How AIG Fell Through the Regulatory Cracks

By | March 9, 2009

U.S. lawmakers blasted state and federal regulators for dodging blame and keeping secrets after the failure of insurance giant American International Group Inc., which now has access to more than $170 billion in taxpayer money.

Calling AIG “the greatest corporate failure in American history,” Sen. Richard Shelby on Thursday needled the New York state insurance regulator and representatives from the Federal Reserve and Office of Thrift Supervision about the lack of oversight leading to the company’s collapse.

AIG on Monday reported a $61.7 billion quarterly loss, the worst in U.S. history. The same day, Treasury provided AIG as much as $30 billion in additional aid from the $700 billion financial bailout program.

The government effectively controls the insolvent company, with the Treasury Department owning up to 79.9 percent.

In turns apologetic and defensive, the regulators explained why their agencies weren’t set up to oversee a firm like AIG, or why the company’s problems were outside of their jurisdictions.

The toughest questioning fell on Federal Reserve Vice Chairman David Kohn. His appearance followed rare and withering criticism of AIG earlier this week from Fed Chairman Ben Bernanke.

“I share your concern, I share your anger,” Bernanke told the Senate Budget Committee Tuesday. “It’s a terrible situation, but we’re not doing this to bail out AIG or their shareholders. We’re doing this to protect our financial system and to avoid a much more severe crisis in our global economy.”

Banking Committee Chairman Sen. Chris Dodd demanded to know Thursday which other banks had benefited from the billions of dollars AIG has spent winding down its credit-default swap business and other relationships. The swaps insure companies against losses on corporate bonds, but are not regulated like insurance. AIG was the top player in the multitrillion-dollar industry that played a major part in the financial crisis.

“The question is, who is actually being rescued?” Dodd asked Kohn.

Kohn refused to say who had been made whole after deals with AIG went bad, arguing that the information would undermine what little confidence remains in the financial markets.

“We need AIG to be stable … and I would be very concerned that if we started giving out the names of counterparties, people wouldn’t want to do business with AIG,” Kohn said.

He defended the use of taxpayer money to repay other banks because “if we imposed losses on the counterparties for AIG,” there could be disastrous ripple effects throughout the financial system.

AIG is so big and sprawling, so intertwined with institutions worldwide, that its downfall could set off a vicious chain reaction. Upheaval on such a global scale would plunge the U.S. economy deeper into recession, drive up unemployment and stifle hopes for an economic rebound any time soon.

Scott Polakoff, acting director of the Office of Thrift Supervision, told lawmakers his agency had relied on imperfect modeling and optimistic assumptions about AIG’s credit-default swap business. But he also suggested the company’s financial products division had furnished inadequate records for examination.

Kohn said the Fed had to swallow its distaste for AIG having “exploited” the strength of other companies.

“I share your frustration and the frustration of everybody else on this committee,” Kohn said. “I wish with every fiber of my body that we didn’t have to come in and do what we did.”

But he said inaction could have forced more big banks to the brink of failure, and “we had no choice if we are to pursue our responsibility for protecting financial stability.”

Dodd was not satisfied with the response. “Public confidence in what we’re doing is at stake, and right now the public is deeply, deeply troubled by this,” he shot back. “We’re going to have an awfully difficult time … if we can’t get answers to this.”

At Dodd’s urging, Kohn agreed to take the senators’ concerns to his fellow Fed governors.

Blaming the failure on AIG’s financial products division, New York insurance superintendent Eric Dinallo said the solvency and capital requirements of the insurance companies “were done well and I’m proud of how the regulators maintained themselves.”

Without the losses on financial products, “arguably AIG would be flourishing in this environment,” Dinallo said.

But Shelby, the committee’s ranking member, argued the problems stemmed from AIG’s insurance business as well as the financial products.

“Are you trying to evade your responsibility?” Shelby asked. “You can claim here today that you have little responsibility if any for all these problems?”

AIG received a new $30 billion lifeline earlier this week, bringing the company’s bailout to more than $170 billion since Sept. 16. The government also has adjusted the terms of AIG’s loans to make the debt easier on the company’s balance sheet.

Dodd said he had asked Treasury to send a representative to describe the department’s relationship to AIG, but no one was available.

Treasury has been criticized for staffing up slowly as it deals with the largest financial crisis in generations. No top deputies to Treasury Secretary Timothy Geithner have yet been named.

AIG provides life, property and other insurance offerings, with 30 million policyholders in the United States alone. It also provides asset-management services and airplane leases.

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