Question: Why weren't state insurance regulators more aggressive in regulating AIG?
Answer: Because the federal government had forced them to back off. An aggressive interpretation of the definition of insurance could have let state insurance agencies regulate the derivatives contracts that AIG's financial-products group was writing out of London. These were, in fact, insurance policies that guaranteed the companies taking them out (banks, other insurance companies, investment banks and the like) against losses on securities in their portfolios.
But Congress had made it very clear in the Commodity Futures Modernization Act -- supported by then-Federal Reserve Chairman Alan Greenspan, steered through Congress by then-Sen. Phil Gramm, R-Texas, and signed into law by President Bill Clinton in December 2000 -- that most over-the-counter derivatives contracts were outside the regulatory purview of all federal agencies, even the Commodity Futures Trading Commission.
With the new law on the books, the market for credit default swaps exploded from $632 billion outstanding in the first half of 2001, according to the International Swaps and Derivatives Association, to $62 trillion in the second half of 2007.
Question: Wasn't anybody worried about the risk to the financial system posed by a market that dwarfed the assets of the sellers of this insurance?
Answer: Worry about leverage? You've got to be kidding.
In 2004, the Securities and Exchange Commission, after hard lobbying by Wall Street, reversed its 1975 rule limiting investment banks to leverage of 15-to-1. The new limit could be as high as 40-to-1 if the investment banks' own computer models said it was safe.
Question: Why wasn't Wall Street more nervous about the rising tide of leverage and the risk it posed?
Answer: Ah, come on. You know why: The new business model was incredibly profitable. In 1999, AIG's financial-products group had revenue of $737 million, Morgenson reported in the Times. That had climbed to $3.26 billion by 2005. And almost all of that was profit: Operating income was 83% of revenue in 2005. The biggest expense, by far, was compensation. Salaries and bonuses ranged, depending on how good a year the unit had, from 33% to 46%.
Question: Why didn't Washington step to at least temper the risk?
Answer: Money. Just look at the who's who of senators receiving campaign contributions from AIG. According to Federal Election Commission data at the Center for Responsive Politics, Sen. Max Baucus, D-Mont., has received more money from AIG -- $91,000 -- than from any other contributing company. Baucus chairs the Senate Finance Committee. Dodd, the head of the Senate Banking Committee, has received $280,000 from AIG. (In the 2003-08 election cycles, AIG was only the fourth-largest contributor to Dodd;ranked No. 1.) And Dodd now admits he's the one who wrote the loophole that allowed AIG to award $165 million in bonuses to its financial-products group. (In his defense, Dodd says he inserted the language at the request of the Obama administration.)
AIG doesn't show up among the top 10 contributors to Shelby, but the ranking Republican on the Banking Committee does count Citigroup (at No. 1) and(at No. 3) among his top donors. Twenty-eight current members of Congress own stock in AIG. Sen. John Kerry, D-Mass., is the biggest investor, with stock valued at $2 million (it was valued at $2 million at the time he filed his lastest financial reports, anyway).
Congress has delivered a lot of other goodies in the past decade or so that have contributed to this crisis -- and made the cleanup more expensive and painful. For example, the Office of the Comptroller of the Currency and the Office of Thrift Supervision both moved to block states from enforcing their consumer-protection laws against any nationally chartered bank.
Among the measures states were prohibited from enforcing were rules against predatory lending. Not that the federal government stepped in for the states: The Federal Reserve took all of three formal actions against subprime lenders from 2002 to 2007, and the Office of the Comptroller, with authority over 1,800 banks, took only three enforcement actions from 2004 to 2006, according to Multinational Monitor.
But you get the idea by this point.
The next round of lootingWhat should worry you now -- if you can spare a neuron or two from worrying about the economy, your job, your retirement savings, your mortgage and the meltdown of the global financial system -- is that the looters aren't in retreat. If anything, they're getting more brazen. For example, in the early days of the AIG crisis, denied it had any "material" exposure to AIG's troubles. It wasn't until months after then-Treasury Secretary Henry Paulson, a former CEO of Goldman Sachs, organized a bailout of AIG that taxpayers found out the biggest recipient of taxpayer money, pocketing $12.9 billion of the $170 billion bailout, was -- ta-da! -- Goldman Sachs.
The next round of looting is likely to come in the name of reform. Already, Shelby has called for federal regulation of the insurance industry. For years, the industry itself has been arguing for this, seeking to replace all those pesky state agencies and their differing rules with one federal standard. That's great if the federal standards are tougher than the toughest state standards and the federal regulators are tougher than the best state regulators.
On recent evidence, I'm not counting on that. Are you?
I'm just as skeptical about calls to give the Federal Reserve more power, turning it into a superregulator for the financial system. More power to the same Fed that could find only three examples of predatory lending, that fought against regulating derivatives and that did nothing as risk piled up at the nation's banks?
I think reform -- stem-to-stern reform -- is an absolute necessity. But I think almost all the existing regulatory bodies have been captured by the industries they are called upon to regulate. Tear them all down, I say, and begin from scratch. Within 20 years, we'll be facing the same problem of regulators captured by their regulated industries, but, as Huey Long said about his plan to redistribute the country's wealth, what a time we'll have had.
In my next column, I'll take a look at why we can expect this same kind of crisis every 10 years or so unless we fix the system.