as well as more importantly, has a very keen eye on housing reform in the United States, Fannie and Freddie coming out of conservatorship and the road ahead as we look toward the 2020 election.
JIM MILLSTEIN: Larry McDonald. Here we are.
LARRY MCDONALD: Former chief restructuring officer of the United States of America.
JIM MILLSTEIN: Great title, bad job.
LARRY MCDONALD: How in the name of the gods do you get that job?
JIM MILLSTEIN: I don't know. I must have done something wrong in my previous life.
LARRY MCDONALD: Well, let's go back to when you're in college, you're making your way through your educational background. And then what was motivating you back then? How'd you get started?
JIM MILLSTEIN: So, I thought, in college, I was going to be a political philosopher at my college. I had to write a senior thesis and it occupied the equivalent of like three or four courses. So, it was a bulk of your commitment. And my thesis advisor suggested after reading this thing that I thought was incomprehensible, that I really needed to pursue a career in political philosophy. So, he sent me out to Berkeley, which everybody goes, oh, Berkeley. But in fact, in Berkeley in the late '70s had already been transformed by then Governor Reagan and the hotbed of protest of the '60s really had turned into a relatively conservative campus, except for my college professors, mentees whom he left behind.
But I very quickly realized in the PhD program out at Berkeley that there's so little in academia to fight over. The fighting is incredibly intense. And so, I shifted gears pretty quickly and became a political economist and start doing policy work. And my focus really was on the then assault of the Japanese on American industry and what policies the federal government could pursue to try to buttress the steel, auto, consumer electronics, semiconductor.
LARRY MCDONALD: So, back in the original dumping days, right?
JIM MILLSTEIN: Yes, the original dumping days and the original mercantilist policies that you've seen after Japan perfected it. You've seen South Korea pursue and now, China pursuing, where you protect your home market, you force technology transfer into your home market. And you use the home market as an export platform to build up scale until you are internationally competitive. And then slowly allow access to your domestic market, to when you have companies that really can compete. And Japan did it too fairly well, as that Korea and China is doing it to us now in that event.
So, I wrote a series of so-called industrial policy pieces, which got some circulation on the Hill in the late '70s. And at some point, testified I think at the Joint Economic Committee of Congress and one of the senators said to me, so if you're so smart, how should we change the law? And I said, I don't know. Yeah, I'm not a lawyer. And he said, well, why don't you go to law school and come back and talk to us about it? And I was looking for an excuse to get out of Berkeley and law school seemed like a pretty straightforward path. So, I went to law school. And by the time I got into law school, Governor Reagan became President Reagan. And Reagan ran on a platform that the government is the problem, not the solution.
So, the idea that my industrial policy prescriptions were going to get any traction in a Reagan White House were small to none. So, I ended up joining an international law firm and started doing international joint ventures and mergers and acquisitions, and ultimately, restructurings. And you had an oil price collapse in the mid-80s, which, just as you've seen a wave of restructurings in the Permian, over the last five, six, seven years. There were a wave of restructurings in Texas in the oil sector in the mid-80s. And that turned me into a bankruptcy lawyer. And so, I did a whole bunch of different kinds of restructuring largely on the debtor side. On the borrower side.
LARRY MCDONALD: Yeah, you're well-known there. Say, 80%, 90% of your work has been on the debtor side?
JIM MILLSTEIN: Yeah. Or on the acquirer side, representing a healthy company trying to buy an unhealthy company out of a bankruptcy. So, I worked as a lawyer for 18 years. I was at McCleary Gottlieb. It is a great law firm. I had a great time. And then in the late '90s as the Asian, the Thai baht crisis turned into an Asian flu and afflicted all of the countries of the newly industrializing South Asian basin. I spent a lot of time in Indonesia, in Thailand and South Korea, working on some large restructurings of some state-owned companies, some privately held companies.
