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AIG And The Failure Of Congressional Oversight

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?


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Comments (14)

Two short leashes, one neck... (Below threshold)
JLawson:

Two short leashes, one neck = disaster waiting to happen.

The difference between unre... (Below threshold)
Bob:

The difference between unregulated capitalism and strict government oversight of business is often (if not always) that the latter offers a false sense of security. The price of this false security is not only the cost of the regulation itself but a general lack of self-protection and the natural instinct of the regulated to find ways to fool or avoid the regulators.

So naturally the answer fro... (Below threshold)
J.R.:

So naturally the answer from our President and congree will be....more regulators!

of course that should read ... (Below threshold)
J.R.:

of course that should read "congress" above.

And who was the guy at the ... (Below threshold)
hermie:

And who was the guy at the NY Fed in charge of regulatory oversight of this fiasco?

That's right! Our current 'genius' Secretary of the Treasury.

Regulators are almost alway... (Below threshold)
Rick Caird:

Regulators are almost always behind the curve. Not only that, they are invariably captured by the industry being regulated. With that understanding, it is amusing to see the left (as long as Bush was President) claiming all we needed was more regulation. They would never bother to explain how to do that, but they were sure it was all Bush's fault.

Rick

Thanks for the link. It's ... (Below threshold)
James H:

Thanks for the link. It's good reading.

I find it rather disturbing that regulators failed in this area. High finance -- a business complicated enough that even its practitioners don't fully understand it -- is an area that demands effective regulation and oversight.

"High finance -- a busin... (Below threshold)
JLawson:

"High finance -- a business complicated enough that even its practitioners don't fully understand it -- is an area that demands effective regulation and oversight."

And yet, we continually put it in charge of people who only seem to have a talent for getting elected.

Seems like a dumb-ass move to me, for some reason...

J.

Hey, at least the Congressi... (Below threshold)
GarandFan:

Hey, at least the Congressional "Now that the horse is out of the barn" Hearings would provide a couple of days distraction and intertainment for the sheeple.

If you want to see a graphi... (Below threshold)
Oyster:

If you want to see a graphic that really drives the point home in regard to just how big the failures were, go here. If the whole graphic doesn't show on your monitor, scroll to the right for a real eye opener.

And these are just the bank... (Below threshold)
Oyster:

And these are just the bankruptcies - not the ones "bailed out".

Its alright if We go anothe... (Below threshold)
914:

Its alright if We go another 50 trillion in debt. Just so Michael TM Jackson gets a proper Sharptongue send off and a day of the year proclaimed a National holiday. A day on which all level 3 offenders are given amnesty.

You see, Congress has way more important things to do besides thier "jobs".

The big weakness, actually,... (Below threshold)
James H:

The big weakness, actually, this that for a long time (and I think still), financial companies essentially had carte blanche to choose their own regulator; and often, they'd go for the weakest regulator ...

Let's not forget Barney Fra... (Below threshold)
Trajan:

Let's not forget Barney Frank and his ilk.
They legislated things that practically
guaranteed a doomsday in the housing market.
This bastard should be burned at the stake.
I'm sure he has an appropriate gown for
immolation....ala Jeanne D'Arc.




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