Topical thread: Regulators could have prevented AIG collapse?
Rdan here…Our loyal opposition Reader Sammy sends along this in your face question:
Regulators could have prevented AIG collapse. Really?
Say what you want about AIG, and it is pretty much open season on them, but just prior to their collapse, AIG was:
1) The largest insurance company in the US, in the business of assessing risk.
2) One of less than 10 companies rated AAA
3) A member of the Dow 30 Industrial Average.
So you think some Insurance Examiner could have foreseen the risk that eluded all the rating agencies, and all the counterparties (including Goldman) and prevented it? As Seth and Amy would say on Saturday Night Live: “Really?”
Even though SEC regulators allowed Bernie Madoff’s ponzi scheme to continue for 20 years, even after they were tipped off?
Not even to mention that what brought AIG down was not underwriting risk, but collatoral posting covenants buried deep in the documents.
I can imagine the conversation:
Brilliant Civil Service Examiner (circa 2003): “Mr. Greenburg it looks like you have a dangerous amount of exposure in CDS, if housing prices decline, or you get downgraded, you will have to post immense amounts of collatoral. I’m going to recommend to my superiors that you to cease and desist”
Greenburg: “Hey Frank (Catalano), fire up the Cray and show the Examiner your simulations. I am sure he will be more than satisfied. If not he should direct further questions through the offices of Sens. Dodd and Schumer, or maybe Bush and Obama.”
Some bureaucrat could have sounded the alarm? “Really?!”
Reader Sammy asks.
There are several different questions here: Could regulators as they happened to be specifically constituted in 2003 have prevented the AIG collapse? Could regulators as they happened to be systematically constituted (but with different particulars, e.g. with different people filling the systematic roles) have prevented the collapse? Could regulators have prevented the AIG collapse had they been constituted differently? In other words, did the particular details of 2003-style regulation fail? Was it a failure of how regulators were systematically constituted? Or would regulation of any recognizable form have failed?
The answer to the first question is a matter of history: the regulators as they were particularly constituted did in fact fail to prevent the collapse. I think Sammy is not too far off the mark by asserting that the particular details did not made much difference: the failure was not due to some individuals who happened to be incompetent or especially credulous.
However, I think it’s also clear that under mid 20th century regulation, AIG (and the financial system as a whole) would never have been allowed to get anywhere close to such a catastrophic collapse. Of course, you have to make some sacrifices: we know empricially that heavy regulation and high taxation leads to lower economic growth*.
AB has consistently carried posts on OCC, IRS, Thrift and other agency defunding, shrinking staff, and agency leadership challenges to the original agency mandates. Also challenges to state rules on banks.
the guy from alephblog (david merkel) went through their books a few months ago and did six or so very detailed posts. he’s probably the guy to ask. i can’t find a link right now but i’m sure you can find it.
Isn’t Sammy’s question off the mark to begin with? It isn’t AIG that was unregulated. It was AIG Financial Products that was operating without any risk protective requirements. One legitimate question is why an insurance company would be allowed to underwrite/guaranty . the speculative deals made by a subsidiary?
Sammy, I’d be more interested to know your opinion regarding the conflict between free market capitalism and the government’s bailout of the AIG Financial Products counter parties.
Another question that comes to mind is why AIG would take on the full resopnsibilites for the liabilities of an incorporated subsidiary?
I would love for some regulator to have discovered AIG’s risks, as I’m sure AIG would have also. I am begging for someone to tell me how that would have been possible. Remember AIG stopped writing CDS on mortgages in 2005, before the housing bubble was somewhat “obvious.” Even if AIG were required to post reserves they obviously would have been small, based on actuarial data. And in the end, there was no way any level of reserves would have been adequate. So same boat.
As far as the AIG bailout, I was initially as suspicious of the GS etc. payouts, but really, at the time, we were trying to save the financial system. Many more vulnerable banks, Citi, Wachovia, were dependent on those CDS’s. As to the WHY of the bailout, it’s because a functioning banking system is a “Public Good” (see Depression, Great).
