Fed Chairman: A.I.G. Was Essentially Running An Irresponsible Hedge Fund

Fed Chairman Ben Bernanke told the Senate Budget Committee he was “angry” at A.I.G. for exploiting a loophole in the regulatory system in order to run what was essentially a hedge fund tied to an insurance company.

The New York Times says:

“A.I.G. exploited a huge gap in the regulatory system,” Mr. Bernanke said. “There was no oversight of the financial products division. This was a hedge fund, basically, that was attached to a large and stable insurance company.” And this quasi-hedge fund, Mr. Bernanke went on, to nobody’s surprise, made irresponsible bets and took huge losses.

“We had no choice but to try to stabilize the system because of the implications that the failure would have had for the broad economic system,” Mr. Bernanke said.

Fed Chief Says Insurance Giant Acted Irresponsibly [NYT]

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  1. dawime says:

    So let it fail now – why throw more money after bad money

    • Herbz says:

      @dawime: Because throwing money at it always corrects the problem, am I right?

    • Coles_Law says:

      @dawime: The problem is letting AIG fail would bring down a lot of companies with it. Look at it this way-suppose Mexico built a nuclear power plant three miles south of the Texas border, and through negligence, the place was on the brink of meltdown. Mexico then turns to us for money to repair the plant and make it safe again. We could easily say they were irresponsible, reckless, and shouldn’t be bailed out-and we’d be right. We’d also have a lot of dead people and contaminated land when the thing blew.
      Sadly, AIG hit a threshold of irresponsibility where we need to save them to save us.

      • t-r0y says:

        @Coles_Law: We wouldn’t need to “repair the plant”, we need to implement a controlled shutdown.

        • Coles_Law says:

          @t-r0y: @QuantumRiff: I agree fully-once the economy recovers, I want to see AIG diced into a bunch of tiny mini-companies, each lacking the financial power to buy a gumball, let alone pull something like this again. We should force the guys at the top to resign/be held liable, and the fact that we have not baffles me. However, we’re still in crisis mode with respect to them,and as distasteful as it is, the loans are necessary to stabilize them until the market recovers-then we can draw blood.

          • stevejust says:

            @Coles_Law: Ah yes, but you all are missing the reason why these companies got “too big to fail” in the first place.

            It is inevitable and inexorable under fractional reserve banking and capitalism. Watch Money as Debt again for a refresher course. The part you need to pay particular attention to comes up about mid way through:

            [video.google.com]

            • Trai_Dep says:

              @stevejust: Remember all those Progressive/Consumer Advocate types saying the Justice Dep’t’s Anti-Trust division had to use stricter scrutiny? And that Glass/Seagal needed to be kept? Remember the Right Wing Wind Machine and Phil Gramm saying, “Free Markets Regulate Themselves, Pinko! Suck down this veto-proof bill, America-haters”.
              Chuckle.
              Boy those were the days.

              The thing is, sensible regulation and – so long as we have our foot over the throat of the finance/insurance sector – forced splitting of them into more manageable, small-enough-to-fail would solve many of the problems, while letting both Capitalism and consumers to thrive. Kick down the leveraging to single-digit multiples and ban “shadow banking systems” and you’ve got a home run.

              • stevejust says:

                @Trai_Dep: Wait… I have a serious question for you. Was the Glass-Segal Act repeal really veto-proof

                ‘Cause you know, Clinton’s gotten a share of blame in the MSM (and of course, especially Fox News) for signing the repeal. And I always say, “jumpin’ jesus on a pogo stick, don’t you remember the economic climate then? It’s not like Clinton didn’t have his hands tied!”

                But I don’t remember the repeal being veto proof. That’s a good factoid to have handy, since I think we’re going to see the return of Newt in four years running for president.

                • Trai_Dep says:

                  @stevejust: Here’s the cite. And yes, veto-proof majorities forced Clinton’s hand, or at least would have made it a moot point.

                  A TON of lobbyist money went into slaying Glass-Steagall, so there was a fair amount of cross-over, but what resistance there was to the Gramm-Leach-Bliley Act (for those counting, that’s Republican, Republican and, you guessed it, Republican) was largely from the Democrats.

                  Of course, crediting (cough) by party isn’t accurate. As I’ve often stated, this failure is one of ideology, that of the Free Market Fundamentalists. They had their run, they set policy largely as they liked and we’re witnessing the results. And will for decades.

                  Everything else is largely designed to muddy things up. While destroying a generation is a remarkable achievement, strangely, they don’t seem too eager to stand tall and take credit for it. (shrug)

            • t-r0y says:

              @stevejust:

              It is inevitable and inexorable under fractional reserve banking and capitalism.

              Fractional Reserve Banking in an anathema to Capitalism. FRB creates money (capital) from nothing, capitalism is all about REAL production!

              Watch Money as Debt again for a refresher course.

              Excellent video!

              • Excited_Utterance says:

                @t-r0y: That’s not true, capitalism is precisely about making money out of nothing. It’s about adding value to REAL production (hence how one “capitalizes” on production). Y’know, surplus, profit, all that stuff.