And the last one I worked on was a company called Daewoo, which at the time represented 10% of the GDP of South Korea. It was into shipbuilding and electronics and steel and trading and about 10% of the output of South Korea was represented by this one company. And I needed an investment bank to help me because they had operations all over God's green earth. Two guys had just joined Lazard, whom I had worked with on different cases over the previous year or two, and I knew them well and think highly of them. And so, I hired Lazard to help me. And the three of us spent the next two years going all over the world, restructuring debt that they both incurred and ultimately restructuring the debt of the parent company with the help of-
LARRY MCDONALD: Is that your big break there? Is that your big break into Wall Street, your relationship to Lazard, or?
JIM MILLSTEIN: Well, no. But I'd worked on other- tried and worked on the restructuring and ultimate dismemberment of Pan American Airlines with Lazard. They were a co-advisor of mine in the early '90s. And I had worked on when they were involved in Cadillac Fairview, but I had had interaction with Lazard, but Lazard didn't really have a restructuring group until these two guys joined them in the late '90s. And so, anyway, we worked together on this for two years. And at the end of the deal, they turned to me and said, you really should be a banker, you're in the wrong job. And I said, okay, so make me an offer I can't refuse. So, I joined Lazard in 2000 and had a great run at Lazard.
LARRY MCDONALD: Those are the famous years of Lazard, the 2000.
JIM MILLSTEIN: Yeah. Well, the NASDAQ topped in what market? 2000. And you then had a four-year run of restructurings in telecom and largely- the WorldCom and the cable industry went through a massive restructuring during that period. And basically, all the companies that traditionally lever up, found themselves in trouble when the internet bubble burst. And so, we had a great run at Lazard.
And then my nose started to twitch in 2006, we at Lazard had a run of mortgage originators in the subprime space starting to come to us with liquidity problems and ultimately failing. And it was no one even knew, I think, other than people in the mortgage industry, this whole non-bank originator of mortgage originator was something that was flying under the radar of both the regulators. And really, I think most of the capital markets, New Century Financial. The only one that I think anyone ever really heard of was Countrywide because they were such a big presence in that market.
So, we had a couple of these. New Century has come in, in 2006-2007. And I had seen waves of industry restructurings over the course of my then 20 odd year career. But there was a wave of non-bank originator mortgage originator restructuring starting in 2006 and 2007. So, rather than just accept the what for us was the plenty of a new wave of restructurings, I started to get smart and read about what had gone on in the mortgage space. And then started sounding alarms. Stupidly, I didn't invest in it on the short side of it, like some of the people in The Big Short, but I started getting smart about it and ultimately ended up receiving a call right after President Obama was elected saying you might have noticed we're doing a couple of restructurings down here, could you-
LARRY MCDONALD: So, you get a call from the White House?
JIM MILLSTEIN: Not from- I got a call from a guy whose career and mine had gotten like this. He'd been a Lazard partner at one point, he'd been in the private equity business, but he became the head of the Treasury transition team. So, in most administrations, when there's a change of administration in the critical departments, a transition team is appointed and it sometimes the people on the team end up becoming the assistant secretaries and secretaries and deputy secretaries and other times, they're really just the baton passers between two administrations.
But in 2008, during the middle of the financial crisis, making sure that baton didn't get dropped, it was pretty critical to maintain the financial stability of the country. And so, they assembled very quickly a team of people who had been in previous administration Treasury departments who knew the building and how it operated and some people like me, who were just experts in what was going on then. And so, by the time the inauguration occurred, it was pretty clear I was going to have a permanent position in the administration, so I went back and negotiated a painful exit from Lazard, financially painful exit.
LARRY MCDONALD: So, you're leaving Lazard to go work for the US taxpayer?
JIM MILLSTEIN: Yeah, in part because it was the biggest challenge. If you're a restructuring jockey, want to ride the most troubled horse and the biggest and baddest horses were then in the Treasury's corral. So, I thought this would be a real challenge. But I thought I could do good. I'd always wanted to work in the government from the time I had been a graduate student. And who knew that my government would need, buy a particular brand of services. So, there it was.
