AIG losses may have been wider

Shares of insurance giant American International Group Inc. plummeted nearly 12% on Monday after the company’s auditor found that faulty accounting might have understated losses on insurance written against certain securities, including dicey mortgages.

The value of so-called credit default swaps issued by AIG declined by $4.88 billion in October and November, four times more than previously disclosed, the company said in a regulatory filing.

Credit default swaps protect institutional investors against losses on debt including corporate bonds and mortgage-backed bonds.

“It’s likely that AIG wrote insurance contracts against securities it thought” had minimal risk, said Jim Grant, editor of Grant’s Interest Rate Observer, speaking on Bloomberg Television. “In reality, these securities were plenty risky.”

The New York-based firm’s shares dived $5.94, or 11.7%, to $44.74, a five-year low. The stock is down 23% this year.

Significantly, AIG’s auditors found “material weakness” in its accounting for the swap contracts, and the firm doesn’t know what they were worth at the end of 2007, the filing said.

“It raises the question about whether management is in control of what’s going on” with derivative securities such as credit default swaps, said Edward Ketz, a Pennsylvania State University accounting professor.

AIG’s new troubles seemed certain to remind investors of an accounting scandal that led to the ouster of former Chief Executive Maurice “Hank” Greenberg in 2005. That scandal was related to risk reinsurance contracts and led to a costly financial restatement.

We “believe AIG management will have an extremely difficult time regaining investor confidence,” Standard & Poor’s said in a note to investors Monday.

AIG’s problems in accounting for credit default swaps also raise concerns about how other financial companies are valuing such derivative securities, which have become heavily used on Wall Street over the last decade.

“Any doubt as to their accounting accuracy would definitely strike fear in the market,” said Brian Yelvington, a strategist at CreditSights Inc. in New York. AIG is “considered to be a very sophisticated and large counter-party in the structured-finance world.”