So I still would like some evidence that more regulation would have prevented AIG. I forgot (somehow) to mention Fannie and Freddie, run by the Federal government, also guaranteeing mortgages. If no evidence is there, the prescription of “more regulation” is worthless.
would regulation of any recognizable form have failed?
“I forgot (somehow) to mention Fannie and Freddie, run by the Federal government, also guaranteeing mortgages.”
You know, or should know, that neither company is “run by the Federal government.” They are both public stock corporations originally sponsored by the Federal government.
And you keep talking about AIG the insurance company though the perpetrator of the losses was AIG Financial Products, a hybrid financial services company with no regulatory restrictions, and unfortunately no apparent expertise in their own area of business. Something of a perfect storm you might say. The fox thought it was raiding the chicken coop only to find it occupied by raptors. Financial regulations would have required it to wear a better set of glasses.
Financial regulations would have required it to wear a better set of glasses.
Be specific Jack.
I believe that if CDS had been regulated as an insurance product, it would have been necessary for AIGFP to operate more responsibly. The regulators were defanged by Congressional action to exclude CDS from regulatory oversight. I take this to be the import of Larry H’s 3rd paragraph.
No Sammy, you are the one promoting the thesis that regulation would have done no good. Given the financial debacle that did occur following less than a decade of deregulation it is incubent upon you to point out evidence to the contrary. That is, how is it that all of this financial dismanagement began to grow out of all reasonable proportion following the deregulation of the financial industry. You might want to contact Phil Gramm to ask him how the country and its financial system are now better off for all of his efforts. He’s far better off given the many millions of dollars that he has earned since playing a key role in the deregulation activities of 1999. From the Senate to Vice Chair of a global bank. Not bad for an economist with his head up his own ass.
AB has consistently carried posts on OCC, IRS, Thrift and other agency defunding,
Not a funding problem either. 1 X 0 = 0. 10 X 0 also = 0. It’s a matter of regulatory competence. It’s not that they were incompetent, it’s that they were not competent enough. In fact NO ONE was competent enough, public or private.
If we were to go back in time, what was needed was someone in a regulatory capacity to say, in 2003, “housing appears to be headed for a bubble, if it does go hyperbolic, the resulting crash will take down the financial system” and regulate accordingly. That would have been perfect. Alas, that did not happen, and it is wishful thinking to think it would. Maybe the best thing is to chalk it up, despite our best intentions, like space shuttle accidents and earthquakes, “sh*t happens.”
I believe that if CDS had been regulated as an insurance product, it would have been necessary for AIGFP to operate more responsibly.
Would reserves have helped? I considered this. First of all, the reserves would have to be based on some actuarial projection, and AIG considered the probability of loss to be virtually zero. So any reserving would be small. So they thought they were just renting their credit rating for a fee.
If some regulator came in and said you must set up a 50% loss reserve, that would have made the transactions less profitable on paper. The accountants might not sign off and tax man would be pissed, and AIG would have probably just looked at it as a deferred profit. The eventual losses blew away any conceivable loss reserve anyway.
What is amazing about the AIG story is that the underwriting didn’t undo them; they were undone by the collatoral requirements. Perhaps some regulator would not have allowed the contracts on that basis. That might have worked.
The UK was a much more stringently regulated banking market than the U.S. and also had significant problems. Canada is much more concentrated than the U.S., but had almost no problems. Both global swiss banks required government capital injections, as did Dutch insurance companies Aegon and ING. Gramm-Leach-Bailey went into effect in 1999, but LTCM bailout was 1998.
There is innovation in financial services (subject to debate whether it’s always/sometimes/never positive), and the innovation of CDS had nothing to do with deregulation. AIGFP was started in 1987, well before the decade of deregulation you cite.
I haven’t seen a strong link between deregulation and the real estate bubble. There hasn’t been a national house price decline since the Depression, but originate to securitize could have been done prior to GLB, and in fact was, as Countrywide was founded in 1969 and was hugely successful prior to GLB.