LARRY MCDONALD: In my book, A Colossal Failure of Common Sense, about Lehman Brothers, we talked about those early warning signs of corporate governance. And one of the things David Einhorn pointed out to me, a famous hedge fund manager, is the footnote indicator. What, in other words, as a balance sheet 10K, 10Q, those SEC filings become more and more complex? You see more and more footnotes, more and more pages, are there any indicators that you've seen over the years for investors watching us right now, in terms of corporate governance, in terms of looking at companies, just something that you look out for, warning signs?
JIM MILLSTEIN: Yeah. The most important thing is cash flow. Forget about adjusted EBITDA, forget about net income, look at the cash flow statement. And see whether or not this is a company generating cash or consuming cash. And see if it's a company that's surviving on refinancing and financing as opposed to cash generated from operations. Because at the end of the day, it's a sign of management's ability not just to be financial engineers, but to actually take productive assets and produce cash from them. And if they're not doing that, if they're relying on financial engineering in order to keep the balance sheet stable, then you've got a problem either of management or the fundamental business problem.
So, when we get involved as restructuring advisors with a company, the first thing we do is try to figure out what's generating cash, what's consuming cash. Because sometimes, just the company will hit a wall and there isn't a financing party either stupid enough or hopeful enough to provide the last loan. And so, you've got to very quickly be able to shut down operations that are consuming cash and invest in those that are actually generating cash in order to keep enterprise value alive.
LARRY MCDONALD: So, we think about 11 years ago, Section 13-3, the Federal Reserve Act, allowed Paulson and Bernanke and company to- in the way I put it in my book, pick winners and losers. And I know you might have a different view. But take us back to that weekend, Lehman is heading down. AIG is in one room on life support. There's a number of banks that are also- and Washington Mutual on life support. And it always felt like to me like Lehman was potentially singled out, you don't have to comment directly on that.
JIM MILLSTEIN: I wasn't involved. I was an observer then too. We at Lazard represented Lehman in those last days and ultimately, in the bankruptcy.
LARRY MCDONALD: It just felt like to me where Lehman probably needed 30 to $40 billion. In the end, the government gave AIG 190. But like just your comment on that time, but also looking forward, where are we now if a big asset manager goes down? Like a major, not just a BlackRock or something like that, or a major asset manager or a major hedge fund, like a long-term capital, or a major bank? Where are we now versus where we were 11 years ago?
JIM MILLSTEIN: Just as a technical matter, as part of Dodd Frank, and in reaction to what the public perceive rightly, I think as a bank bailout, the Congress in its infinite wisdom decided to scale back. The power is granted to the Fed 13-3. Just on a footnote there, I love the quest of history. So, the Federal Reserve Act is the creation the Fed occurred in 1913 after what was then the last great panic of 1907, where the financial markets froze, and the Dow sold wildly off. And as a result of that experience, where JP Morgan famously organized a cabal of private bankers to provide liquidity to the New York banking system, President Wilson and the leading economic lights of the time determined that maybe the federal government should the power that JP Morgan to actually stabilize the financial system in a crisis and created the Federal Reserve System and in legislation passed in 1913, creating the Federal Reserve System and the Federal Reserve Board.
It was amended subsequently a couple of times in the '30s, during the Great Depression. But this section 13-3 of an act passed in 1913, there's some- and 13 is viewed generally as a not a very lucky number, but it is the source of the Fed's emergency powers. And under Dodd Frank, really is a reaction to just how much firepower Ben Bernanke assembled hanging on really just a couple of words, one sentence in the Federal Reserve Act in Section13-3, which says, in unusual and exigent circumstances, the Federal Reserve may make loans to nonmembers of the Federal Reserve System, i.e. non-banks. So, a broker dealer, like Lehman potentially could have received a loan, an insurance company like AIG could receive a loan, even though they were not members of the Federal Reserve System, didn't hold their reserves at the Federal Reserve, weren't regulated by the Federal Reserve.
