New York Insurance Superintendent Eric Dinallo was hit with withering criticism from the leadership of the U.S. Senate Banking Committee as he tried to defend the role of state regulators in overseeing American International Group.
Mr. Dinallo was placed under the congressional microscope as panel members sought to determine why the federal government has been forced to pony up $170 billion so far to stabilize AIG–and if the Treasury Department and the Federal Reserve Board know how much more will be needed to keep AIG afloat.
One lawmaker accused Mr. Dinallo of giving vague testimony and failing to properly monitor securities dealings by AIG's life units.
In his opening statement, Sen. Chris Dodd, D-Conn., chair of the committee, called the debacle at AIG "quite frankly, sickening," adding that "the lack of transparency and accountability in this process has been rather stunning."
Federal Reserve Vice Chair Donald Kohn defended the actions of the Fed and the Treasury in the four successive bailouts of AIG, arguing that "no one was minding the whole company and looking at how things interacted, and whether the whole company would, under some circumstances, put the financial system at risk."
The strongest comments came from Sen. Jim Bunning, R-Ky., who called AIG a "lost cause" and ridiculed regulators–especially the Treasury Department and Federal Reserve Board–for not knowing exactly how much it is going to cost to ultimately stabilize the company.
Mr. Kohn and Scott Polakoff, acting director of the Office of Thrift Supervision, were also criticized for their roles in regulating the company.
In acknowledging his agency's role in AIG's near collapse, Mr. Polakoff said that "where OTS fell short, as did others, was in the failure to recognize in time the extent of the liquidity risk to AIG" of certain credit default swaps held in the portfolio of the company's financial products division.
OTS oversaw the holding company, which was where AIG Financial Products operated, trading credit default swaps on collateralized debt obligations backed by subprime mortgages.
It was the need to provide counterparties with more cash as AIG's credit ratings fell that prompted the original U.S. government bailout last September.
Mr. Dinallo was criticized mainly because of AIG's securities lending program, which resulted in a $21 billion loss by the firm's life insurance subsidiaries in 2008. The Fed created a mechanism in December that took AIG off the hook for the securities lending program.
But Mr. Dinallo was resolute in defending state regulation. In his written testimony, he said AIG's problems did not stem from its state-regulated insurers.
"The primary source of the problem was AIG Financial Products, which had written credit default swaps, derivatives and futures with a notional amount of about $2.7 trillion, including about $440 billion of credit default swaps," he said.
He contended that the main reason why the federal government decided to rescue AIG was not because of its insurance companies. Rather, he said, the problems were caused by the systemic risk created by AIG's Financial Products unit, based in London.
"There was systemic risk because of Financial Products relationships and transactions with virtually every major commercial and investment bank, not only in the U.S., but around the world," he added.
"I would like to note that insurance companies were not the purchasers of AIG's toxic credit default swaps," he said.
He said the problems from the securities lending unit would not have required a federal bailout except for the problems created by the huge risk that AIG's Financial Products unit incurred by insuring more than $400 billion in credit default swaps issued by other major banks and brokerages.
He also argued that the liquidity needed to deal with the securities lending issue could have been raised if AIG was not under federal control and had not lost its top credit rating because of the problems created by the overall financial crisis of last fall, as well as the need to provide new funds to the counterparties of AIG Financial Products as its ratings and the value of residential mortgages declined.
At the same time, Mr. Dinallo acknowledged that, prior to late 2007, his insurance department had not "monitored" AIG's securities lending program through its life units "as good as it should have been."
But Sen. Richard Shelby, R-Ala., ranking minority member, criticized Mr. Dinallo's defense of state regulators–five of whom were involved in the securities lending program. "Your testimony is ambiguous," he said.
Sen. Shelby noted that "according to the National Association of Insurance Commissioners, a life insurance company may participate in securities lending only after it obtains the approval of its state insurance regulator."
"If so," he asked, "why did state regulators allow AIG to invest such a high percentage of the collateral from its securities lending program in longer-term mortgage-backed securities lending, since it involved life insurers regulated by at least five states?"
Mr. Kohn was criticized by panel members for the Fed's role in initially bailing out AIG, and also for not guaranteeing AIG's credit default swaps instead of using a huge part of the $170 billion the government has provided to reimburse the counterparties.
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