NU Online News Service, April 13, 2:08 p.m.EDT

Federal Reserve Board Chairman Ben Bernanke characterizedAmerican International Group as part of a “shadow banking” systemthat played a key role in the catastrophic economic downturn of2007-2009.

Bernanke says AIG's problems in the fall of 2008 “exposedweaknesses in the statutory and regulatory framework” for theshadow-banking sector, and “meant that in practice they wereinadequately regulated and supervised.”

He put AIG in the same category as Bear Stearns and LehmanBrothers, both of which had severe financial problems, and saidtheir problems “severely damaged the financial system.”

Bernanke made his comments at a conference on “RethinkingFinance” sponsored by the Russell Sage Foundation and The CenturyFoundation.

He says the “insurance operations of AIG were supervised andregulated by various state and international insurance regulators,and the Office of Thrift Supervision had authority to supervise AIGas a thrift holding company.”

However, he adds that “oversight of AIG Financial Products,which housed the derivatives activities that imposed major losseson the firm, was extremely limited in practice.”

Gaps in the Fed's statutory authority to oversee companies inthe shadow-banking sector “had the additional effect of limitingthe information available to regulators and, consequently, may havemade it more difficult to recognize the underlying vulnerabilitiesand complex linkages in the overall financial system,” Bernankecontends.

The Fed was barred by a provision of the Gramm-Leach-Bliley Actof 1999 from overseeing insurance-holding companies.

Bernanke says shadow-banking institutions that were unregulatedor lightly regulated “were typically not required to report datathat would have adequately revealed their risk positions orpractices.”

He also says the shadow-banking system played a far greater rolethan the subprime-housing market in making the 2007-2009 economiccrisis more serious than the “dot-com” bust in 2000.

Bernanke argues that “…any theory of the crisis that ties itsmagnitude to the size of the housing bust must also explain why thefall of dot-com stock prices just a few years earlier, whichdestroyed as much or more paper wealth—more than $8trillion—resulted in a relatively short and mild recession and nomajor financial instability.”

He adds, “Once again, the explanation of the differences betweenthe two episodes must be that the problems in housing and mortgagemarkets interacted with deeper vulnerabilities in the financialsystem in ways that the dot-com bust did not,” Bernanke said.