U.S. regulators failed to spot how much risk insurer AIG was piling on, and by the time they understood, they had no choice but to pour in tens of billions of taxpayer dollars, officials said on Thursday.
The fact that a multitude of regulators of American International Group Inc
Where OTS fell short, as did others, was in the failure to recognize in time the extent of the liquidity risk to AIG of certain credit default swaps held in the portfolio of the company's financial products division.
That unit, although a small part of the global insurance giant's worldwide operations, racked up such heavy losses that it threatened the entire company's survival, eventually forcing the Treasury Department and Federal Reserve to launch a series of costly bailouts.
Under a revised bailout deal announced on Monday, the amount of funds committed to help AIG increased to about $180 billion, although the insurer has not tapped it all and plans to pay back roughly $38 billion soon. The U.S. government holds about an 80 percent stake in the insurer.
AIG sold insurance-like protection, known as credit default swaps, against declines in the value of securities -- including subprime mortgages that began defaulting at an alarming rate when the housing market tumbled.
Fed Chairman Ben Bernanke said earlier this week that the unit operated like an unregulated hedge fund, and he expressed anger that its risky behavior put taxpayers on the hook.
AIG's troubles forced the Fed to make decisions that were particularly difficult and discomforting because they involved addressing systemic problems created largely by the poor decision-making by the company itself, Donald Kohn, the Fed's vice chairman, said at the hearing.
Our judgment has been and continues to be that, in this time of severe market and economic stress, the failure of AIG would impose unnecessary and burdensome losses on many individuals, households and businesses, disrupt financial markets, and greatly increase fear and uncertainty about the viability of our financial institutions, he said.
OTS's Polakoff detailed the agency's interaction with AIG going back to 1999, but despite that OTS still failed to understand that the insurer's finances could be devastated by the activities of the financial products division.
No one predicted, including OTS, the amount of funds that would be required to meet collateral calls and cash demands on the credit default swap transactions, he said.
In retrospect, if regulators had recognized that risk, they could have told AIG to reduce its exposure, he said.
New York Insurance Superintendent Eric Dinallo, whose agency oversees AIG's insurance business but was not the primary regulator of the financial products arm, said that unit had written some $440 billion in credit default swaps and should have been subject to more and better regulation.
Polakoff said a key lesson learned from AIG was that the United States needed a systemic risk regulator that would have responsibility for monitoring companies that are so large or so interconnected that their failure would pose a risk to the country's financial stability.
(Additional reporting by Mark Felsenthal; Writing by Emily Kaiser; Editing by Kenneth Barry)