Yesterday, the U.S. Senate Committee on Banking, Housing, and Urban Affairs, chaired by Senator Christopher Dodd (D-CT), held a hearing entitled “American International Group (AIG): Examining What Went Wrong, Government Intervention, and Implications for Future Regulation.” The hearing focused on the government actions related to the bailout of AIG, and testifying before the Committee were the following witnesses:

  • Donald Kohn, Vice Chairman, Board of Governors of the Federal Reserve System
  • Scott Polakoff, Acting Director, Office of Thrift Supervision (OTS)
  • Eric Dinallo, Superintendent, New York State Insurance Department

Vice Chairman Kohn outlined the support given by the Federal Reserve and the Treasury to AIG, and the reasons for these actions, highlighting that the exposure of AIG’s Financial Products unit (AIGFP) to a “very large notional amount of derivatives contracts outstanding with numerous counterparties” largely served to destabilize AIG’s overall viability. He defended the government’s actions at the time they were taken, stating “we believe we had no choice if we are to pursue our responsibility for protecting financial stability,” and that allowing AIG to fail would have worsened the financial crisis and deepened the recession the country is now facing. However, several Republican and Democrat lawmakers, noting the latest government actions undertaken with respect to AIG, rebuked Kohn and the Federal Reserve’s handling of AIG. They insisted that he reveal how the approximately $160 billion injected into AIG has been spent and identify the counterparties to AIG contracts that the Federal Reserve unwound by paying off such counterparties at the full long-term value they expected to realize. Lawmakers expressed their ire that taxpayer funds were likely used to pay off AIG’s trading partners, and they warned that if Kohn failed to reveal the names of these parties, Congress could be prompted to block future bailouts of AIG and the financial sector. Kohn asserted that the identification of these counterparties would serve to “undermine the stability of [AIG] and could have serious knock-on effects to the rest of the financial markets and the government efforts to stabilize them,” though he conceded that effectively rescuing some of AIG’s counterparties had created “huge moral hazard.”

Acting Director Polakoff readily acknowledged the failures of OTS, the primary federal regulator of the AIG holding company, in preventing the events requiring government rescue of AIG. He referenced OTS’s inability to “foresee the extent of the risk concentration and the profound systemic impact [credit default swap] products caused within AIG,” as these “toxic products posed significant liquidity risk to the holding company.” As a result of the events surrounding AIG, Polakoff recommended the “establishment of a systemic risk regulator with broad authority, including monitoring, over companies that if, due to the size or interconnected nature of their activities, their actions, or their failure would pose a risk to financial stability of the country.”

Finally, Superintendent Dinallo, explaining that the New York Insurance Department is the primary regulator of AIG’s ten U.S. insurance companies (out of 71) that are domiciled in New York, claimed that the “crisis for AIG did not come from its state regulated insurance companies,” but rather stemmed from “certain credit default swaps and collateral calls by global banks, broker dealers and hedge funds that are counterparties to these credit default swaps.” When faced with questions regarding AIG’s state insurance companies’ securities lending businesses, Dinallo stated that the New York State Insurance Department had been working with AIG to unwind these investments, though such efforts were thwarted by crisis facing AIG last September.