So, in unusual and exigent circumstances, the Act passed in 1913 gave the Bernankes and the world power in 2008, almost 100 years later, and a power that hadn't been used, but three times before in American history, to basically write loans to the largest insurance company and ultimately, to the largest broker dealers in the United States on top of everything else they were doing for the regulated institutions through the discount window and a series of alphabet suit programs. Tough tip. There were just an endless array of programs that the Federal Reserve created to make sure that the banking system and the non-bank financial system had adequate liquidity to meet their obligations in the ordinary course.
As a reaction to that massive firepower that was brought to bear on those couple of words in Section 13-3 of Congress in the Dodd Frank Act amended those couple of words and said, in particular, that enormous firepower can only be brought to bear in programs of general applications. So, you couldn't, again, do a single purpose AIG loan. You would have to create a loan program for the insurance industry as a whole. And in that loan program for the insurance industry as a whole, take down a loan.
LARRY MCDONALD: So, those are its general application, is how this famous law that goes back 100 years has changed?
JIM MILLSTEIN: Yes. So, instead of having the authority to write a single institution loan, now, you have to create a program of general application from which liquidity can be derived for a specific institution. But it has to be a program of general application. Arguably, it hasn't limited the Federal Reserve's discretion all that much because they can create a- as I've joked to you before, they could create a program of general application for any insurance company located on Pine Street in the city of New York. AIG. But I think the people who exercise that power the next time around are going to be very concerned about not treading onto Congress's intent that there shouldn't be single institution bailouts, there should be industrywide type programs.
LARRY MCDONALD: Here we are 11 years after the financial crisis. We've got GDP in the United States close to 20 trillion. Millions of jobs have been created, unemployment rate close to 3%. And Fannie and Freddie are still in conservatorship.
JIM MILLSTEIN: The great unfinished business.
LARRY MCDONALD: What in the name of the gods is going on here? Why are they in conservatorship if we're in this glorious recovery, and are they able to- first of all, for people watching this right now- right now, are they able to retain capital and store capital for the next crisis while they're in conservatorship?
JIM MILLSTEIN: No, no, right now, they're not. But notwithstanding the fact they have very limited amounts of capital supporting trillions of dollars of mortgage guarantees.
LARRY MCDONALD: Say that, again, they have what?
JIM MILLSTEIN: They have a very thin sliver, couple of billion dollars of capital that they've been allowed to retain.
LARRY MCDONALD: And they have a $5 trillion mortgage portfolio.
JIM MILLSTEIN: Yeah. So, they're grossly undercapitalized except for the fact that they are the beneficiaries of a line of equity that backstops their balance sheet provided by the US Treasury Department. And that line of equity still has 250 billion dollars of undrawn availability. And so, although on their balance sheet themselves, they have very little capital, they are still backed by the full faith in credit in effect of the federal government, which has allowed them to operate seamlessly during the financial crisis and after, in conservatorship, providing the service they have provided since really the mid-60s, which is supporting the primary mortgage market by making secondary markets and mortgage secure and mortgages.
So, the reason they're still there is that this is an extremely complicated part of the mortgage market. The mortgage market generally is pretty complicated. Most Americans think it's pretty straightforward. I ring up my bank, I want to buy a home, I fill out a mortgage application. And as long as I meet the criteria that the bank establishes for lending, I get a mortgage, and it begins and ends there. But actually, that's just the beginning of the mortgage market.
The banks then generally can do one of two things- they can leave the mortgage on their balance sheet, have an asset, my claim against you for the loan I've given you, or they can take that loan, and put it in a- pool it with other loans, and ultimately, dump that pool in a trust, bring it to Fannie or Freddie and get Fannie and Freddie to say, I'll guarantee