Bernanke Says Insurer AIG Operated Like a Hedge Fund

Date: Wednesday, March 4, 2009
Author: Craig Torres and Hugh Son, Bloomberg

Federal Reserve Chairman Ben S. Bernanke said American International Group Inc. operated like a hedge fund and having to rescue the insurer made him “more angry” than any other episode during the financial crisis.

“If there is a single episode in this entire 18 months that has made me more angry, I can’t think of one other than AIG,” Bernanke told lawmakers today. “AIG exploited a huge gap in the regulatory system, 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.”

Bernanke’s comments foreshadow tougher oversight of systemically important financial firms, and come as President Barack Obama seeks legislative proposals within weeks for a regulatory overhaul. The U.S. government has had to deepen its commitment to prevent AIG’s collapse three times since September as the company accumulated the worst losses of any U.S. company.

The company “made huge numbers of irresponsible bets, took huge losses, there was no regulatory oversight because there was a gap in the system,” Bernanke said. At the same time, officials “had no choice but to try and stabilize the system” by aiding the firm.

AIG is getting as much as $30 billion in new government capital and relaxed terms on its bailout announced yesterday.

In another sign of tighter regulation to come, Bernanke said supervisors should have authority to bar new financial products that may be destabilizing to markets.

Bernanke made the AIG comments in response to a question from Senator Ron Wyden, an Oregon Democrat, at a Senate Budget Committee hearing today in Washington.

‘Adult Supervision’

“AIG is a huge, complex, global insurance company attached to a very complicated investment bank, hedge fund that was allowed to build up without any adult supervision,” U.S. Treasury Secretary Timothy Geithner said today during testimony to the House Ways and Means Committee. Because of “the risks AIG poses to the economy,” he said, “the most effective thing to do is to make sure the firm can be restructured over time.”

In his testimony, the Fed chief said that policy makers may need to expand aid to the banking system beyond the $700 billion already approved, and take other aggressive measures even at the cost of soaring fiscal deficits.

“Without a reasonable degree of financial stability, a sustainable recovery will not occur,” Bernanke said. “Although progress has been made on the financial front since last fall, more needs to be done.”

The Obama administration last week unveiled a budget blueprint that included standby authority for as much as $750 billion in new aid to the financial industry.

Bank Tests

Whether those funds will be needed “depends on the results of the current supervisory assessment of banks” and the evolution of the economy, Bernanke said today.

He also said that while Obama’s $787 billion fiscal stimulus should boost the economy over the next two years and alleviate the slide in payrolls, the size of the impact is “subject to considerable uncertainty.” Consumers may decide to pay down debt or save their cash rather than spend it, he noted.

U.S. policy makers face headwinds from equity markets, with the Standard and Poor’s 500 Index falling this year by 22.5 percent and the S&P Financials Index tumbling 44.2 percent.

The government is still trying to stabilize large financial institutions such as Citigroup Inc. and AIG. Shares of Citigroup traded at $1.25 at 12:19 p.m., and AIG was at $0.45.

New Credit

AIG’s fourth-quarter loss widened to $61.7 billion, the New York-based insurer said yesterday. The results brought its annual loss to almost $100 billion, prompting the U.S. to offer a package of equity, new credit and lower interest rates on existing loans designed to keep it in business and prevent a new shock to the world’s financial system.

The first rescue of the insurer came in September the day after officials couldn’t find a buyer for Lehman Brothers Holdings Inc., leaving the investment bank to file for bankruptcy. AIG also marked a turning point in the relationship between the U.S. Treasury and the Fed, with the central bank pushing then Treasury Secretary Henry Paulson to seek cash from Congress for additional bailouts.

“Whether we like it or not, America’s federal policy is now driven by the need to avoid another Lehman,” said David Kotok, chairman and chief investment officer of Cumberland Advisors Inc., in Vineland, New Jersey.

Bailout Package

The insurer’s first bailout package grew to $150 billion last year. After failing to sell enough subsidiaries to repay the government, the company had to turn to the government again. The company may need more support if financial markets don’t improve, the Treasury and Federal Reserve said in a joint statement yesterday.

Bernanke said the revised bailout gives taxpayers “the best chance” of eventually recovering “most or all of the investments” the public has.

Critics including former AIG Chief Executive Officer Maurice “Hank” Greenberg said the strategy of breaking apart the insurer and selling units wouldn’t reap enough to repay AIG loans.

Banks relied on AIG’s financial products unit to back about $298 billion of assets through derivative contracts at year-end, making the firm a “systemically significant failing institution” that has to be propped up, the Treasury said.

“We’re doing our absolute best in partnership with the Fed and Treasury to unwind the very issues that Chairman Bernanke is talking about in a way that preserves systemic stability and pays back taxpayers,” said Christina Pretto, an AIG spokeswoman.

AIG has reduced the number of bets made by the financial products unit that sold credit-default swaps by more than 25 percent since October and cut expenses by “ hundreds of millions” of dollars, she said.

To contact the reporters on this story: Craig Torres in Washington at ctorres3@bloomberg.netHugh Son in New York at hson1@bloomberg.net;