                • t-r0y says:

                  @Excited_Utterance: But it doesn’t make money out of nothing, it makes money out of work effort. It takes little or no effort to print $$, but to produce something, it takes effort.

                  Money, like the U.S. dollar, is just a form of stored capital … the result of work effort. When the government can just print it without effort they are counterfeiting true stored capital.

          • bohemian says:

            @Coles_Law: We did this for the phone company. We need to absolutely put some restrictions that limit these “too big to fail” companies.

      • QuantumRiff says:

        @Coles_Law: You are exactly right, however, in your example, after the short term crisis is fixed, shit would hit the fan. People would go to jail, Sanctions against Mexico, forcing them to disassemble the plant, etc. All under the idea of making it obvious that NOBODY EVER WANTS TO DO SOMETHING THIS STUPID AGAIN.

        Yet with AIG, we keep the same guys in charge, and let them make all the same decisions. Why the hell haven’t we forced most of the people at the top to resign. Why haven’t we forced them to sell off entire divisions at a HUGE loss to teach them a lesson. Why not break them up, call them a monopoly. If they are too big to fail, we should make sure that after the mess, nobody is too big to fail again. Companies get all the upside (they make lots of money in good times, bonuses, new yachts, etc) and none of the downside, (we cushion it for them).

        • bohemian says:

          @QuantumRiff: The government needs to appoint an administrator to go in and run AIG to do the controlled shutdown analogy t-r0y mentions.

          If they are too big to fail and it has become obvious that they were just running a high risk game disguised behind an insurance company it has to stop now. What I don’t understand fully is what the horrible damage would be to all these people and businesses that used AIG. Or is this an issue of a big bunch of shareholders that will lose money if the stock becomes worthless? At some point we need to just try to conduct some sort of soft landing and quit trying to fix it.

  2. shoelace414 says:

    So who going to jail for this?

  3. Rippleeffect says:

    So why are we trying to save this company?

    • Veeber says:

      @Rippleeffect: Because we are hoping (cross our fingers and pray) that if we can keep them solvent for a little while longer, their obligations will lapse. If they go down, the money they owe other institutions will push other banks closer to the edge, making the problem that much worse.

      The general hope is that the “insurance” terms on many of the CDS will expire over the next few years.

    • everfade says:

      @Rippleeffect: Because, that’s why.

    • Tmoney02 says:

      @Rippleeffect: Well there is this quote from the story/Bernanke

      “‘We had no choice but to try to stabilize the system because of the implications that the failure would have had for the broad economic system,’ Mr. Bernanke said.”

    • lancepeeples says:

      @Rippleeffect:

      Or the question being posed might be, “Why is only the US trying to save this company when AIG operates in dozens of countries?”

      • Trai_Dep says:

        @Lance Peeples: Probably because other countries would look at which country AIG operated under, whose governance allowed it to flame out so spectacularly, then say, “You jerks broke it, you jerks buy it”.

  4. valen says:

    This is a prime example of why the “Too Big To Fail” doctrine is doomed to failure. The exploitability via Moral Hazard is too great.

    • Tmoney02 says:

      @valen: Yep after things are stablized any company that was said to be “to big to fail” need to be broken up or at the very least be forced to maintain some sort of bankruptcy fund. For example require that 10% (just throwing a number out there) of all profits be set aside and untouchable except in the case of bankruptcy.

    • Coles_Law says:

      @valen: Too bad the “Too big to Fail” doctrine wasn’t too big to fail.

    • Eyebrows McGee (now with double the baby!) says:

      @valen: Too bad moral hazard doesn’t work the way people think it should.

  5. bearymore says:

    Louis Brandeis condemned this kind of combination as early as 1913. Organizations just like AIG were tolerated during the 1920′s and in part led to the Great Depression. Glass Steagall was passed to outlaw such protean organizations and prevent future outbreaks of financial meltdown.

    Thanks to Phil Gramm and his fellow free-marketeers, including Bob Rubin and Larry Summers, Glass Steagall and a host of other banking regulations were repealed with the predictable results we are experiencing now.

    Don’t we ever learn?

    • econobiker says:

      @bearymore: Glass Steagall and a host of other banking regulations were repealed.

      But that was supposed to drive value into the market.

    • MooseOfReason says:

      @bearymore: Please read this Newsweek interview with Bill Clinton. Here’s a snippet of what he said:

      “No, because it wasn’t a complete deregulation at all. We still have heavy regulations and insurance on bank deposits, requirements on banks for capital and for disclosure. I thought at the time that it might lead to more stable investments and a reduced pressure on Wall Street to produce quarterly profits that were always bigger than the previous quarter. But I have really thought about this a lot. I don’t see that signing that bill had anything to do with the current crisis. Indeed, one of the things that has helped stabilize the current situation as much as it has is the purchase of Merrill Lynch (MER) by Bank of America (BAC), which was much smoother than it would have been if I hadn’t signed that bill.”

