House Panel Grills Witnesses Over Aid To AIG

PAULSON

Paulson says the Treasury Department took the actions it took because the failure of AIG would have had "disastrous consequences."

"Although the road to complete recovery is slow and unemployment is still high, had AIG failed I believe we would have seen a complete collapse of our financial system, and unemployment easily could have risen to the 25% level reached in the Great Depression," Paulson says.

"The rescue of AIG was necessary, and I believe that we in government who acted to rescue it–including [Treasury] Secretary Timothy Geithner, Federal Reserve Chairman Ben Bernanke, and me–acted properly and in the best interests of our country," Paulson says.

AIG had to be rescued because it was "incredibly large and interconnected," it was "serious under-regulated," and "it could not have been effectively wound down," Paulson says.

AIG had a $1 trillion balance sheet; a massive derivatives business that connected it to hundreds of financial institutions, businesses, and governments; tens of millions of life insurance customers; and tens of billions of dollars of contracts guaranteeing the retirement savings of individuals, Paulson says.

"If AIG collapsed, it would have buckled our financial system and wrought economic havoc on the lives of millions of our citizens," Paulson says.

A second reason that the federal government had to step in was that AIG was not effectively regulated, Paulson says.

"Although, many of AIG's subsidiaries–including its insurance companies–were subject to varying levels of regulation, the parent entity was, for all practical purposes, an unregulated holding company," Paulson says.

Consequently, "it was not until AIG started to fail, that regulators began to understand how badly managed it had been and how much the toxic aspects of parts of its business had infected otherwise healthy parts," Paulson says.

A third reason that the government had to act was that "there was–and is–no resolution authority available to wind down a failing institution like AIG," Paulson says.

If AIG had been a bank, the Federal Deposit Insurance Corp. could have taken it over, and, if AIG had been a government-sponsored enterprise, the Treasury Department and the Federal Housing Finance Agency could have placed it into conservatorship, Paulson says.

Today, to wind down problems at AIG as a whole, "the only option is bankruptcy, a process that is simply not capable of protecting the millions of Americans whose finances are intertwined with AIG's," Paulson says.

"I do not mean to say that I am happy that we needed to intervene, noting that taxpayer money should not have to be spent to save a mismanaged and misguided enterprise," but "the fundamental problem lies not in how we intervened, but in why we needed to intervene," Paulson says.

Paulson says the United States needs to modernize our regulatory structure by creating a systemic risk regulator and resolution authority so any large firm that fails can be liquidated without de-stabilizing the system.

"Large financial enterprises in this country will always play a role that is essential to our economic growth, but they must only be permitted to grow and interconnect throughout our economy under careful oversight and with a mechanism for allowing those connections to be broken safely," Paulson says.

GEITHNER

Geithner says the Federal Reserve Board took the actions it took to help AIG because it was "the only fire station in town."

It is "important to remember that the Federal Reserve, under the law, had no role in supervising or regulating AIG, investment banks, or a range of other institutions that were at the leading edge of crisis," Geithner says in the written version of his testimony.

But Congress gave the Federal Reserve System the authority to provide liquidity to the financial system in times of severe stress, Geithner says.

"Imprudent risk-taking in better times" at AIG "meant that, when the financial cycle turned, AIG had hundreds of billions of dollars in commitments without the capital and liquid assets to back them up," Geithner says.

That "excessive risk-taking should not have been allowed," Geithner says. "But it was…. Despite regulators in 20 different states being responsible for the primary regulation and supervision of AIG's U.S. insurance subsidiaries, despite AIG's foreign insurance activities being regulated by more than 130 foreign governments, and despite AIG's holding company being subject to supervision by the Office of Thrift Supervision, no one was adequately aware of what was really going on at AIG."

Geithner is defending the decisions of the New York Fed, the Federal Reserve Board and the U.S. Treasury.

The steps the government took to rescue AIG "were motivated solely by what we believed to be in the best interests of the American people," Geithner says. "We did not act because AIG asked for assistance. We did not act to protect the financial interests of individual institutions. We did not act to help foreign banks. We acted because the consequences of AIG failing at that time, in those circumstances, would have been catastrophic for our economy and for American families and businesses."

FEDERAL RESERVE BOARD CHAIRMAN BEN BERNANKE

Rep. Darrell Issa, R-Calif., the highest-ranking Republican on the House Oversight Committee, has asked why the Fed took the actions it took in connection with helping AIG, paying AIG counterparties and shaping AIG disclosures of bailout efforts.

In a written response, Bernanke says the Fed decided to pay off AIG credit default swaps at par to stabilize AIG, not to help the trading partners.

"The overriding motivating factor in structuring the payments to the counterparties was to relieve AIG of the destabilizing drains on its liquidity caused by the requirement to continue to post collateral as required by the [credit default swaps] contracts," Bernanke says. "All counterparties were treated the same for payment purposes. Whether the individual counterparties were in relatively sound financial condition or not was not a factor in the decision regarding the amount paid to the counterparties or whether concessions should be sought from them."

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For later coverage of this hearing, please read AIG Witnesses: We Had No Time To Get Haircuts.

For earlier coverage of this hearing and the issues surrounding the hearing, please read Special Inspector General To Describe New York Fed Investigations and House Republicans Blast AIG Bailout Disclosures.