What Have We Learned From AIG’s Downfall?

aig.jpgThe federal government agreed today to provide an additional $30 billion in assistance to the thrice-bailed out American International Group (AIG), on the same day that the company announced “it lost $61.7 billion in the [2008] fourth quarter, the biggest quarterly loss in U.S. corporate history”:

The government intervention would be the fourth time that the United States has had to step in to help A.I.G., the giant insurer, avert bankruptcy. The government already owns nearly 80 percent of the insurer’s holding company as a result of the earlier interventions, which included a $60 billion loan, a $40 billion purchase of preferred shares and $50 billion to soak up the company’s toxic assets.

The $30 billion is not going to be used by AIG right away, but is meant to appease credit agencies that were “preparing to sharply downgrade A.I.G.’s credit ratings on Monday because of the record quarterly loss.” A downgrade would have forced AIG to default on its debt, sending a shock through the financial system. As the Treasury Department noted today, AIG holds insurance policies for “more than 100,000 entities…who together employ over 100 million Americans,” and it would be catastrophic for a company that entangled to collapse into dust.

That said, what have we learned from the AIG debacle? AIG’s downfall was hastened by its inability to honor $40 billion in credit default swaps (CDS), after taking advantage of a CDS market that went “from zero” in 2005 to a peak of $62 trillion. So maybe the place to begin is by figuring out which regulator should watch CDS. No less a culprit of the economic crisis than former SEC Chairman Christopher Cox acknowledged as much when testifying before Congress:

The $58 trillion national market in credit default swaps — double the amount outstanding in 2006 — is regulated by no one. Neither the SEC nor any regulator has authority over the CDS market, even to require minimal disclosure to the market…As the Congress considers fundamental reform of the financial system, I urge you to provide in statute the authority to regulate these products to enhance investor protection and ensure the operation of fair and orderly markets.

Another step to take in sorting out who regulates what is getting regulation of financial derivatives — instruments used to mitigate economic risks — out of the hands of the Commodity Futures Trading Commission (CFTC). As we noted last week, regulatory reform may be most effective if focused on some of the smaller agencies, and the CFTC is a prime example.

The CFTC was meant to regulate trading in the agricultural sector, not trading of debt instruments derived on Wall St. Giving those who police the rest of the financial sector oversight of derivatives — instead of spreading the responsibility around — as well as placing CDS under someone’s supervision would be a positive response to AIG’s implosion.


The SEC’s Elisse Walter said today that the SEC and CFTC should be merged and given authority over derivatives:

Congress should merge the two agencies because their jurisdictions have grown “increasingly indistinguishable,” Walter, a Democrat, said today during a speech at a banking conference in Washington.

Share Update