      [www.businessweek.com]

      Also, read this Reason article that attempts to debunk the “deregulation myth”.
      [www.reason.com]

  6. Snarkysnake says:

    AIG – Too big to fail,too big to save.

    Many journalists,investors and regulators DID see the train wreck coming. They screamed about the dangers for years (Especially about the overextended consumers using their hearth and home as a checkbook). The problem was/is that when the greedy,short sighted companies that perpetuate this bullshit are in danger of being found out,they purchase a little protection from their allies in congress and the administration (Barney Frank, Chris Dodd, GWB, Phil Gramm etc) and the problem gets so big that the only answer is making the taxpayer liable.When stuff like this hits the fan, it’s never the fault of just one party. It’s too damn big for that.

  7. minsky says:

    And we keep giving them billions!

    Let ‘em friggin’ die!

  8. razremytuxbuddy says:

    I really hate the use of the word “hedge fund” for the type of activity this AIG unit was engaged in. It’s not hedging when you’ve literally bet the company.

  9. Subsound says:

    What you have to do is take the people who exploited the loophole and put a bullet in their brain. Explain anyone who does it again will suffer the same fate. Instantly all faith is restored in the economy and effectiveness of the government, and consumer confidence stops going down.

    • craptastico says:

      @Subsound: that’s what they do in China. when we started hearing about tainted Chinese products the guy in charge of their FDA-equivilent was sentenced to death. he was sentenced for taking $650k in bribes. I’m not saying it’s right or wrong, but it is refreshing to see accountability, albeit extreme. that might be too much, but it’d be nice if the government could at least seize all of their property.

    • runswithscissors says:

      @Subsound:

      What you have to do is take the people who exploited the loophole and put millions of dollars in bonuses in their offshored, tax-dodging bank accounts.
      Fixed for reality.

  10. Borax-Johnson says:

    I watched Bernanke’s testimony this morning. Something about his personal demeanor was different. At first I couldn’t quite put my finger on it and then it hit me. The guy seemed out of his depth. He was having a hard time giving a straight answer (no, not like Alan Greenspan who could talk for 45 minutes and not say anything). He simply couldn’t find the words necessary.

    An add in out now MIA treasury secretary who is good for a 3-5% drop in the Dow every time he speaks publicly.

    I am beginning to think that the answer isn’t ‘throw as much money as fast as you can at it’. The Wall Street Journal had a very good editorial on that this morning.

    Don’t bankrupt us to subsidize the moral hazard.

    Let them fail.

    Pick up the pieces.

    Move forward.

  11. ironchef says:

    laissez faire LMAO.

    Just goes to show business can’t regulate itself.

    • MooseOfReason says:

      @ironchef: We haven’t had a free market economy. I don’t know where you get your information.

      Irresponsible companies should be allowed to fail. Bailing them out with hundreds of billions of taxpayer dollars is not ‘laissez faire’.

  12. Corbin123 says:

    “A.I.G. exploited a huge gap in the regulatory system,”

    I think we may have found the bigger problem…

    • econobiker says:

      @Corbin123: Only doing what they did all the time. Reference A.I.G. and their syntheic coal business to get tax credits.

      “Financial Products’ drive to keep ahead of its competitors led Cassano and his Transaction Development Group to coal. At first, it seemed like an odd turn, but it played to the company’s strength – discovering gaps in regulations and markets and exploiting them.”

      [www.tennessean.com]

  13. econobiker says:

    This kind of makes GM/Chrysler/Ford seem like winners…

  14. sleze69 says:

    Someone explain to me again why I am paying mortgage insurance?

  15. du2vye says:

    Watching the news around here and they are still blaming “people who were living beyond their means” and “this is all the consumers’ fault” ….

    No one is going to learn a thing until these guys are busted – meaning on the same level as you and I would be. Letting them get away with it is the crime.

    If we didn’t “bail them out”, then the US would have to nationalize them – which might not be so bad right now.

    Either way, there’s no point in investigations if they aren’t going to follow through and do what they’d do for everyone else. Support them or send them to jail. If not, just wait … they’ll be back with bigger and better schemes to fly under the wire.

  16. ageshin says:

    The people who are running AIG are not business men they are part of a mafia designed to fleece the public. They should be in prison, and their companies nationalized, straightened out, and then sold to real business men. I include in this the scum who helped to remove the regulations that protect us all.

  17. TEW says:

    As a free market capitalist type of person the regulators had dropped the ball big time. The regulators like the SEC should either have known what was going on and did not mind as long as it was all going up or they were so clueless they should all be fired. The only way the confidence will be in the market is if the SEC will keep the playing field legal. They should have never allowed AIG to have this hedge fund side with the insurance based company. There are laws regarding this but they were not enforced.

    • highpitch_83 says:

      @TEW: so what is the penalty for breaking those laws? No time like the present to start locking people up! Let these CEO’s stimulate the economy through their lawyers and then rot in jail…