Michael Lewis has written an extraordinary piece on the AIG failure for Vanity Fair. As with most of his work, the article is informative, funny and written in an easy to follow manner. When you have time read the whole thing.
As Lewis relates, the problems at AIG (and particularly AIG Financial Products, the unit that was excoriated in the infamous “bonus payments” of a few months ago) were not the result of some ingenious evil scheme hatched by devious masters of the universe. The AIG implosion was, rather, the result of some incredibly dumb decisions, a lot of greed and the inexplicable regulatory failure of government agencies. That the government failed in its mission to regulate Wall Street and the financial sector should surprise no one. And before any stereotypes like “wealthy bankers/ Republican Party” take root let it be known that this was a truly bipartisan fiasco until 2006, at which time the Democrats cornered most of the political cash (particularly from AIG).
In short, AIG blew up because it had underwritten massive risk via credit default swaps (CDS) with other major investment banks. In these CDS trades, AIG basically insured other investment firms against losses they might incur on trillions in mortgage bond holdings. These “insurance contracts” were unregulated on the insurance side, hence the failure of state insurance regulators to step in and stop the practice. However, no one should assume that New York state insurance regulators were unaware of what AIG was doing. The unregulated aspect of CDS was the fig leaf regulators hid behind as AIG publicly boasted about their business.
However, the SEC and the Federal Reserve had no such fig leaf to hide behind because the counter parties to AIG’s massive insurance bets were the largest commercial and investment banks in the world. It is certainly in the purview of those agencies to question counter party risk at places like Goldman Sachs, Bank of America and Morgan Stanley. But apparently they didn’t ask the right questions and $180 billion tax payer dollars later the right questions are still not being asked. As Lewis notes:
At no point did anyone from the U.S. Treasury or the U.S. Congress, or any of the various New York State authorities that had gotten involved, call them up, much less visit A.I.G. F.P.–as, say, someone might who was genuinely curious to know what, exactly, had happened there.
The AIG failure is Exhibit A as to how ineffective and unresponsive government regulation can be in a rapidly evoloving industry such as finance. It is also a testament to the unmitigated disaster that can result when politicians and bankers both have regulators on a short leash. Congress has a thing for holding widely publicized and televised hearings after a disaster has occurred. But conducting actual oversight of regulators to prevent disasters? Not so much. Are you sure you want these people in charge of health care?