What Have We Learned From AIG’s Downfall?
What Have We Learned From AIG’s Downfall?
The 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.
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.
3 Responses to “What Have We Learned From AIG’s Downfall?”
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I’ve learned that when you try to talk to people about inaccurate actuarial estimations of risk from, for example, stronger storms, more frequent floods, and a not-always-increasing-after-all housing market, they will tell you, “you would think that, but it was actually a problem with leverage,” as if the underlying risk wasn’t the basis for poor estimates of the bases of leveraged instruments.
March 2nd, 2009 at 5:33 pmThe CDS market was at “zero” in 2005? What are you smoking? There were $12.5 trillion in CDS outstanding at the beginning of 2005, and $17 trillion in the second half of 2005. CDS became everyday financial instruments on Wall Street in 2001, and they exploded after they helped JPM and MS avoid the fallout from the Enron debacle (thus “proving” that they worked as advertised). Data on the size of the CDS market have always been public; why can’t journalists just look at the data?
March 2nd, 2009 at 5:59 pmNick:
I wasn’t trying to claim that there were no CDS in 2005, just that, for purposes of causing real market risk, the rocket ride for CDS was between ‘05-’07. Looking back though, I definitely did not make that clear. Thanks for calling me on it!
March 2nd, 2009 at 6:59 pm